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Yale ICF Working Paper No. 04-20
June 14, 2004
FACTS AND FANTASIES ABOUTCOMMODITY FUTURES
Gary GortonUniversity of PennsylvaniaK. Geert RouwenhorstYale School of Management
This paper can be downloaded without charge from theSocial Science Research Network Electronic Paper Collection:http://ssrn.com/abstract=560042
Facts and Fantasies about Commodity Futures
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Gary GortonThe Wharton School, University of Pennsylvaniaand National Bureau of Economic ResearchandK. Geert RouwenhorstSchool of Management, Yale UniversityThis Draft: June 14, 2004
Abstract
We construct an equally-weighted index of commodity futures monthly returns over theperiod between July of 1959 and March of 2004 in order to study simple properties of commodity futures as an asset class. Fully-collateralized commodity futures havehistorically offered the same return and Sharpe ratio as equities. While the risk premiumon commodity futures is essentially the same as equities, commodity futures returns arenegatively correlated with equity returns and bond returns. The negative correlationbetween commodity futures and the other asset classes is due, in significant part, todifferent behavior over the business cycle. In addition, commodity futures are positivelycorrelated with inflation, unexpected inflation, and changes in expected inflation.
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We thank Dimitry Gupalo and Missaka Warusawitharana for research assistance, AIG Financial Productsfor financial support, Michael Crowe of the London Metals Exchange for assistance with data, Chris Lownof the Commodities Research Bureau (CRB) for assistance with the CRB data, and Frank Strohm and AmirYaron for comments and suggestions.
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1.
Introduction
Commodity futures are still a relatively unknown asset class, despite being traded in theU.S. for over 100 years and elsewhere for even longer.
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This may be because commodityfutures are strikingly different from stocks, bonds, and other conventional assets. Amongthese differences are: (1) commodity futures are derivative securities; they are not claimson long-lived corporations; (2) they are short maturity claims on real assets; (3) unlikefinancial assets, many commodities have pronounced seasonality in price levels andvolatilities. Another reason that commodity futures are relatively unknown may be moreprosaic, namely, there is a paucity of data.
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The economic function of corporate securities such as stocks and bonds, that is, liabilitiesof firms, is to raise external resources for the firm. Investors are bearing the risk that thefuture cash flows of the firm may be low and may occur during bad times, likerecessions. These claims represent the discounted value of cash flows over very longhorizons. Their value depends on decisions of management. Investors are compensatedfor these risks. Commodity futures are quite different; they do not raise resources forfirms to invest. Rather, commodity futures allow firms to obtain insurance for the futurevalue of their outputs (or inputs). Investors in commodity futures receive compensationfor bearing the risk of short-term commodity price fluctuations.Commodity futures do not represent direct exposures to actual commodities. Futuresprices represent bets on the expected future spot price. Inventory decisions link currentand future scarcity of the commodity and consequently provide a connection between thespot price and the expected future spot price. But commodities, and hence commodityfutures, display many differences. Some commodities are storable and some are not;some are input goods and some are intermediate goods.In this paper we produce some stylized facts about commodity futures and address somecommonly raised questions: Can an investment in commodity futures earn a positivereturn when spot commodity prices are falling? How do spot and futures returnscompare? What are the returns to investing in commodity futures, and how do thesereturns compare to investing in stocks and bonds? Are commodity futures riskier thanstocks? Do commodity futures provide a hedge against inflation? Can commodity futuresprovide diversification to other asset classes? Many of these questions have beeninvestigated by others but in large part with short data series applying to only a smallnumber of commodities.
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An exception is Bodie and Rosansky (1980), who studiedcommodity futures over the period 1950 to 1976, using quarterly data.
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In this primer we
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Modern futures markets appear to have their origin in Japanese rice futures, which were traded in Osakastarting in the early 18
th
century; see Anderson, et al. (2001).
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For example, the University of Chicago Center for Research in Security Prices has no commodity futuresdata, nor does Ibbotson Associates. In addition, the well-known commodity futures indices either do notextend back very far or cannot be reproduced for various reasons.
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There is a very large literature on commodity futures. For example, see the papers collected in Telser(2000).
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Bodie and Rosansky (1980) obtained their data from a U.S. Department of Agriculture publication calledCommodities Futures Statistics and from the Journal of Commerce.
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