Backwardation is a market condition in which a futures contract far from its delivery date is trading at a lower price than a contract closer to its delivery date. A “normal” futures curve shows increasing prices as time moves forward because the cost to carry the goods increases with long contract expirations (traders don’t want to deal with transport and storage costs). In backwardation this curve is inverted.

Investors look at futures backwardation as a sign that price deflation is on the horizon. Backwardation is most likely to occur when there is a short-term shortage of a particular commodity, specifically “soft” commodities like oil and gas, but less likely to occur in money commodities, such as gold or silver. 

How can investors spot commodities that may have inverted futures curves? Look to the news. Backwardation is most likely to occur from short-term factors leading to fears of scarcity: extreme weather, wars, natural disasters, and political events. Examples of events include a hurricane threatening to knock out oil production, or disputed vote counts in an election in a country that produces natural gas.

One way to identify futures that are experiencing backwardation is to look at the spread between near month contracts and contracts that are further out. If a futures contract is trading below the spot price it will eventually increase because the price must eventually converge with the spot price upon contract expiration. Investors trading futures contracts in commodities considered to be in backwardation are most likely going to hold a long position.

Analyzing price spreads between contracts will not always give investors the most accurate view of what will happen with a futures contract, but in extreme cases, it can provide useful information that can guide further research. Markets can change quickly, and the state of the market when an investor takes a long futures position to take advantage of backwardation can shift to make that position unprofitable.

  1. What is the best reason to pursue a backward integration?

    Learn if backward integration is a good or bad move for a business. Learn what backward integration does for a business's ... Read Answer >>
  2. Is backward integration the same thing as vertical integration?

    Learn if there are any differences between backward integration and vertical integration. Learn where on the production line ... Read Answer >>
  3. What are the most famous instances of backward integration?

    Learn more about backward integration in the supply chain and see how two famous examples, Carnegie Steel and Apple, used ... Read Answer >>
  4. How are futures used to hedge a position?

    Learn how futures contracts can be used to limit risk exposure. Read Answer >>
Related Articles
  1. Trading

    Contango vs. Normal Backwardation

    Learn about the futures curve, contango and backwardation, and what they mean for hedgers and speculators.
  2. Investing

    Is USO a Good Way to Invest in Oil?

    The United States Oil Fund is better suited to short-term investors who actively manage their portfolios.
  3. Investing

    USO Vs. DBO: Comparing Oil ETFs

    Discover two major oil ETFs, The United States Oil Fund and The PowerShares DB Oil Fund, and the major differences between the two funds.
  4. Trading

    Futures Fundamentals

    This tutorial explains what futures contracts are, how they work and why investors use them.
  5. Investing

    Commodity Investing 101

    From the orange juice we drink to the gas we use to power our vehicles and heat our homes, commodities play important roles in our daily lives.
  6. Investing

    UNG: US Natural Gas ETF Performance Case Study

    Explore the performance of the United States Natural Gas Fund since 2012, including the influence of contango and backwardation on the fund's returns.
  7. Trading

    Futures Quotes Explained The "Easy" Way

    If there’s a security whose price fluctuates, there can theoretically be a futures marketplace for it.
  1. Backward Integration

    A form of vertical integration that involves the purchase of ...
  2. Convergence

    Convergence is the movement of the price of a futures contract ...
  3. Front Month

    Front month refers to the futures contract in each market with ...
  4. Current Delivery

    A type of futures contract that requires the delivery of the ...
  5. Futures Contract

    A contractual agreement, generally made on the trading floor ...
  6. Delivery Price

    The delivery price is the price at which one party agrees to ...
Hot Definitions
  1. Liquidity

    Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's ...
  2. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  5. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center