Cost to Carry -- Commodities are Worth More in the
However, the commodities markets and financial innovation cannot eliminate one
important situation, giving rise to a normal cost to carry or contango.
People want to eat every day, but farmers can't harvest crops every day.
Therefore, farmers and wholesalers must store produce or animals until the market is
ready to receive deliveries of it.
If a farmer is obligated to deliver 100,000 bushels of winter wheat right now, it's just a
matter of arranging transportation and arranging the transfer of money. The farmer is
selling it at the current price.
But if a farmer is obligated to deliver 100,000 bushels of winter wheat in four months,
but has it now, that winter wheat must sit in a grain silo somewhere. The farmer must
often pay a warehouse storage fee to the silo owner. And pay for insurance, and
whatever must be done to protect that wheat from rats, insects, mold and other hazards.
And interest on the money he has yet to receive.
Therefore, that winter wheat is worth more in five months than now, simply to repay the
costs of storing it for those five months.
If that winter wheat has to be stored for only one month instead of five, it can be
profitably sold for less money, because the farmer needs compensation for only one
month of storage costs, not five.
Therefore, if you plot the price of the winter wheat starting now with the spot price, and
extend it into the future, it will normally form a slow rising curve. That's referred to as
So long as the price goes up in the future, the commodity is in contango.
Sometimes, however, the curve actually goes backward, which means it's inverted. This
can happen when a commodity is scarce right now, making the spot price high. But more
of the commodity is expected to be available in the future.
For example, perhaps last year's harvest of winter wheat was extremely small due to
some disease. That makes it very scarce (and therefore expensive) now.
But in six months there'll