According to John Kemp, columnist at Reuters, last month was the first time in more than three years that the non-energy components of the Goldman Sachs Commodity Index were collectively in backwardation, meaning that investors following a passive strategy of rolling from commodity front-month contracts into the succeeding month were being paid, rather than being charged, to roll their positions.
The chart below, taken from Kemp’s blog, shows the monthly roll returns from the index’s non-energy components. However, Nymex crude oil futures have also seen their contango shrink, while Brent oil contracts moved briefly into backwardation last week, suggesting that a similar overall trend is occurring in the energy sector.
As Kemp notes in his blog, between 2005 and 2008 the sharp rise in commodity prices meant that investors in commodity trackers like ETFs were less concerned about the negative roll yield resulting from contango than they might have been.
Since 2008, however, roll costs have been a significant burden on trackers following the typical strategy of rolling from the front-month futures contract to the next. In cases of extreme contango, such as that which we saw in oil and gas last year, the negative roll yield offset almost all the increase witnessed in the spot commodity price (for more detail on this, see the articles we published in November last year, “Contango Blues” and “Rolling Into Trouble”).
The outsized profits made by traders taking the other side of the ETFs’ futures positions have meant that specialised strategies have been set up to copy them. Many new investors have been seeking to capitalise on these so-called “cash and carry” strategies. The net result has been to eat away the contango that made these cash and carry trades so profitable.
As Kemp writes in another article from earlier this week, “well-connected banks and physical traders exploited the difference between the actual cost of financing, storing and insuring raw materials and the implied cost in upward sloping futures prices as a source of comparatively low risk profits. This has helped commodity markets carry record stocks and supported overproduction of many raw materials through the recession and the early stages of the recovery with only minimal downward pressure on prices.”
In what might be interpreted as a response to changing market conditions, Goldman Sachs, which made record profits from its commodity trading division during the first half of last year when energy contango was at its peak, has just announced that it is winding down some of its raw materials trading activities. Are the pickings now becoming too slim?
It’s ironic that a new aluminium ETF involving physical storage of the commodity (as opposed to existing aluminium ETFs and ETCs that gain their exposure through futures) is rumoured to be on the verge of being launched just as the primary reason an investor might want to own a physical fund is going away.
For other investors in commodity trackers, though, the disappearance of contango is at least one less thing to worry about.