Hedging with Jorge #Episode19: Understanding Contango and Backwardation in the aluminium market

Happy New Year! As 2025 begins, let’s dive into a quick recap of market dynamics we discussed last week. Specifically, we explored two critical concepts: contango and backwardation, and their implications for the aluminium market.

What Are Contango and Backwardation?

Contango occurs when the future price of a commodity is higher than its current or “spot” price.
Backwardation is the opposite—when the spot price exceeds the future price.

Theoretical Contango Explained: In theory, contango should reflect the costs associated with holding a commodity.

If you buy aluminium today, you incur costs such as:

• Interest on the money spent upfront.
• Insurance for safeguarding the material.
• Storage fees for keeping the inventory.

These factors create a “theoretical contango,” often serving as a baseline for understanding market trends.

The Current Aluminium Market: Currently, the aluminium market is in contango, but at a much lower level than expected – around $30 instead of the $80–$90 theoretical benchmark.

Implications for Market Players:

Producers: A contango allows producers to benefit by locking in higher future prices through forward contracts. In three months, this might yield a $30 gain.
Consumers: For consumers, contango means higher costs for future purchases. However, this increase could be offset by financial benefits, such as deferring payments for 90 days. If the cost of deferring payment (e.g., 2%) outweighs the contango (1.5%), the deal may still be favorable.

The Balancing Act: While producers typically favor contango, consumers often see it as an added burden. Understanding the cost-benefit dynamics is crucial for making informed decisions in such market conditions.

Stay tuned as we delve deeper into this fascinating topic next week. Until then, here’s to navigating 2025 with clarity and strategy!