Question 1

Is there a way to know when is everyone going to sell, so that one can choose a different time to sell to avoid drop in value?

Accepted Answer

No, there is no way to know.  Think about it this way.  If someone told you there was gold in a cave somewhere, wouldn't that person already have known and have taken the gold?  If a poker player has a tell, and someone lets you in on it, don't you think the person who told you will take advantage of that, and now that he knows that you know the tell, don't you think your informant will take advantage of YOU, knowing that you know the tell?
The short story is: advantages exist for only a short period of time and for a small number of people.  If you think you know something secret, guess what--so does everyone else.  And once the mice know where the cheese is, it's gone quickly.  Best to find your own cheese :)

Question 2

Won't this be quite bullish in the short term, and for the shorter-dated contracts?  I mean, why not enter into a contract 3 months out to purchase for $75, and then a contract for 12 months out to sell at $150.  You only have 9 months of storage costs and are making a killing.  To me, severe contango gets rectified (curve gets less steep)by arbitrage, but it could just as easily occur by a quick rise in the shorter dated futures.

Accepted Answer

Basically if you ever got that much contango in a market, the sheer volume of people buying 3 months and selling the 12 would quickly bring the prices back into line with carrying costs. You just aren't likely to see that much price difference ever get created in the real markets.

Question 3

1) What do exactly "Bulls" and "Bears" mean ? I come across these terms quite a lot but never understand what it stands for regarding selling and buying.
2) Is the practice of "buying goods when the price is low, store it and later sell it for a much higher price" related to Hoarding in some respects ?

Accepted Answer

1) Bullish is positive for whatever you're following (bulls strike upwards) and Bearish is negative (Bears swipe downwards). Ideally you buy at the start of a Bullish trend and vice-versa for Bearish.
2) As for the hoarding aspect, it is true in some respects, however, you're always at risk that prices can move against you and holding the asset is no guarantee of profit.

Question 4

Wouldn't the  initial cause of severe contango be a bullish persective on the underlying commodity (more demand for commodity in the future, thus higher demand for the contract), and the effect of this overbidding bring the bearish sentiment later on?

Accepted Answer

Yes, but we can't see that bullish signal in the price setting. Because it's probably for fundamental reasons. Here, we know it's a bearish signal because it's money to be made due to arbitrage.

Question 5

There seems to me that a arbitrage opportunity does not exist because there is no guarantee how prices will evolve during the 1 year maturity date of futures contract. It may as well be that prices fall for that maturity and as a result of marking to market Daily we can loose Money on our margin account. And as far as I know arbitrage is meant as a free lunch without taking risks against return. But in this case there is some risk inherent. Can someone comment on this please ?

Accepted Answer

Strictly speaking, arbitrage is supposed to be a free lunch.  If there's risk involved, it's not really arbitrage.  People do use the word loosely, though.

Question 6

About 1:45 is Sal says since this is a severe contango it won't cost us $100 a barrel to store this oil for a year.  Is he meaning it won't cost us $100 to store because we buy it at $50? That doesn't make sense to me as I thought that's the price to purchase, and nothing to do with storage, and the opportunity cost.  Also, how come the gold is not in a severe contango, both gold and oil have a difference of $100 between present and future, would it be due to how much gold is available? Or because one is a commodity?

Accepted Answer

First, he says IF. He's not saying it won't cost us that much, it very well could. There is no necessary relation between price you buy at and storage costs. The future price was $150, the spot price is $50. So if we could hold it for the year for less than $100, we buy it at spot for $50, hold it for the year and sell at $150.

And severe isn't a litmus test, but $1500 to $1600 seems a lot less severe than $50 to $150. Both are generally considered commodities. A commodity is a commodity because we don't care who produces it (with rare exceptions). Gold mined in Europe is no less valuable than gold mined in Australia as long as in both cases I have it here. No one cares enough about the difference. Fancy wines are not commodities because I care what hill they were grown on.

Question 7

So Contango Spread can be inclusive of some opportunity cost of storing and insuring a nonconsumable item like Gold. However, what if instead of actually buying gold on the spot market I instead buy a Gold Spot ETF? Is the spread wrapped up into that because the fund manufacturers take their management fee for storing and insuring the gold and so forth? So the opportunity cost is there, its just hidden?

Accepted Answer

when you buy the ETF there is an expense ratio built into that fund.  The cost of storage is paid by the fund.

Finance and capital markets

Unit 9: Lesson 2

Severe contango generally bearish

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