Gold Futures Contracts: Contango and Backwardation

Gold Futures Contracts

This article will work on explaining seemingly mysterious gold futures trading lingo terms that are used among experienced traders, namely, contango and backwardation.

Gold futures contracts are purchased in order to guarantee delivery of a standard unit of gold commodity, normally 100 ounces, at a future date at a set price. Most of these contracts are resold before they reach their maturity to gain profit on the difference between purchase and resale prices.

Gold futures contracts provide stability and assurance to the market of precious metals. Producers sell gold futures contracts sometimes before they even begin mining to guarantee its sale in the future. Precious metals consumers, on the other hand, are in need of a constant commodity supply at a favorable price to satisfy their production needs. Setting gold futures prices on the day of contract commitment gives all players a sense of stability and hedge against unpredictable yellow precious metal prices in the future that can either go up or down.

Having introduced the basics of gold futures, we can now move to explaining what contango and backwardation truly are. When futures contracts are in contango, it means that the future price of delivery is higher than the predicted future spot price of the metal. Oppositely, when gold or silver futures are in backwardation, it stands for futures prices to be set below the future spot prices.

Gold futures contracts are almost always in contango due to the nature of the this commodity and constantly high supply. Gold commodity, opposed to oil or wheat, for example, is never fully consumed but rather gets re-circulated taking on various forms like coins, bars, jewelry. Later scrap gold is recycled again to produce new gold products.

Contango scenario is based solely on the banks’ interest rates making credit scarce of plentiful for investors. Understanding the basics of these contracts plays a very important role in gold price prediction. Precious metals futures market is an opportunity to diversify a portfolio by hedging against ever-changing spot prices of such commodities. In addition, futures market allows traders to profit from volatility of precious metals without any physical ownership of the commodities.