Contango
Also: Forward premium, Contango market
Contango describes a market situation in which the forward price of a commodity sits above the current spot price.
Contango is a central term of the futures market: it describes the state in which the futures price (forward price) of a commodity — gold or silver, say — quotes higher than the current spot price. The further out the maturity date, the larger the premium tends to be. In precious-metal markets, contango is the statistically more frequent normal state and reflects above all the cost of carry.
Why does contango arise?
The forward price is made up of the spot price plus the so-called cost of carry. This includes:
- Financing costs — capital tied up to buy the physical metal incurs interest.
- Storage costs — physical gold or silver must be securely stored and insured.
- Transport costs — delivery to the agreed forward location.
- Convenience yield — a negative component: the benefit of having the metal immediately available (for example for industrial processing) reduces the forward premium.
Formally:
Forward price = spot price × e^((r + s) × T)
where r is the risk-free interest rate, s the storage/insurance cost and T the term in years.
Contango vs. backwardation
| Feature | Contango | Backwardation |
|---|---|---|
| Forward price | > spot price | < spot price |
| Typical cause | cost of carry dominates | tight immediate supply, high demand |
| Frequency (gold) | normal state | rare, mostly in times of crisis |
| Market signal | comfortable supply | strained physical demand |
In the gold market, backwardation appears only rarely — for instance when demand for physical delivery suddenly surges or confidence in paper gold falls. Historical price records show that pronounced backwardation phases often coincided with strong price moves.
What it means for investors
Anyone investing in precious metals through futures or ETCs should understand the contango effect:
- Roll losses: an ETF or ETC that rolls expiring contracts into newer (more expensive) ones always buys higher than it sells. This roll loss erodes the return relative to the pure spot-price development.
- Physical metal is immune: anyone holding physical gold or silver bears no roll loss. The carrying costs (storage, insurance) correspond economically to exactly the contango.
- Carry trade: professional traders can exploit contango by buying physical metal, storing it and simultaneously selling a forward contract at the higher price — provided the premium exceeds the carrying costs.
The current seasonality of the gold market can influence how strongly contango is pronounced in particular months, because seasonal demand swings move spot prices.
Contango on COMEX and LBMA
On the COMEX, gold and silver futures trade in standardised contracts. The forward curve usually shows a rising structure — a classic contango market. The LBMA fixing, by contrast, refers to the spot price and is not directly tied to forward prices, but it serves as a reference for calculating the forward premium (GOFO — Gold Forward Offered Rate, today replaced by the LBMA Gold Forward Rates).
In brief
Contango is the normal case in precious-metal markets and means: forward prices lie above the current spot rate. For long-term investors holding physical metal, contango has hardly any direct effect — but for ETF and ETC investors the roll losses can noticeably trim the return. Tax and return assessments differ from case to case; this text is not investment or tax advice.