Backwardation occurs in commodity futures markets when the spot price of a commodity is higher than its futures prices.
This means that the price for immediate delivery is greater than the prices for future delivery dates.
Normally, futures prices exceed spot prices due to costs like storage, insurance, and financing, creating a situation known as “contango.”
Backwardation is atypical and usually indicates a supply shortage or high demand in the present market, pushing spot prices above future prices.
Here are some important aspects of backwardation:
- Incentive to Sell Now: It encourages holders of the commodity to sell at the higher spot price rather than waiting to sell at lower future prices.
- Accelerated Supply: Producers might expedite bringing their products to market to take advantage of the higher spot prices.
- Impact on Market Participants: While producers benefit from high spot prices, consumers suffer from increased current costs.
- Market Signals: Prolonged backwardation can indicate a potential commodity price bubble or a significant supply shortage in the market.
In summary, backwardation reflects a current imbalance in supply and demand, leading to higher immediate prices and signaling urgency in the market.