Don't Worry About The Gold Contango, It's Actually Normal

Includes: GLD
by: Richard Bloch

Jared Cummans of CommodityHQ wrote an article warning us to: "Beware: Copper, Gold And Silver Are Sitting In Deep Contango."

Uh oh. Contango. Is that bad? Evidently, it might be:

When it comes to commodity trading, few words are more serious in an investor's vocabulary than contango. This phenomenon has been known to burn a hole in positions and cause problems for those who were not amply prepared.

I think Jared may be overdramatizing the issue at least when it comes to gold. For example, here's a chart showing the weekly gold contango (9 nearest contracts) since 2000

Notice how gold has basically been in contango for more than a decade, but it still up from around $300 per ounce back in 2000.

You see, gold is almost always in contango. To understand why, consider why a contango exists in the first place and why it would turn into backwardation.

In a normal market, you'd expect to pay a premium to defer taking delivery of a commodity now in favor of delivery later. If I want some copper next year, but don't want to pay for it until then, I should expect to pay a storage premium and other carrying costs.

But what if supplies get tight - really tight? Then storage premiums evaporate. The cost of not having the copper you need right this very minute exceeds those carrying costs. Then copper would go into backwardation.

If fact, copper does go into backwardation

You can see that yes, backwardation is generally associated with rising prices, and when the contango gets higher, that tend to correlate with lower prices.

Why doesn't gold behave this way?

Well, gold may be a volatile commodity and the price can indeed fluctuate, but there's just not that much gold being "used up." Sure, there's some that's used up, but the vast majority of the gold in the world sits around in vaults, some of it in the SPDR Gold ETF (GLD) and other funds. You can't say the same thing about copper.

So I would not watch the gold contango in the same way that I'd watch the contango in some of these other commodity markets.

Jared may be right o be concerned about contango in other markets. But the contango levels for gold are generally not going to provide nearly the same price cues as say, the contango for silver, copper, oil, soybeans, etc.

Disclosure: I am long GLD.