Paying a premium on assets influenced by supply and demand is nothing new to the precious metals and retail industry. You want or need something in short supply, you’ve got to pay a certain price. On the surface, supply, demand and costs are simplistic, but when you delve deeper and find backwardation and contango impacting the market, how can that influence your buying?
Whether you’re a novice or expert in physical investing, the term backwardation in commodities can be confusing, and understanding its impact on the market can be difficult. Backwardation occurs when the immediate cost (spot price) is higher than future cost, which means demand for immediate delivery is greater than in the future. It directly correlates to an increasing shortage, causing prices to rise based on the premiums for those assets.
If a consumer needs physical silver or gold during a period of backwardation, it is typically more difficult to acquire due to holders of the commodities not wanting to decrease their position. The main reason for continued holding is fear the seller wouldn’t get physical metal back in the future, based on the shortage of assets, if they sold now. Many investors also aren’t interested in exchanging physical metals for paper contracts because of an uncertainty in the market and the possibility of not having their assets delivered.
A shortage in a precious metal can occur for many reasons, whether it be mining or use in other industries. Silver, for example, is not only sought by investors and collectors worldwide, but also for use in electronics, jewelry, medicine and more.
The opposite of backwardation is contango, where the futures or forward price of an investment metal is higher than the anticipated spot price. In other words, consumers are willing to spend a higher amount in the future rather than the current spot price of a commodity to avoid storage or carrying costs of buying today.
To see it another way, if you were willing to purchase a car from a seller but wouldn’t need it for three months and didn’t want to keep it stored, you might be willing to pay more at a later date. You could sign a contract with the seller to continue holding your vehicle until you purchased for the higher amount on the future date agreed upon.
The same applies to precious metals.
Whether you’re willing to pay more for a commodity now rather than in the future or need to purchase at a higher cost on a later date, you’ll know the difference between backwardation and contango and will be able to make an educated decision for your investment needs.
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