Author: shyam

For commodities, the futures or forward curve would typically be upward sloping (i.e. “normal”, “in contango”), since contracts for further dates would typically trade at even higher prices. In broad terms, backwardation reflects the majority market view that spot prices will move down, and contango that they will move up. Both situations allow speculators to earn a profit.”

A contango is normal for a non-perishable commodity that has a cost of carry. Such costs include warehousing fees and interest forgone on money tied up, less income from leasing out the commodity if possible. For perishable commodities, price differences between near and far delivery are not a contango. Different delivery dates are in effect entirely different commodities in this case, since fresh eggs today will not still be fresh in 6 months’ time.

Back in April 2012, the ministry of consumer affairs, food & public distribution shot a show cause notice to the National Spot Exchange Ltd (NSEL) asking it to explain why products that monetize contango shouldn’t be treated as short-selling. The problem was that brokerages and “wealth managers” were hawking products that involved simultaneously entering into a 3-day buy contract and a 20-day sell contract and pocketing the difference.

This ET article of October 2012 explains the trade: “There is no product offering assured or fixed rate. In physical trade, the practice is such that a trader or stockiest, who buys from mandi on cash payment and supplies to a mill such stock, gets payment from the mill after 15-25 days (varies from commodity to commodity and place to place). If the supplier insists for cash payment, the mill applies a CD (cash discount of 2%). Hence, the interest rate prevalent in physical trade of commodity varies from 24 % p.a. to 30 % p.a. Compared to that, on NSEL the cost of money involved in procurement has come down to 15 – 18 %, which is beneficial to the processor.”

However, the Consumer Affairs Ministry, in all its wisdom, decided that this practice needed to stop. In July, it asked NSEL not to launch new contracts until further instructions from the government. This was akin to yelling “fire” in a crowded movie theater and the commodity markets went into a tail spin. The NSEL had this to say in its press release: “Such structural change has disrupted the market equilibrium as volumes on the Exchange have gone down significantly. It created conflicting views in the minds of large number of members that there are certain regulatory issues pertaining to the contracts running on the Exchange in view of direction dated July 12, 2013, which has been widely reported in media. This abrupt action has created uncertainty and doubt about continuity of trading on the Exchange and hence most of the participants started withdrawing from the market. While the Exchange has run successfully without any disruption since last five years, such structural change has created market dis-equilibrium, leading to this scenario.”

Meanwhile, financing costs in the real-world for stokiests has probably gone back up and beyond 30%. And this happened: