Commodity Curves for Beginners: Contango and Backwardation Without Confusion

• Commodity ETFs that track futures don’t always follow the spot price, because futures curve shape and roll timing change returns.
• Contango happens when later futures are more expensive than near-term futures, and it can cause negative roll yield.
• Backwardation happens when later futures are cheaper, and it can create positive roll yield that helps ETF returns.
• Simple numeric examples show how an ETF that rolls from front-month to next-month contracts can lose or gain value even if spot price is flat.
• Before you buy a commodity ETF, check the futures curve, read the prospectus for roll rules, and consider alternatives if you want pure spot exposure.

Introduction

Commodity curves describe the prices of futures contracts across different delivery months. Understanding contango and backwardation helps you see why commodity ETFs that track futures may behave differently from the underlying cash commodity you expect to own.

Why does this matter to you as an investor? Because if you buy a commodity ETF without knowing how it rolls futures, you can get surprises in performance over weeks, months, and years. Will your ETF lose value even if oil’s spot price stays the same? Could it outperform the spot market? You’ll learn how and why.

This article explains the mechanics in plain language, shows a simple curve example with numbers, and gives practical steps you can use when evaluating commodity ETFs like $USO and $UNG. You’ll learn what roll yield is, how the term structure forms, and how to reduce unwanted surprises in your portfolio.

How futures curves work

A futures curve is a sequence of futures contract prices for different delivery months, laid out from the nearest month to farther-out months. Traders call this the term structure. The curve tells you what buyers and sellers expect to pay at different future dates.

Two common shapes matter a lot: contango, where farther contracts cost more than near-term ones, and backwardation, where farther contracts cost less. The curve can change daily because of supply forecasts, seasonal demand, storage costs, and geopolitical events.

Key drivers of curve shape

Storage costs, insurance, and financing push future prices higher than spot. When those costs outweigh benefits, you often see contango. In contrast, when immediate availability is valuable because of tight supply or seasonal demand, you can see backwardation, where front-month prices are higher than later months.

Convenience yield is a concept that helps explain backwardation. It captures the non-monetary benefit of holding the physical commodity now versus holding a contract for later delivery. When that benefit is high, the curve tends to slope downward.

Contango and backwardation explained

Contango means future prices increase with maturity. If the near-month contract is $50 and the next-month is $52, the curve is in contango between those months. When an ETF repeatedly sells the near-month and buys the next-month, it is selling low and buying higher, which creates a negative roll yield.

Backwardation is the opposite. If the near-month is $50 and the next-month is $48, the ETF sells high and buys lower, capturing positive roll yield. That boost can help ETF returns even if the spot price does not move.

Roll yield in plain English

Roll yield is the gain or loss created when an ETF (or any futures investor) sells a nearer contract and buys a later contract as the front month approaches expiration. It is separate from the actual price movement of the commodity.

Think of roll yield as a transfer that happens because contracts for different months are priced differently. If you don’t account for it, you might expect an ETF to track spot, but instead you get spot plus or minus roll yield over time.

Why commodity ETFs can behave unexpectedly

Many commodity ETFs don’t hold the physical commodity. Instead they hold a sequence of futures contracts and continuously roll from the front-month contract into later months. The ETF prospectus describes the roll schedule, but investors often skip that step.

Because ETFs roll, their returns depend on two things: changes in futures prices and the roll yield created by the curve. Even if spot is flat, contango can slowly erode the ETF’s net asset value, while backwardation can add returns.

Examples of ETFs with roll effects

$USO is a widely known example that tracks crude oil futures. During periods of deep contango in oil, $USO has shown negative performance relative to spot because it sold cheaper front-month contracts and bought more expensive next-month contracts.

$UNG, which tracks natural gas futures, has a history of significant roll losses because natural gas often shows strong contango outside of high-demand winter months. Compare these to physical metal funds like $GLD that hold bullion, and you’ll see why ETF structure matters.

Practical example: a simple curve and an ETF roll

Let’s walk through a concrete numeric example you can follow. We’ll use a hypothetical commodity with a two-month part of the curve so you can see the mechanics.

Assume front-month price is $100 and next-month price is $104. The ETF holds the front-month contract and on the final trading day it sells that contract and buys the next-month contract, repeating every month.

Contango example with numbers

1. Start: ETF holds front-month at $100.
2. At roll: it sells the $100 contract and buys the $104 contract, a 4% price increase to replace exposure.
3. If the spot price stays at $100 over the month, the ETF has a 4% roll loss because it sold low and bought higher.

So even though the underlying spot didn’t move, the ETF is down roughly 4% from roll mechanics alone. Over many rolls, that compound effect becomes sizable.

Backwardation example with numbers

1. Start: front-month $100, next-month $96.
2. At roll: ETF sells $100 and buys $96, making a 4% gain from the roll alone.
3. If spot stays unchanged, the ETF gains roughly 4% because it replaced exposure with a cheaper contract.

That positive roll yield helps performance over time in backwardation. In real markets, shapes vary across months and years so roll yield can change often.

Real-world considerations and mitigating actions

Here are practical steps you can take when evaluating or holding a commodity ETF. These are actionable checks you can do before you buy and while you own the fund.

1. Check the ETF prospectus for roll rules. It explains which contract months the fund holds and when it rolls. Knowing the schedule helps you estimate potential roll effects.
2. Examine the current futures curve. Many broker research pages or commodity exchanges show the curve. Look at the front three to six months to see whether the market is in contango or backwardation.
3. Look at historical roll return or total return differences. ETF factsheets often show how the ETF performed versus the spot proxy over 1, 3, and 5 years. Large gaps often reflect roll yield, not manager skill.
4. Consider alternative structures. If you want pure spot exposure to gold, a physically backed fund may work better than a futures-based ETF. For some commodities, store-and-ship physical ownership is impractical, so be aware of tradeoffs.
5. Size and horizon matter. If you plan short-term trading around roll dates, be mindful of extra volatility. If you hold long term, compound roll losses in contango can be material so monitor the curve periodically.

Common Mistakes to Avoid

• Assuming futures-based ETFs track the spot price exactly, and then being surprised by persistent underperformance. How to avoid: read the prospectus and compare ETF returns to spot and futures indices.
• Ignoring roll dates and the ETF’s roll schedule when trading. How to avoid: mark roll dates on your calendar and expect higher costs or tracking error near those days.
• Using short-term performance to judge long-term suitability. How to avoid: evaluate multi-year returns and understand the term structure environment the ETF has faced.
• Failing to consider tax and fee implications that can amplify roll effects. How to avoid: review expense ratios and tax treatment in the fund’s documentation.

FAQ

Q: What exactly is roll yield and why does it matter?

A: Roll yield is the gain or loss that arises when an investor sells a nearer-dated futures contract and buys a longer-dated contract. It matters because futures-based ETFs perform based on spot changes plus or minus roll yield, so roll shape can significantly affect returns.

Q: Can ETFs avoid roll losses during contango?

A: Some funds use strategies to reduce roll losses, such as holding longer-dated contracts, using optimised roll schedules, or maintaining partial exposure to physical assets. Read strategy details in the prospectus to see what the fund does, because no approach eliminates all risk.

Q: Why do commodities like oil often show contango while others show backwardation?

A: Contango often appears when storage costs and financing are high or when there is ample supply relative to demand. Backwardation usually happens when immediate delivery is more valuable due to tight supply or seasonal demand. Each commodity has different storage and demand dynamics, so term structures vary.

Q: If I want exposure to commodity price moves, what practical options do I have?

A: Options include futures-based ETFs, physically backed ETFs for certain metals, commodity producers equities, or commodity-focused mutual funds. Each has tradeoffs around tracking error, roll yield, liquidity, and cost. Match the product to your investment goals and time horizon.

Bottom Line

Understanding contango, backwardation, and roll yield is essential when you consider commodity ETFs. These funds often hold futures and must roll contracts, so the futures curve can add or subtract returns regardless of spot price moves.

Before you buy a commodity ETF, check the futures curve, review the fund’s roll rules in the prospectus, and compare historical ETF performance to spot and futures indices. If you want to avoid roll risk entirely, look for physically backed products when those exist, or choose investments that align with your time horizon and tolerance for tracking differences.

At the end of the day, a little homework helps you avoid surprises and make clearer decisions about how commodities fit into your portfolio. If you want, start by checking one ETF’s prospectus and the current futures curve this week to see how the mechanics work in real time.