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We've all heard the adage that it's not the fall from great heights that kills a person, it's that sudden stop at the bottom. Likewise, contango may pinch profits for long-only commodity index investors, but a positive carry literally kills ‘em. Contango is a condition of the futures delivery curve in which the nearby prices are cheaper than deferred contracts. If, for example, June futures are trading for $48 while March futures change hands at only $42, the market's in a $6 contango. Long-only index investors don't like contango markets, because negative roll yields paid when expiring contracts are swapped for higher-priced deferred contracts reduce commodity returns. Contango typically represents the cost of carrying, or storing, a commodity from the nearby market to the deferred delivery: from March to June, in other words. Typically, but not always. Sometimes, there's something extra in the contango: a return above the cost of carry. That's what you've got to watch for. The life span of a contango's extended if there's room for a cash-and-carry trade. Because a carry trade involves financing and storage, not all contango markets yield carry trades, though. The current oil market, for example, flipped into contango back in June 2008 (though there have been occasional and very short excursions into backwardation since then). It wasn't until November, however, that the confluence of low interest rates and storage costs made for a profitable carry. Why's that? Well, if you're going to carry oil, you first have to buy a cargo. That's where the credit comes in. October's 200-basis-point (2%) drop in nominal financing costs certainly made cargos cheaper. Once you have a cargo, of course, you need a place to put it. Storage costs are, not surprisingly, keyed to supply. Storage is relatively cheap if there's a lot of capacity available. Last fall, landside storage capacity was augmented by idled tanker ships. A carry trade gives real legs to a contango. It, of course, depends upon a contango and can be unwound if the oil market slips into backwardation. Quarterly Oil Contango Vs. Cash-and-Carry 
The cash-and-carry, however, will disappear before the contango. So think of it as the canary in the coal mine. Once the carry trade dissipates, the contango will eventually follow. Not immediately, mind you. After all, it took five months for the trade to appear. No matter how long it takes for the contango to evaporate, you can be sure it won't be soon enough for long-only commodity index investors.
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