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Current time:0:00Total duration:4:07

Video transcript

if a commodities trader were to tell you that a market is in contango they're just referring to the idea that it is cheaper today so if you're talking about now it's cheaper to buy that commodity on the spot market so it's cheaper to buy it on the spot market than it is to agree to buy it at some futures date or some future date using a futures or forward contract so in the future in the future it is more expensive it is more expensive so let's say that that commodity is gold and I'll just make up gold prices for the sake of simplicity this isn't the current gold prices let's say that today you can go on the spot market and buy gold at $1,500 at $1,500 per per ounce but if you wanted to buy gold if you don't want the gold today and you want to enter a futures contract to buy the gold one year from now so let's say the future is now one year later one year from now instead of buying that let me write this down this is the spot market instead of buying it in the spot market for $1,500 an ounce you could agree to buy it one year later one year from now for $1,600 an ounce $1,600 an ounce and so to a trader this would be a market in contango and what I want to point out is that this isn't that strange of a thing because if you think about it you have two options if you want to invest in gold and gold is something that you want to invest for the long term you're not going to eat the gold you're not going to use it to fuel your cars or anything like that so in the situation with gold let's say you want to keep gold for definitely a year but maybe many many many years so you have two ways of making that investment you could take your $1,500 and buy the gold today but if you take your $1,500 and buy the gold today you would lose the returns on that $1,500 on that cash that you could invest other places so you have the opportunity cost of the cash so had you invested that cash someplace else and you also have to store that gold in the case of gold storage you have to find some place to really secure and maybe you need to ensure the gold and you just people can't steal it in all the rest so you also have the storage cost storage cost in general you could save both of these costs you could if you enter into the futures contract so instead of just buying fifteen hundred dollars in the spot market today you could enter into this contract where you can definitely buy the gold one year later for sixteen hundred dollars an ounce and then you could take your fifteen hundred dollars you could take your fifteen hundred dollars and get interest on it you could get interest on it so that will grow and you'll also save money on the storage cost so in either way especially for commodities like gold precious metals things that aren't consumable things that people don't need immediately for consumption it's not unusual for a market to be in contango sometimes you might see a severe contango maybe with something that is consumable so maybe right now oil is trading at $50 a barrel once again I'm just making up the number and in the future it the futures price is at a hundred and fifty dollars so this is probably taking more into account than just the storage cost and the opportunity cost of your cash and this might be because there's a surplus there's a surplus for oil consumption today there's just a big glutton the mark and people are just trying to dump it or there might be some type of perceived shortage in the future so you could think about it either way but this is very unusual this type of severe contango is very very unusual unusual you would you would expect to see kind of minor ones things that take this cost into consideration but not something like this and something like this you can usually arbitrage it out and make some money assuming you can store oil or you have oil to sell or or buy and all the rest of all the rest of that