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How to interpret forward curves

13 Feb 2020

Forward curves are an important instrument in supply and demand analysis. They are constructed by drawing a line along the sequence of futures contract price quotations, typically proceeding forward for about 18 to 24 months from the spot or nearby futures month at fixed monthly intervals.

Forward curves displaying successively higher price quotations over time – called contango – are upward sloping. These indicate a surplus supply situation relative to demand and relay a “buy“ or “hold” signal to participants along the commodity supply chain. Forward curves displaying successively lower price quotations over time – called backwardation – are downward sloping. These indicate a deficit supply situation relative to demand and relay a “sell” signal to participants along the supply chain.

In agricultural markets which feature renewable commodities, forward curves often include both upward sloping and downward sloping configurations that proceed from a surplus situation right after harvest time to relative scarcity towards the end of the crop year.

Certain portions of the forward curves are commonly referred to as “spreads” and are quoted as the arithmetic difference between the nearest and the furthest contract month. For example, the difference between the July and November soybean contracts of any one year is keenly watched as a highly dynamic spread. To illustrate, in 2013, the July/November spread displayed steep backwardation reaching a level of USD 132 per tonne as global demand exceeded supplies. Conversely, in 2018, the July/November spread declined from a small inverse to a USD 9 contango as the demand rate slowed amid abundant supplies.

In 2019, the maize market exhibited dynamic movement during the growing season between June 20 and August 20. As record spring rainfall threatened to reduce acreage and yields dramatically, the y/y spread between December 2019 and December 2020 reached a high point of USD 18.21 inversion in June. Following the USDA August crop report, which projected larger crops than private estimates, the spread declined to USD 18.01 contango by late August, moving more than USD 36 in total (see image).