The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Tuesday, January 23, 2007

Contango Fango: The languid state of oil & commodity prices

This post is a follow up to a previous blog post Glenn Gould and Commodity Prices (Nov. 9, 2006). The Economist magazine's Buttonwood column had an article on the ongoing languid state of oil and copper prices: Oil's not well: A fall in commodity prices raises concerns about the appetite for risky assets (Jan. 11, 2007). According to the article, January 9th of this year saw crude prices at an 18-month low. Copper prices, which had risen to lofty levels, aren't doing much better. All of this is despite rather compelling stories of increased geopolitical risk which should increase commodity prices and decrease emerging market asset values (it might have the latter effect, but it is not currently having the former effect).

The Buttonwood piece cites several reasons for why commodity prices are in a slump and also debunks some reasons that have been offered up for the current languidness of oil and copper prices. As I had suggested in the 'Glenn Gould ...' blog post, the slump probably has more to do with the fickleness of speculative capital than any of the rationales that have been offered up. Buttonwood concurs. As the article points out, speculation in commodities futures created a phenomena known as 'contango' -- where roll yields are negative (i.e., futures prices are higher than spot prices) and futures investors had a harder time making a profit (since they can't count on futures prices to rise to future spot prices). Factoring this in means that commodities speculators lost money even if the spot prices of commodities had remained high (and even that might no longer be true).


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