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Backwardation
Definition
Backwardation is when cost of the futures contract is lower than the cost of the spot (immediate delivery) price.
Using the term Backwardation :
The spot price of silver may be $7 an ounce today in the spot market, but in two months the futures price is $6 payable at the time of delivery. A buyer would not buy spot normally as they can pay $1 less in two months for the same silver. Hence, backwardation is signalling the marketplace that there may be near term shortages in the marketplace (paying more today than in the future . . . meaning that maybe less of the commodity will be available in the future and won't be deliverable). Formally, backwardation shows that the cost of carry is less than the difference between the future price and the cash price is less. Hence, the market is saying that this item is likely in shortage so pay more today to own it certainly rather than pay less to potentially have uncertainty about future delivery.
Pay Special Attention To :
The futures and commodities markets are very volatile and are often best left to the domain of professional investors and traders.
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Related terms
Contango
