State of Contango

Contango or normal forward curves are alive and well in most commodity markets. As of this writing (the Dec 13 2012 close) the commodities in the VistaCTA commodity basket have the following curve shape characteristics:  

Crude- bump then backwardated

Heating oil- backwardated

Natural gas- sharply backwardated

RBOB gasoline- backwardated

Corn- sharply backwardated

Wheat- normal to flat to slightly backwardated (mostly flat)

Soybeans- backwardated

Gold- contango

Silver- contango

Copper- contango then back down

Coffee- contango

Sugar- contango

Cocoa- mostly contango

Cotton- contango

Frozen Concentrated Orange Juice- contango  

Of the fifteen names in the basket, eight are contango and seven are primarily backwardated.  The question remains, does this mean anything?  Many commodity analysts maintain that contango is a bearish or negative indicator for long investors.  Many ETF and commodity index providers also point to “negative roll yield” (i.e. the presence of contango) to account for the dismal performance of some commodity indexes and ETFs.  Likewise, inverted market curves are claimed to be bullish for long investors.  

Let’s test this assertion.  In the next few posts I’ll review the predictive value of curve shape name by name in the VistaCTA basket.   

WTI Crude Oil Forward Curves

Let’s first consider the NYMEX WTI crude oil futures contract.  There are many ways to do this but a simple way is to look at the futures curves on the last day of the year for the past five years and see if one year’s curve shape can predict the next year’s performance.

The chart below shows the crude oil forward curves on the last day of the year for five years (2007 to 2011) and the forward curve as of the 12/13/2012 close. (I am using “forward curve” and “futures curve” interchangeably here, although, technically, there is a difference.)  The vertical y-axis shows price per barrel and the x-axis shows the contract expiration month.  For instance, the bottom red curve, for the 12/31/2008 trade date, starts at $40.59 per barrel for the March 2009 contract and ends at $74.32 per barrel for the October 2014 contract. 

Aside from the crazy 2008 extreme contango year, 2007 was sharply backwardated; 2010, 2011 and 2012 were generally backwardated, as well.  Did this backwardation predict anything, let alone predict a future bull market?  Looking at the curves note the following:

2007 backwardation then sharply lower in 2008

2008 contango then sharply higher in 2009

2009 contango then higher in 2010

2010 backwardation then higher in 2011

2011 backwardation then lower in 2012

2012 backwardation then ? 

The results show that in the three backwardated years, the markets ended higher, lower and higher.  In the two years of contango, the markets were both higher.  If nothing else, the forward curves indicate that, since 2007, contango is NOT bearish, at least in WTI crude oil.   

Crude Oil Conclusion: Curve Shape is NOT a predictor of future returns.