The Fundamentals of Commodity Futures Returns
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What they found
The theory of storage says that when inventories are low, spot prices rise above futures (backwardation) and the risk premium is high because the commodity cannot be easily obtained. The authors collected physical inventory data for 31 commodities from 1969 to 2006 and tested this. Low inventories predicted backwardation, higher volatility, and higher futures risk premiums; signals like the futures basis, past returns, and spot price changes forecast returns largely because they proxy for inventory. Positioning of speculators and hedgers did not add much once inventories were controlled for.
See it drawn
Original diagrams for the ideas on this page. Illustrative, not real market data.
What you can use
- Commodity futures returns are driven by physical scarcity: low inventories mean backwardation, high volatility, and high expected returns.
- Backwardation and momentum work in commodities because both are signals of tight inventories.
- Inventory data, where available, is the underlying fundamental; the futures curve is its market-price reflection.
Caveats
Inventory data is hard to obtain and imperfectly measured. Sample ends before the 2008 boom and bust. Technical.
Tags: commodities, futures, inventories, theory-of-storage
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.