In other words, if you were to buy an asset today for immediate delivery (the spot price), you would pay more than if you bought it at some point in the future (the futures price).
For example, say gold’s spot price is $1,000/ounce but its February delivery options are currently trading at $1,100/ounce. Gold’s backwardation means that many people think gold will rise going forward and so they are willing to pay more now rather than later to take advantage of this trend.
The spot price is the current value of an asset, while the futures price refers to what that same asset could be worth in the future.
So if you buy something today, it has a higher value than if you were to wait until tomorrow when it will become cheaper because people want it more now than later.
Backwardation may result from short-term or seasonal factors such as supply shortages or changes to shipping regulations, but it may also result from fundamental changes to production costs, market prices or expectations about future changes.
Backwardation sends signals to investors about changes in market sentiment regarding a particular security or commodity, which can affect investment strategies.
The opposite of backwardation is called contango.
What is the difference between contango and backwardation?
Contango is where the futures prices are trading above the spot (the current spot price) while Backwardation is where the spot price is trading above its futures price.
In contango, investors have very little confidence that prices will increase in the future; instead, they believe them to be high today due to increased demand or limited supply relative to future expectations.
In contrast to contango markets where futures contracts are trading above the spot (the current spot price), backwardation happens when they trade below spot prices.
In some cases, contango can be normal market conditions; however, if it persists for too long, it could indicate a lack of interest in owning the asset—which would then lead to lower prices overall and impact other markets (such as stocks).
Is backwardation bullish or bearish?
If everyone wants to own something and will pay more for it in the future, then that’s usually bullish news. When you see backwardation, it’s a good sign that the underlying asset is in demand. This means that there must be some sort of shortage or demand for the underlying asset which increases its value.
How do you benefit from backwardation?
Backwardation is a good thing for investors. It means that the future price of an asset is lower than its current price, so you can buy the asset later and sell it at a greater profit because there will be people willing to pay more than you did when they want it later on.
Key Points
Backwardation is a market situation that indicates changes in supply and demand conditions. It is typically associated with an expectation of future supply shortages, which puts upward pressure on spot prices as buyers anticipate higher future prices in order to compensate for the increased cost of buying now.
Backwardation can also arise when there are expectations of lower demand in the future due to factors such as seasonal cycles or other temporary conditions that change an asset’s utility over time.
However, these situations are not always easy to predict accurately and may only last for a short period of time before reverting back to normal backwardation.
Learn more about investing
No matter your level of financial literacy, we have more than enough financial education resources to get you started. Also, with our wealth management app, you can easily save, invest, and begin your own path to financial independence.
Related Terms:
Related Articles: