Spot vs Futures: Why are investors willing to spend more money to buy future commodities?

Have you ever wondered why the future prices of major commodities like oil and grain are often more expensive than their current prices? This is called contango, a signal in the futures market that can indicate a profit opportunity.

What is contango? Understand it with one picture.

The relationship between spot prices and futures prices determines market sentiment:

• contango: spot price < futures price (market bullish)
• Contango: Spot price > Futures price (market is bearish)

For example: Wheat is currently priced at 310 dollars per 5000 bushels, but the contract quote for three months later is 340 dollars. This upward price curve state is called contango, indicating that investors expect further increases.

Why is there contango? 4 core reasons

1. Inflation Expectations

• If investors believe that inflation will persist, they are willing to pay higher prices for future goods.
• Logic: The oil that costs 100 yuan now may be worth 120 yuan in 3 months due to inflation.

2. Supply Chain Risks

• Bad weather destroying farmland? Investors will rush to buy forward contracts.
• Conversely, a good harvest year will lead to a sharp drop in spot prices, creating contango.

3. Cost of Carry ← The most easily overlooked

• Storing oil costs money, buying insurance costs money, and preventing rust and moisture also costs money.
• Some companies would rather spend more money to buy futures contracts than buy spot now and bear storage costs.
• This is the main reason for the existence of contango.

4. Market Uncertainty

• Buyers tend to lock in future prices rather than betting on spot prices.
• VIX futures are a typical example: “I don't know what the stock market will be like in 6 months, so I will pay for insurance first.”

How to make money with contango?

Consumer Perspective

• Seeing oil prices in contango → Buy cheap tickets now to lock in costs
• Seeing the building materials in contango → Renovating now will be more expensive in the future

Investor Perspective (Futures Trading)

• If you think the market has overestimated future prices
• Sell the futures contract (for example, $90/barrel) → Wait until the expiration date to buy at a lower spot price ($85/barrel) → Earn a $5/barrel price difference

Commodity ETF Trap

• Most commodity ETFs do not hold physical assets, but rather roll over futures contracts.
• Contango Era Purchase: ETFs must buy new contracts at a higher price each time they roll over → Continuous losses → Shorting these ETFs can actually make money
• This is called “contango drag”

contango vs backwardation

Real Case: The Oil Price Storm of COVID-19

In 2020, when the pandemic broke out, a magical scene occurred:

• Demand plummets, flights are grounded, and the spot price of crude oil even falls to negative (suppliers are forced to pay buyers to clear their inventory)
• However, the futures contracts still report a positive price, and the price is relatively high.
• This is a typical contango: the market knows this is a short-term shock and believes that oil prices will rebound.

What impact does contango have on your investment portfolio?

Has little direct impact on stocks, but a significant indirect impact:

• Oil prices in contango → Airlines face less cost pressure → Positive outlook for airline stocks
• Oil prices in contango → Oil companies have profit margins → Energy stocks bullish
• Monitoring the contango of bulk commodities can optimize stock selection direction.

The greatest impact on commodity ETFs: The contango era will cause ETFs to underperform spot markets, which is an invisible cost.

Risk Warning

Contango is not permanent; market conditions can change rapidly. If you trade based on “persistent contango”, the probability of getting burned is very high. Remember: futures prices are merely predictions, not guarantees.