Traders, especially arbitrageurs, make use of contango when it widens or narrows from normal values. Gold contango creates arbitrage opportunities in this particular metal.
A forward curve is said to be in contango (contango in gold) when futures (for instance gold futures) are traded at a premium over spot (for instance spot gold price). In commodity markets, the same is true when a far month delivery is priced high in comparison with a near term delivery. In case of a non-perishable commodity, contango refers to the cost of carry; however, this difference between spot and future is not constant. Contango indicates the supply demand balance in commodity markets to an extent; in fact, supply demand determines the shape of the forward curve. Commodities do not follow contango/backwardation strictly; they are highly prone to shifting from contango to backwardation and vice versa depending on the market fundamentals.
The reverse condition where futures trade at a lower price than spot is termed as normal backwardation.
Let’s detail the situation using an example. Look at the chart below. At t=0 (today), if the futures are priced above spot, the condition is contango. On the other hand, if the futures trade at a discount to spot, then it is referred as normal backwardation scenario. Ideally, both forwards and expected spot are anticipated to merge at maturity.
Does Contango in Gold Have Any Predictive Power?
Generally speaking, contango is a normal situation for durable and easily storable commodities which have a cost of carry, such as gold. This is due to the carry costs - higher futures price is a way of paying for these costs.
Indeed, gold spends most of the time in contango. It is reflected by the positive. Given that it's a normal state, gold remaining in contango doesn't say too much about the market. , i.e. the opposite of contango in gold, is much rarer, and thus, interesting situation. Investors can trace the backwardation in the gold market, as it may reflect the unusual and short-lived imbalance between supply and demand for the yellow metal.
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