 Hey guys, it's MJ the students actually and in this video. I want to talk about Contego and backwardation so Contego is not a style of Latin American dancing But it's a situation when our futures price is greater than the expected future spot price Now that sounds very complicated. So let's break it down with an example So let's say we have restored yellow. Let's say we have a chunk of gold So we have this piece of gold and it's currently trading at a price of 10 rend In the future That price is gonna be worth Let's just say we expect it to go up to 30 rend Contego means that the current future price So the price of the futures contract Is going to be greater than 30 so it has to be selling like 40 okay, so You're locking in the futures price at 40 Whereas it's only going to go to 30 which means this is a future that is seven days away When it's six days away Then the contract will be a little bit less. It might be say 39 and then five days away It will be say 35 and it will come and it will converge to 30 so What we call this is a downward sloping futures curve so what we see here is this is time and this is the price of the future, okay, so The vet look your contracts value decreases with time Which means if you had to buy the future hold it for seven days You would lose 10 rend if it was the expected spot price So why would anybody do this? I mean this seems pretty dumb doesn't it you buying something at 40 rend and In seven days time, it's only expected to be 30 rend Well, not necessarily remember this is a futures price and a lot of textbooks will refer to it as an unknown But you can actually think of it as a random variable It's a random variable whose actual value is you know, it's uncertain So we don't know what this 30 is gonna be This is what we expect it to be so there could be a 50% chance that it is 15 and a 50% chance that it is 45 Which means if you're buying it at 40 and You're trading it in here. You could actually realize a profit, which is why some people will do it But One of the reasons or what you might just say is well, okay Why don't we just rather buy the physical gold at 10 rend and then whether it's 50% at 15 or 50% of 45 We make a profit either way so Isn't that the more logical thing to do is just to buy the gold Not really because you see when you buy gold You have to store it You have to secure it and If you live in South Africa, you probably want to ensure it as well and What we refer to this is this is a carrying cost So holding gold actually costs you money and this is why Warren Buffett's very much against commodities Or he doesn't see the benefit in it You spend a lot of money on gold and then you have to spend a lot of money on storing it a lot of money on protecting it and a lot of money on ensuring it and it's kind of like if This will say it's cash flow diagram You're making this big payment share and then you're making all these other payments going on and you're hoping that you can sell it later At a price more than this and this combined So we call this commodity in Contego And so the futures contract This 40 rent this additional amount to the 10 rent is is like the premium for For not having to spend money and worrying about these carrying costs And this makes a lot of sense, especially when you've got something like your commodity is Like a bunch of cattle, okay If you want to like they say you think that the the price of cattle is gonna go up You really don't want to buy 2000 cows Because the thing is where on earth. Are you gonna put 2000 cows for seven days? Or if you buy it for say a two-year future contract, you know, then you're gonna need to rent a farm You're gonna have to get some shepherds or cowherders or whatever those things are You're gonna have to give it food then one of the cows might die So you need insurance and you have to replace it and I mean On a commodity such as con such as cattle like beef pork and all of these We would expect to see this whole thing known as Contego and that actually is what Contego is There is a flip side to it, which is known as backwardation where the price of the future actually increases In time, but I'm thinking let me do another video on that Just so that people who are happy with Contego can just skip straight to that one and people want to focus on Contego Can just watch this one But there we go that is Contego in a nutshell with a downward sloping futures curve And you're paying the premium so that you don't have to carry the actual commodity Thanks guys so much for watching and I'll see you next time when we talk about backwardation. Cheers