Legal Definitions - normal market

A normal market, also referred to as a contango market, describes a common situation in financial and commodity markets where the price for an asset to be delivered in the future is higher than its current price (known as the "spot" price). This difference in price typically accounts for the various costs associated with holding or "carrying" the asset over time, such as storage expenses, insurance premiums, and the cost of financing (interest) for the period until future delivery.

Here are some examples to illustrate this concept:

• Example 1: Crude Oil Futures

  Imagine the current price for a barrel of crude oil available for immediate purchase (the spot price) is $75. However, a futures contract to buy a barrel of crude oil for delivery six months from now is priced at $78. This scenario represents a normal market because the future price ($78) is higher than the current price ($75).

  How it illustrates the term: The additional $3 per barrel reflects the costs incurred by someone holding that oil for six months, including the expense of storing it in a tank farm, insuring it against loss, and the interest that could have been earned on the $75 if it hadn't been tied up in the oil. These "carrying costs" lead to a higher future price.

• Example 2: Grain Storage

  During a bountiful harvest season, the immediate price for a bushel of corn at a local silo might be $4.50. However, a contract to purchase a bushel of corn for delivery ten months later, well after the harvest period, is quoted at $4.80. This is a normal market situation.

  How it illustrates the term: The higher future price of $4.80 accounts for the costs of storing the corn for nearly a year, protecting it from pests and spoilage, and the financial cost of holding that inventory until it's needed by processors or consumers in the future. The market expects to pay more for corn that has been stored and preserved over time.

• Example 3: Precious Metals

  Suppose the current price for an ounce of silver available for immediate purchase is $25. A futures contract for delivery of an ounce of silver one year from now is trading at $25.75. This indicates a normal market.

  How it illustrates the term: The 75-cent difference primarily reflects the "cost of carry" for silver. This includes the interest that could have been earned on the $25 if it were invested elsewhere for a year, as well as any minimal storage and insurance fees for holding the physical metal. Buyers are willing to pay a slightly higher price in the future to compensate for these holding costs.