Storage, Transport and Cost of Carry
Physical goods need warehouse space and insurance, and they tie up money. The cost of carry sets the price gap between buying now and buying later.
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Text version · Physical Commodities, lesson 3: “Storage, Transport and Cost of Carry”
Physical goods need warehouse space and insurance, and they tie up money. The cost of carry sets the price gap between buying now and buying later.
Physical goods cost money just sitting there
cost of carry = storage + insurance + interest on the money. Gold takes up almost no space, but natural gas needs special storage facilities.
Forward ≈ spot + cost of carry
A price for “delivery later” has to include the cost of carry over that time, so forwards are often pricier than spot. This is called contango.
In a shortage: spot is pricier than forwards
Having goods on hand keeps factories running; this benefit is called the convenience yield. When spot is scarce it outweighs the cost of carry: people would rather pay more to get the goods now, so forwards end up cheaper, which is backwardation.
Key takeaways
- Cost of carry = storage + insurance + financing interest (− the convenience yield of holding the physical goods).
- Forward price ≈ spot price + cost of carry, which also explains why futures are often in contango.
- When physical supply is tight, convenience yield is high and forwards can even trade below spot (backwardation).
- Commodities that are hard or expensive to store (natural gas, fresh produce) swing more in price.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Example” and press ▶ to play to month 3: with spot at $100 and $1 a month in costs, what's the 3-month forward price?
- Click “Gold”, “Wheat” and “Natural gas” in turn and compare the monthly cost of carry: which one costs the most to store?
- Pick “Gold” and drag the funding rate to 0%: how much cost of carry is left? Where does most of gold's cost come from?
- Keep the “Example” settings and drag the holding period from 3 to 12 months: how do the forward price and the contango change?
Quiz and explanations
- 1. Spot is $100 and storage plus financing costs $1 a month. Roughly what's a fair 3-month forward price?
- Answer: $103.$100 + 3 × $1 = $103.
- 2. Which commodity usually has the highest storage cost?
- Answer: Natural gas.Natural gas needs specialized facilities; it's bulky and hard to store.
- 3. Spot is $80, storage + insurance is $0.30 a month and the financing rate is 6% a year. Roughly what's a fair 2-month forward price?
- Answer: $81.40.Monthly interest is $80 × 6% ÷ 12 = $0.40, plus $0.30 = $0.70 a month; 2 months is $1.40, so the forward ≈ $81.40.
Terms in this lesson
- backwardation (Backwardation): A market where futures (or later months) trade below spot (or nearer months).
- cost of carry (Cost of Carry): The storage, insurance and financing costs of holding a physical commodity.
- contango (Contango): A market where futures (or later months) trade above spot (or nearer months).
- convenience yield (Convenience Yield): The benefit of holding the physical goods, like never running short at the factory; the scarcer the supply, the higher it is, and forward prices can even drop below spot (backwardation).