Mecardo Analysis - Wheat both better and worse in the future
- By: "Farm Tender" News
- Cattle News
- Mar 07, 2019
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It is important to always take an interest in the pricing for grain both overseas and domestically along the entire horizon. As either a consumer or producer of grain, this can highlight potential opportunities for reducing price risk management. In this article we will explain the forward curve and two important situations: contango and backwardation.
Contango
The market is in contango when the forward futures price of a commodity is above the spot price. A contango market usually occurs when buyers are more willing to pay more for a commodity in the future than the present. This generally occurs in storable commodity markets, when there is an excess of supply. This typically encourages sellers to hold a commodity rather than sell for a spot price, as a ‘premium’ is paid further out from the spot contract.
At the moment, the Chicago wheat market is currently in contango (figure 1).
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Backwardation
The opposite of contango is backwardation. In a market experiencing backwardation, the forward future months will be priced at a discount to the spot futures market. A market in backwardation suggests that supplies are currently short, and buyers want the commodity now as opposed to the future. This encourages sellers with stocks to sell now rather than hold, as the commodity is discounted in forward contract period.
The Australian futures market is currently providing an example of backwardation (figure 2), which follows logic with drought conditions discouraging growers to hold onto grain.
Key points
* US wheat futures are in contango, where the forward months are at a premium to the spot contract.
* ASX wheat futures are in backwardation, where the forward months are at a discount to the spot contract.
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What does this mean?
As the time horizon narrows between futures contracts, the two are liable to converge. However, the market factors will determine how that convergence occurs.
In the backwardation example using ASX, we could find that the market converges downwards to meet the forward month. This is likely if we have a near average year on the east coast, however if we have a drought the forward prices will rise to meet where the current market.
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