|  MAR 1991

Spread Prices As A Leading Indicator by Curtis McKallip Jr.

Spread Prices As A Leading Indicator by Curtis McKallip Jr. Commodities that are deliverable today trade at a different price than the very same commodity to be delivered in the future. This price differential is called a spread. Spreads exist because of two factors: charges (usually interest and storage charges) and relative demand for a product. Assuming these two factors stay relatively constant, the spread is controlled by the demand anticipated in the short run versus that for longer periods. A recent extreme example of a commodity spread is crude oil during the 1990 Iraqi/Kuwait crisis, when near-month contracts were bid up higher than far-month contracts because of the threat of a short-term supply disruption. Financial and gold contracts trade mostly on real and anticipated interest rate differentials. For this reason, their spreads are much more complex to analyze. Month-to-month spreads often can be used to pick tops and bottoms in agricultural commodities. The following examples show how spreads often diverge from price action at critical points. While the method doesn't always work, it can be a very helpful tool.

by Curtis McKallip, Jr.