VET - response to tyke
To: tyke who wrote (21221) 9/17/2006 12:41:13 AM
From: The Vet Read Replies (1) of 21233
tyke, your comment
"The only trouble is that according to my understanding the metal markets are in backwardation. Does that fact destroy your and their arguments ? ( i.e long roll-overs would be profitable)"
is correct, providing the backwardation is deep enough.
I purposely simplified the examples but of course all trades have a cost in commissions, risk, spreads and holding costs so in order to make a profit on roll overs, the degree of contango or backwardation has to be extreme. (profit or loss depends on whether the person is rolling over short or long positions)
The best current example is copper where backwardation has been quite marked but is tending to revert to the normal contango situation. To my way of thinking, this means that the copper market is settling into a trading range and that extreme spikes are unlikely in the near future. That doesn't mean volatility is dead, but it does mean supply/demand is relatively even and the market is in balance.
In the case of copper I am sure there were long rollovers that were profitable if you were a purely paper trader. The near term contract could be sold for a higher price than you could get the same amount of metal at a later date. However if you were an actual user of copper that didn't help you much if you needed actual metal for production of your goods, not some future profit.
The other factor is risk. The further forward you buy the greater the chance that the price may drop and your paper profit evaporate. The shorts had to roll forward because they were naked short, couldn't deliver, and they had no other option.
No well financed long would roll forward in this case because their highest and safest profit is made by holding out for immediate delivery of a commodity which they could sell on the spot market at an even higher price getting immediate cash in hand.
Why would anyone who had physical copper sell a future contract on that metal for delivery months down the track at a lower price than he could get on the spot market today? Not only would he be locking in a lower price, but he has the storage, holding and carrying costs plus lost opportunity of the cash he could have right now rather than months later.
A miner selling future production which cannot be delivered immediately may sell that in the future, but with a market in backwardation the longer he waits to sell the better off he is as the price rises the closer he gets to the delivery date. As a result in backwardation, miners hold off future sales, delay expansion of mines, avoid hedging and this all combines to limit future supply.
Hoarders of metal and scrap dealers sell their entire stock into the spot market as quickly as possible and that leaves little physical available for offer in the longer dated future months. The shorts are forced to roll forward their paper promises into the future months, where actual real metal is scarce, at whatever they can get which in turn depresses the future price and maintains the backwardation.. and so on...
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