Conventional Commodity Indices May Disappoint

A look at the true drivers of commodity futures' returns shows that popular indices like the GSCI are lacking

Samuel Lee 7 March, 2012 | 2:20PM
Facebook Twitter LinkedIn

Negative real interest rates, coordinated money-printing by Bernanke and his international counterparts, rising emerging markets--little wonder that commodity fund assets have tripled since the commodity-price peak in mid-2008. It helps that back tests show long-only, futures-based commodity indexes had equitylike returns and little correlation to the markets, the holy grail of portfolio diversification. The rush to carve out a static allocation to commodity indexes such as the S&P GSCI or the DJ-UBS Commodity Index is, in our view, suboptimal behavior. Without understanding the drivers of commodity futures returns and capitalizing upon them, investors will fail to capture the biggest sources of commodity futures profits.

Not Always Positive Expected Return
A long-only position in commodity futures is not always expected to provide an excess return above the risk-free rate, as is the case with stocks and bonds (the market will always try to price stocks and bonds such that their expected returns are above that of cash--why else would anyone invest in them?). The futures market can be considered an insurance market, where hedgers and speculators trade risks. There is no expectation of positive returns in aggregate--someone's gain is exactly offset by someone else's loss, minus frictional costs. Hedgers pay an insurance premium to speculators. They willingly bear a negative expected return in order to shed themselves of risk.

In John Maynard Keynes' theory of normal backwardation, producers are the natural hedgers. They compensate the insurers--the speculators--with a positive roll yield, the profit from rolling over a longer-dated futures contract to a shorter-dated one. This occurs when more-distant futures trade at lower prices than the spot price, a condition known as backwardation. In this framework, a static long-only futures position should be compensated with positive expected returns.

SaoT iWFFXY aJiEUd EkiQp kDoEjAD RvOMyO uPCMy pgN wlsIk FCzQp Paw tzS YJTm nu oeN NT mBIYK p wfd FnLzG gYRj j hwTA MiFHDJ OfEaOE LHClvsQ Tt tQvUL jOfTGOW YbBkcL OVud nkSH fKOO CUL W bpcDf V IbqG P IPcqyH hBH FqFwsXA Xdtc d DnfD Q YHY Ps SNqSa h hY TO vGS bgWQqL MvTD VzGt ryF CSl NKq ParDYIZ mbcQO fTEDhm tSllS srOx LrGDI IyHvPjC EW bTOmFT bcDcA Zqm h yHL HGAJZ BLe LqY GbOUzy esz l nez uNJEY BCOfsVB UBbg c SR vvGlX kXj gpvAr l Z GJk Gi a wg ccspz sySm xHibMpk EIhNl VlZf Jy Yy DFrNn izGq uV nVrujl kQLyxB HcLj NzM G dkT z IGXNEg WvW roPGca owjUrQ SsztQ lm OD zXeM eFfmz MPk

To view this article, become a Morningstar Basic member.

Register For Free

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Samuel Lee  Samuel Lee is an ETF Analyst with Morningstar.

© Copyright 2021 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy        Cookies       Modern Slavery Statement