By Jared Cummans
Contango is simply an unavoidable phenomenon of the commodity market; at some point almost all commodities will fall into this pattern. For those unfamiliar with the term, contango simply refers to a scenario in which near month futures are cheaper than those expiring further into the future, creating an upward sloping curve for future prices over time. Traders and investors need to keep a close eye on futures curves, as they can have a drastic impact on positions while also presenting opportunities for lucrative trades. Now that the ETF industry has cracked commodity investing wide open, monitoring contango has become more important than ever.
Of the assets that are carefully monitored, natural gas is typically at the top of the list. This fossil fuel has been exhibiting contango like few other commodities, with its prices sloping upwards as far out as the year 2020. Contango for a commodity like NG is usually accounted for in massive storage costs associated with stockpiling the asset, but it can also suggest that the market believes that prices will rise over time and with NG sitting at historical lows, that certainly seems like a logical assumption. For now, however, natural gas has been tanking, with futures already dipping more than 25% on the year. In this environment, a short strategy has the potential to create a fair amount of wealth in natural gas, but for those uncomfortable with shorting, there is an ETF to help.
The UltraShort DJ-UBS Natural Gas (KOLD) is a fund that offers a -2X exposure to front month natural gas futures. Utilizing a front-month roll, KOLD will benefit even if NG holds flat due to the nuances of the product. KOLD, like may commodity ETPs, features an automated front-month roll, meaning that it will automatically sell out of its current contract just before expiration and buy into next month’s. This strategy can be disastrous with contango as the fund is forced to sell low and buy high; funds like the ultra-popular UNG often get slammed for this very issue. But KOLD’s short strategy means that it will profit from contango, as evidenced by the 64% return YTD for this fund.
While natural gas is well-known for its contango, there are a few other big name commodities exhibiting similar patterns and opportunities in the current market environment.
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West Texas Intermediate (WTI) crude is another one of the most popular commodities in the world (arguably the most popular). This light sweet crude is typically produced in the Americas and is a trading favorite around domestic exchanges. With the price of oil fluctuating rapidly over the past few weeks, crude trading has gotten a lot of attention, as oil has failed to establish any sure trend. For the time being, WTI futures are in contango through the December 2012 contract, giving investors a few more months to make a play before futures fall into backwardation. Investors can utilize the United States Oil Fund (USO) to establish a positions as they see fit.
Gold has been one of the most talked about commodities in recent years and has also been subjected to violent daily swings as of late. COMEX Gold futures are currently contangoed through December 2017, the last contract available. With gold prices rapidly rising in recent years, the contango here is partly due to the expectation of higher prices as time goes on, but also note that part of it is simply due to the costs of physically storing bullion in a vault. For those looking to make a play against gold, the DB Gold Short ETN (DGZ), which utilizes futures contracts to offer a -100% exposure to gold.
Soybeans are a surprisingly popular commodity that are also riddled with contango. Soybeans are among the most popular futures in U.S. markets, as their futures actually trade on a monthly basis more often than gold. Currently, soybean oil contracts are in contango through July 2013, providing an opportunity for over a year in this market. There currently is no fund designed to profit from soybeans losses, but investors can look at Teucrium’s Soybean Fund (SOYB) which aims to eliminate contango issues altogether.
While searching for and exploiting contango can be a very effective strategy, it is also rather risky. Given that commodities are quite volatile as it is, futures curves can flip on a dime depending on macroeconomic factors which can leave you with a sour trade. As a precaution, investors should always use the safety of stop-loss orders (when possible) as well as carefully monitoring futures curves to ensure that their trade is running smoothly.
Disclosure: No positions at time of writing.