Borrowing In a Backwardation is Bad

LME aluminium, copper, and zinc are now firmly in a backwardation. With several threats to nearby supply, those backwardations could become considerably tighter before conditions improve.

This is important because physical traders are typically long before they sell. Once those positions are hedged they will be short futures - and potentially exposed to expensive rolls if the timing of their physical sales changes.

Avoiding those costs - or even better, profiting from backwardations - requires careful forward planning.

But for those new to the industry, it can be surprisingly confusing to remember which carry trades are beneficial. Whenever I teach spread trading I use a simple phrase:

Remember the three B's: Borrowing in a Backwardation is Bad.

It sounds slightly childish, but it is extremely effective.

If borrowing in a backwardation is bad (it costs money) then borrowing in a contango must be good (it makes money). And because lending is the opposite to borrowing then lending in a backwardation is good, and lending in a contango is bad.

Like most trading concepts, repetition and practice eventually make this second nature. But while you are still learning, this simple phrase can help prevent a costly mistake.

I did consider trademarking this phrase but my wife informed me that most people wouldn't want a T-shirt that says "Borrowing in a Back is Bad (™)." However, I'm here to be convinced otherwise.