I am scrolling through the various metals on lme.com and some are in contango and some in backwardation. For example:

Copper: backwardation

Aluminium: contango

Further examination of other metals reveals the same. Why is this? Why is one metal in contango and another in backwardation?

I guess if I take

$$ f^T(t) = S(t)e^{(r+g-c)(T-t)} $$

where $r$ is the risk free rate, $c$ is storage cost and $g$ is convenience yield then depending if $r+g-c$ is negative or positive you get the two curves. But why would $r+g-c$ be that different for 2 different metals? Could it have something to do with inventories - e.g. full inventories would raise $c$, the cost of storage?

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    $\begingroup$ Supply and demand are not constant across time, so that can also explain the intertemporal substitution -- which interacts with carry and convenience yield to make those also not constant over time. $\endgroup$ – kurtosis Sep 10 '20 at 21:57

There could be any number of explanations for copper to be backwardated and aluminum to be in contango right now.

The simplest (and most correct) explanation is the most vague: that these futures curves represent time-varying expectations of supply and demand over the next half year or so.

More helpful is to know that copper and aluminum took a sharp dip earlier this year due to the precipitate economic slowdown; however, copper has more than recovered while aluminum's recovery has been weaker. Therefore, another reason for copper to be backwardated is that cash and the front contracts have been dragging the rest of the curve upward -- while aluminum has not done that.

We could also look for explanations in the macroeconomy: there is a bit of a recovery in China and Europe and that will lead to more homes being built as well as more vehicles being sold.

Contango in rebar futures (traded in Shanghai) makes the housing story less likely. Figures on construction in China also point to mixed results: growth in residential but shrinkage in commercial properties -- and an across-the-board decline in completions and large declines in sales for commercial and industrial properties.

Vehicle production is another possibility. An increasing number of vehicles are electric, so that would also increase demand for copper while decreasing demand for aluminum (used to make engine blocks). Furthermore, electric vehicle production in July 2020 was up 77% versus July 2019.

Is a shift in vehicle production toward electric vehicles likely to be the explanation behind these two differing curves? If we consider that EVs are changing the marginal vehicle being produced, then that should certainly be part of the reason and should affect prices. However, the real question is if that is a dominant force behind the difference. Without a much more in-depth study, we cannot be certain if shifts to electric vehicle production are the major driving force for the difference.

  • $\begingroup$ Sorry, I think I might have gotten them wrong - I think copper is in contango and aluminium in backwardation - assuming the curves haven't changed since I wrote this. $\endgroup$ – s5s Sep 17 '20 at 15:55
  • $\begingroup$ No, copper is in backwardation: prices are lower for later expirations. Aluminum is in contango since prices are higher for later expirations. If you are looking at the graph on Wikipedia: don't. That graph has confused students for years and is misleading. $\endgroup$ – kurtosis Sep 17 '20 at 19:48

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