The shape of the commodity forward curve — whether it slopes upward (contango) or downward (backwardation) — is not just a pricing curiosity. It determines whether a long futures roll costs money (contango) or earns money (backwardation), which is the dominant driver of commodity index returns over time. It signals the physical supply-demand balance to the market. And it determines what price a hedger can lock in versus what they expect to receive in the spot market.
Two competing theories explain the relationship between the futures price and the expected future spot price. The Keynes/Hicks view is institutional: hedgers are net short, so speculators must be net long and require a positive expected return to bear the risk — meaning the futures price must be below expected spot (normal backwardation). The modern CAPM view is about systematic risk: the futures price equals the expected spot price adjusted for the systematic risk premium of the underlying commodity, using the same framework as equity valuation.
Learning objectives. After this note you should be able to:
- define contango and backwardation in both the spot-vs-futures and futures-vs-expected-spot senses;
- state the Keynes/Hicks normal backwardation hypothesis and identify when it applies;
- apply the CAPM formula to determine whether a commodity futures price is above or below the expected spot price;
- interpret the shape of the forward curve given inventory signals;
- describe calendar-spread strategies that exploit expected curve shape changes.
In this lesson
- Two definitions of contango and backwardation
- The Keynes/Hicks normal backwardation hypothesis
- The modern CAPM view
- Contango and backwardation in practice
- Calendar-spread strategies
Before you start
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