Facts and Fantasies about Commodity Futures

Facts and Fantasies about Commodity Futures -...

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Financial Analysts Journal Volume 62 . Number 2 02006, CFA Institute Facts and Fantasies about Commodity Futures Gary Gorton and K. Geert Rouwenhorst For this study of the simple properties of commodityfutures as an asset class, an equally weighted index of monthly returns of commodityfutures was constructedfor the July 1959 through December 2004 period. Fully collateralized commodityfutures historically have offered the same return and Sharpe ratio as U.S. equities. Although the risk premium on commodityfutures is essentially the same as that on equitiesfor the study period, commodityfutures returns are negatively correlated with equity returns and bond returns. The negative correlation is the result, primarily, of commodity futures' different behavior over a business cycle. Commodityfutures are positively correlated with inflation, unexpected inflation, and changes in expected inflation. C ommodity futures are still a relatively unknown asset class, despite being traded in the United States for more than 100 years-and elsewhere for even longer.1 The reason may be that commodity futures are strikingly different from stocks, bonds, and other conventional assets. Among these differences are the following: (1) commodity futures are deriva- tive securities, not claims on long-lived corpora- tions; (2) they are short-maturity claims on real assets; and (3) unlike financial assets, many com- modities have pronounced seasonality in price lev- els and volatilities. Another reason that commodity futures are relatively unknown may be more prosaic-namely, the paucity of commodity futures return data.2 The economic function of such corporate secu- rities as stocks and bonds-that is, liabilities of companies-is to raise external resources for the company. Investors in these securities are bearing the risk that the future cash flows of the company may be low and may not occur during bad times, such as recessions. Investors expect to be compen- sated for taking these risks. These claims represent the discounted value of cash flows over long hori- zons. Their value depends on the decisions of cor- porate managers. Commodity futures are quite different; they do not raise resources for companies to invest. Rather, commodity futures allow companies to obtain insurance for the future value of their outputs (or inputs). Investors in commodity futures receive compensation for bearing the risk of short-term commodity price fluctuations. Commodity futures do not represent direct exposure to actual commodities. Futures prices represent bets on the expected future spot price. Inventory decisions link current and future scar- city of the commodity and, consequently, provide a connection between the spot price and the expected future spot price. But commodities them- selves, and hence commodity futures, display many differences. Some commodities are storable and some are not; some are input goods and some are intermediate goods. We provide here some stylized facts about com-
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Facts and Fantasies about Commodity Futures -...

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