"There are three drivers of returns [for commodity investments]: the return on collateral or unused cash, the appreciation of the underlying commodities, and roll yield."
What is Contango, Backwardation, and Roll Yield?
ROLAND MORRIS: Contango describes the shape of a futures curve with appreciating prices. This may cause problems when you're carrying such a product as an investment, because when it comes to the roll date, you must sell the forward contract and replace it by purchasing the next contract at a higher price. This creates negative roll yield, which is similar to negative carry in other investment products.
MORRIS: Backwardation describes a forward futures curve with declining prices. This is a situation where you can create positive roll yield. When it comes time to roll the contract, you must sell the front contract at the higher price and replace the position with the next contract at a lower price. This creates positive roll yield, which is very similar to positive carry in other investment products.
Drivers of Returns
MORRIS: We've now discussed roll yield, both negative and positive, and what creates roll yield. It is an important component in the commodity investment. There are three drivers of returns: the return on collateral or unused cash, the appreciation of the underlying commodities, and roll yield.