(1) Consumers of the commodity who are not willing to pay higher spot prices than the storage arbitrageur is willing to pay. (See for instance the Nat Gas contango in a fast falling spot price market.) In other words contango usually only exists with surplus supply.

(2) Speculators or Commercial buyers who are willing to buy the market forward such that prices are higher forward than spot. These are the folks who by being willing to pay higher prices in the future than prices now, allow the storage arbitrageur to make near risk free profits by buying spot and selling forward. Indeed (as oil last year) if there is super speculator demand then they can outbid the consumer in 1 above allowing contango to exist in the absence of supply glut.

(3) The storage aribitraguer – the insider with access to capital and storage who can take advantage of the trade. Whilst legally strictly speaking a speculator, however in reality this is as near to a risk free trade as one can get.

Why does the arbitrage get large and the contango get steep … well in some markets it is non-existent: Gold for instance – since the barrier to entry is small. Almost anyone can buy a few Gold bars stick them under their mattress (uncomfortable!) and sell them forward.

In others it is huge (look at Nat Gas spot at $2.20 against the November futures contract at $3.75 where the contango carry is at a stunning 55%) because (a) the barrier to entry is very very high – who has access to caverns to store Nat Gas, to pipelines to transport it, to swap lines to convert Henry Hub to Hubs near storage and so on? and (b) seasonal demand will lift price in Winter when most Nat Gas is consumed (almost 2 x the summer) and (c) storage is very limited.
MW

It supposedly takes two to contango – that would be, at least one who makes or legitimately purveys the goods, and another party entirely betting the outcome in terms of availability and consumer predisposition when the goods are due to meet market. Vision and a certain willingness to take risk in exchange for profit potential being not unreasonable to reward.

When however arbitrageurs so very much fancy themselves that they become so-called entrepreneurs of the grotesque ilk described in this article, the two parties above have become one and the same, which is odd to say the least and decidedly not visibly accountable by the rules of regular capitalism, including the fiscal principles underlying this economy.

The inevitably resulting market scarcity of essential commodities is synthetic, not to say jacked-up, while the means by which the preneur involved came by his betting cash for this game of his own making is questionable at best, no matter how much of it there is nor how freely it flows, and flows only his way only – not the same way it seems to flow – namely, away – from at this time generally cash-strapped taxpayers.

The contango being danced here is more like something out of Fight Club, except that here the partners aren’t even pretending to be two different people. Instead of fighting nobly against one another to see who gets the upper hand or as it were stays erect longer, they are ogling and plying one another with seemingly infinite amounts of Spanish Fly to see what manner of offspring their hellish union might produce.

Reuters readers are not alone in having a hard time telling apart this form of casino capitalism gone wild from felony insider trading. Let’s call this song exactly what it is: insider trading whose extent and venality appears destined to sabotage the entire economy formerly known as capitalism, from within. And we all know what’s supposed to happen to inside traitors- I mean, traders.

Profits are not evil but the expectation of marketeers of manipulated triple digits verses the earned high single digit one is a root problem to this market and the equities markets. The ability to determine Value is what is destroyed in this environment and confidence.

I challenge you to look at the wheat spot last year and tell me the same thing again. If you read more closely, you will note that ethanol production, cap and trade are based on these occlusive markets and not one which this reader finds favorable or desirable. Its unsubstantiated and is also unsustainable. Read again a little more carefully.

Thanks again for your perspective.

Jay

Hussman pointed out that contango signalled that we were nearing the end of the speculative ride as it had a year before that, while he cautioned that the final frenzy could send the price vertical before it crashed. Of course, that’s what happened,although it took another six-eight weeks before the crash came.

None of it had anything to do with supply. It was all speculation. My hope is that the next crash finally collapses some of these trading houses ao we won’t be forced to bail them once again and allow them to trade on our nickel.