Article Review : "Backwardation Economy" By Anthony de Jasay
Both consumption and production can be liable to fluctuations which would influence the preference between present and future. Other things being equal, oil refineries are liable to increase their stocks in the spring in order to satisfy rising demand for gasoline during the summer driving season. Flour mills may well draw down their reserves of grain in the winter in the expectation of plenty full supply from the forthcoming harvest. Commodity markets used to call the increasing demand and the rise in price from one period to the other the contango, and the increase in supply as the backwardation.1 Backwardation in the general, non-technical sense is the subject of the present column.
A holder of a resource at a point we shall call spot wishes to increase his holding at a future date when its price is expected to be higher in the market. He will either wait for the price to rise and leave his position uncovered, or increase his holding at present at the lower price, and thus have his position covered. The interest expense of the purchase at the lower price, and thus the cover of the position, will be the contango and the marginal holder would expect to be indifferent between an uncovered position and the covered position by the expense of the contango interest. For simplicity's sake, we will leave out consideration of interest and storage expense as well as the subjective value, if any, between a covered and uncovered position.
If a holder expects the resource to be lower in price between the spot and a future date, he will either wait for the price to fall and leave its position uncovered, or decrease his spot holding and collect the interest between the spot and the lower future price at which he can cover his position. Abstracting the interest received and the subjective value, if any, of the difference between the covered and the uncovered position, he should be indifferent between the two alternatives. We are examining different market responses under backwardation but not under contango constellations. The contango corresponds to an inflationary and the backwardation to a deflationary horizon.
source : http://www.econlib.org/library/Columns/y2016/Jasaybackwardation.html
A holder of a resource at a point we shall call spot wishes to increase his holding at a future date when its price is expected to be higher in the market. He will either wait for the price to rise and leave his position uncovered, or increase his holding at present at the lower price, and thus have his position covered. The interest expense of the purchase at the lower price, and thus the cover of the position, will be the contango and the marginal holder would expect to be indifferent between an uncovered position and the covered position by the expense of the contango interest. For simplicity's sake, we will leave out consideration of interest and storage expense as well as the subjective value, if any, between a covered and uncovered position.
If a holder expects the resource to be lower in price between the spot and a future date, he will either wait for the price to fall and leave its position uncovered, or decrease his spot holding and collect the interest between the spot and the lower future price at which he can cover his position. Abstracting the interest received and the subjective value, if any, of the difference between the covered and the uncovered position, he should be indifferent between the two alternatives. We are examining different market responses under backwardation but not under contango constellations. The contango corresponds to an inflationary and the backwardation to a deflationary horizon.
source : http://www.econlib.org/library/Columns/y2016/Jasaybackwardation.html
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