If supply of commodities is abundant, is it contango? I read somewhere that it is because a producer, commodities producer, needs to keep his inventory and he adds storage cost to futures contract. That’s why longer maturity futures contract is higher than short maturities. But I also read that if commodities users dominate the market, it will be contango because they want to make sure that they have enough commodities and are willing to accept higher price for commodities. Are these statements correct? And are they related?
Contango has a negative roll yield, backwardation a positive one. In the first you are selling your contract lower than the price you buy your roll at and in the later, you are selling your contract higher than you are buying your roll at. Contango is created when the lease rate is less than the risk free rate and backwardation the opposite. At the end of the day, the lease rate is determined by the convenience yield, meaning that if there is huge incentive for me to hold the physical, then current prices will be higher than future prices. The positive roll yield will be an incentive for me to forgo the current purchase and move it to the future. I will sell my front month future and buy it cheaper at the next contract date. As far as supply and demand, that can make spot prices go up and down, an futures as it relates to seasonality or foreseen future shortages or surpluses. In general though, the basis difference and basis difference between contracts (roll yield) is determined by interest rates, storage costs and convenience yield. Not so much straight supply and demand.