Persistent oil contango seems to be easing
As academic research pointed to commodities being an effective diversifier in a portfolio and as products began to be developed and marketed, there was a surge in demand for commodity futures contracts. Observers of this trend noted that it was accompanied by years of persistent contango in the markets for oil contracts. When contango exists, commodity futures funds have to sell contracts at low near-month prices and buy into costly further-month contracts. The persistent state of contango caused the returns of the funds to trail the returns of spot prices by an abnormally large degree.
One argument heard against investing in commodities futures was that the demand from hedgers permanently doomed the markets to a state of large contango. And that seemed to be the case for a while. As investor demand soared, assets in collateralized commodity futures rose sharply, and contango in the oil market reached high levels.
While the hedging demand from investors doesn't seem to have subsided, the size of the contango has been coming down over the past several months. And as of the close of trading on October 28, oil futures were trading in backwardation. For example, the nearest month (December 2011) was trading at 93.93, and the January contract was trading at 93.75. And the further you looked out on the curve, the larger the backwardation became. For example, while the December 2012 contract was trading at 92.48, the December 2013 contract was trading at 91.32. Investors in oil futures, and broad-based commodity futures in general, were no longer facing the headwind of contango.
Was the disappearance of the contango caused by investors liquidating their investments in commodities funds? It doesn't appear that way: As of September 2011, total assets in 31 commodity-related mutual funds were at $46.8 billion, up from $23 billion in 15 mutual funds at the end of 2009. And there were $111.1 billion in 122 commodity related ETFs, up from $73.5 billion in 88 ETFs at the end of 2009.
While my crystal ball is always cloudy, the markets have provided another lesson for investors who think they know what the future holds. Perhaps the continued demand from hedgers will drive the market back into contango. However, it certainly isn't clear that investors aren't doomed to persistent contango. And for now at least, they have a small tailwind at their back.