Backwardation

While normally in CONTANGO, the platinum markets periodically experience BACKWARDATION.

What does this mean?

Backwardation describes the relationship between the price of platinum NOW, which is the spot price, and the price of platinum LATER, which is the futures price.

NOW                             LATER

SPOT price                      FUTURES price

 

Normally the price of platinum LATER is HIGHER than the price of platinum NOW. Why? Mostly because of interest rates, though other elements such as volatility have a role to play. When this - the normal - price relationship holds true, the difference between the two prices is called the CONTANGO.

 

NOW                             LATER

SPOT price                      FUTURES price

LOWER                           HIGHER

 

Example

NY Spot:   $400                 NYMEX Futures Contract: $405   

CONTANGO = $5

 

Sometimes this relationship is reversed. This can happen when lease rates (the rate paid for physical metal on loan) is higher than current market interest rates. This condition is called BACKWARDATION.

 

NOW                             LATER

SPOT price                      FUTURES price

HIGHER                         LOWER

 

Example                     

NY Spot:   $405                 NYMEX Futures Contract: $400   

BACKWARDATION = $5

 

BACKWARDATION in the platinum market usually means two things:

A) physical platinum is in relatively scarce supply. B)the cost of carrying physical platinum increases.

 

This is why many dealers are forced to widen spreads in times of BACKWARDATION. They have to pay more to buy platinum, and their purchases are hedged with a forward sale at a discount, thereby incurring a loss.

 

The upside of BACKWARDATION is, however, that it typically reflects a rising trend in platinum prices. If a shortage of physical(spot) supply abates, the futures market price will eventually adjust accordingly and a contango will be re-established .