Reading 49: Investing in Commodities- LOS a～ Q1-7

others, future, natural, limited, indicate

LOS a: Explain why some commodity futures such as gold have limited “contango,” while others such as oil often have natural “backwardation” and indicate why these conditions might be less prevalent in the future.

Q1. Minnie Adams, CFA, and Cornelia Peters, CFA, are two sell side analysts working for a large London-based investment firm. They are engaged in a discussion on the recent surge in oil prices.
Adams states: “Airlines are the unfortunate victims of high oil prices. To mitigate the risk of further price increases, they frequently use commodity futures, driving futures prices above the spot price. I recall that this is referred to as backwardation.”
Peters adds: “Airlines are often not the only users of commodity futures. High oil prices attract speculators with long positions in oil futures for their portfolio. This would likely decrease the level of backwardation.”
With regard to their statements:

A) only Adams' is correct.

B) only Peters' is correct.

C) both are incorrect.

Q2. Kornelia van Melles is the rather eccentric owner of M’s, an upscale Amsterdam art gallery famous for its rare china and pottery. The gallery has been extremely profitable since its opening 15 years ago, in large part due to Melles’ ability to find unique art pieces and her large network of patrons. While most of her wealth is tied up in the gallery, she has also been able to build up a sizeable investment portfolio. The portfolio, until recently managed by a large investment management firm, was invested mainly in small-cap stocks which suffered significant losses over the past two years. Following a heated debate with her portfolio manager, Melles sold her investments, withdrew the funds and invested the entire proceeds in government treasury bills. The portfolio today is worth

[2009] Session 13 - Reading 49: Investing in Commodities- LOS a～ Q1-7

Q1. Minnie Adams, CFA, and Cornelia Peters, CFA, are two sell side analysts working for a large London-based investment firm. They are engaged in a discussion on the recent surge in oil prices.
ffice:smarttags" />Adams states: “Airlines are the unfortunate victims of high oil prices. To mitigate the risk of further price increases, they frequently use commodity futures, driving futures prices above the spot price. I recall that this is referred to as backwardation.”
Peters adds: “Airlines are often not the only users of commodity futures. High oil prices attract speculators with long positions in oil futures for their portfolio. This would likely decrease the level of backwardation.”
With regard to their statements:

A) only Adams' is correct.

B) only Peters' is correct.

C) both are incorrect.

Correct answer is B)

Adams’ statement is incorrect, since when consumers’ demand for commodity futures drive futures prices above the spot price, this is referred to as contango. Peters’ statement is correct. Speculators with long positions in futures drive futures prices up, reducing backwardation and increasing contango.