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Severe contango generally bearish

Thinking about why a severe contango could be bearish. Created by Sal Khan.

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  • blobby green style avatar for user Angela Guerrero
    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?
    (4 votes)
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    • blobby green style avatar for user joshdance
      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 :)
      (13 votes)
  • old spice man green style avatar for user TerryMHogan
    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.
    (4 votes)
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    • blobby green style avatar for user MathewRPhillips
      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.
      (5 votes)
  • duskpin ultimate style avatar for user tuannb1997
    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 ?
    (3 votes)
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    • blobby green style avatar for user Adam Pickett
      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.
      (5 votes)
  • leaf green style avatar for user santi
    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?
    (3 votes)
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  • leaf green style avatar for user Jon Dough
    About 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?
    (1 vote)
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    • blobby green style avatar for user footballplayer72
      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.
      (4 votes)
  • winston baby style avatar for user ahmet
    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 ?
    (2 votes)
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  • male robot johnny style avatar for user jondrometa
    Is there an example that we can take away from today's current markets? (2/21/15).
    For instance, I'm observing that oil is in a decline at the moment. If a futures contract existed for X- term and the price at maturity looks significantly higher than today, would that be an example of contango?
    (2 votes)
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  • piceratops seed style avatar for user Tanay Trivedi
    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?
    (1 vote)
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  • blobby green style avatar for user tijmenvandermaas
    It makes no sense to me that Khan calls contango bearish. For example, in the recent (and severe) oil contango, storage prices went way up, indicating that people were willing to pay more with a bullish belief they would cover this cost by the rising prices.
    (1 vote)
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Video transcript

Voiceover: Now that we know what a trader means when they say that a market is in contango. Let's think about whether it would be a bullish or a bearish signal for prices in that commodity. So, as I mentioned in the last video, it's actually normal for things to have a contango because it takes into account the opportunity cost of the cash and the storage cost for that commodity. So, if something is kind of in a, in a reasonable contango you really can't make a call on it one way or the other whether it's bullish or bearish. It's really just something that you would expect. What's not as usual is a severe contango. Severe contango. And that's when the current spot price is a lot lower than the future's price or the forward price. And in that situation as we've mentioned in the last video it's because that there's perceived to be a big glut in the market. There's a surplus on the spot market or maybe there's a perceived shortage at some point in the future. And in general this is perceived although once again, you can't just look at one simple signal and be able to you know, bet your life savings on the direction of the market. It's a very quick way to lose your money but the general view is, is that a severe contango is a bearish signal. Is a bearish signal for the future price of that commodity and the reason why it's perceived to be bearish is because if you have this huge discrepancy all someone has to do is buy a bunch of oil today. We assume that these are oil prices. So, buy a bunch of oil today for cheap. Store it and once again, we're assuming this is severe contango. So this, it won't cost a $100 a barrel to store this, this oil for a year and then we agree to sell it for $150. So, we agree, agree to sell it and assuming the storage cost is less than $100 we're going to guarantee some money. So, if you have a bunch of people doing this, buying on the spot market it will increase demand on the spot market, raise prices there but for the future's market, there's a bunch of people who are now agreeing to sell in the future. So it's going to lower, it's going to increase the supply on the selling side of the future's contract so to lower the future's prices. So, in general severe contango is bearish for the future's price.