I have retrieved the below term structure curve for livestock (lean hogs) from Bloomberg and noticed that it is inverted. I have a vague intuition that this has to do with the storage costs and perishability of agricultural underlyings, but I lack a rigorous explanation. Searching for the solution online has yielded publications and PhD theses on term structure models which slightly exceed my understanding as an undergraduate student.

I would thus greatly appreciate any suggestions for economic explanations.

Term structure of lean hogs.


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In Keynes's Treatise on Money he argued that the phenomenon you describe, known as "normal backwardation", is due to the fact that certain commodities producers hedge their price risk (importantly, they hedge their risk much more than consumers) by selling futures. The intuition for why the producer does this is that it allows the producer to lock in the price of the commodity in advance, allowing them to plan their production based on a guaranteed price.

Now, remember that relatively fewer consumers hedge their risk than producers. Intuitively, this might be because, for example, if the price of pork rises significantly, consumers can easily adapt by substituting away from it; in contrast, if the price of pork falls significantly, pork producers who have been raising pigs for months are unable to adapt easily and may face a significant loss. So the risk is concentrated on producers, and selling futures is essentially just shifting this risk from the producers out into the financial system so that it is (hopefully) more dispersed.

But now the twist: because there aren't a lot of consumers who feel that it's important to lock in today the cost of a ham in the future, there are no natural buyers of these futures. As a result, producers have to sell pork futures at a discount to the expected future spot price, to compensate people for accepting the risk. When this is the case, futures prices in these markets are said to experience normal backwardation.


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