Applied Economics

ISSN: 0003-6846 (Print) 1466-4283 (Online) Journal homepage: http://www.tandfonline.com/loi/raec20

Relative scarcity and convenience yield: evidence

from non-ferrous metals

Akihiro Omura, Richard Chung, Neda Todorova & Bin Li

To cite this article: Akihiro Omura, Richard Chung, Neda Todorova & Bin Li (2016): Relative
scarcity and convenience yield: evidence from non-ferrous metals, Applied Economics, DOI:
10.1080/00036846.2016.1181832

To link to this article: http://dx.doi.org/10.1080/00036846.2016.1181832

Published online: 28 May 2016.

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 APPLIED ECONOMICS, 2016
http://dx.doi.org/10.1080/00036846.2016.1181832

Relative scarcity and convenience yield: evidence from non-ferrous metals

Akihiro Omura, Richard Chung, Neda Todorova and Bin Li
Department of Accounting, Finance and Economics, Griffith Business School, Griffith University, Brisbane, Queensland, Australia

ABSTRACT KEYWORDS
We study the relationship between convenience yield and relative scarcity in the non-ferrous Commodity markets;
metal market for the period January 2000–March 2015. We identify various sets of economic options; economic linkages;
relationships for six major base metals, namely, aluminium, copper, lead, nickel, tin and zinc. Our convenience yield; the
bivariate and multivariate VARs and associated Granger-causality test results generally support theory of storage;
the existence of a positive relationship between convenience yields of base metals and our forecasting
relative scarcity measure. Furthermore, the time-varying characteristics observed in the results, JEL CLASSIFICATION
especially during contango and backwardation periods, provide useful information to market
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G15; Q31; D51; D81; E20

players in developing inventory strategies.

I. Introduction relative scarcity should play an important role in

considering the convenience yield of a commodity.
Non-ferrous industrial/base metals are vital materi-
For instance, thermal coal, natural gas and crude
als for our modern technologies. Understanding how
oil are some of the most commonly traded energy-
spot and future prices are related is crucial for mar-
related commodities and the consumption of each
ket participants including producers, stockists and
commodity can be replaced by the other two. In this
manufacturers to secure stable supply and produc-
sense, the consumption decision on thermal coal is
tion of goods. Furthermore, although the price levels
also determined by the market condition of the other
of major base metals have dropped from their peak
two commodities. Casassus, Liu, and Tang (2013)
in the last several years, drastic price hikes that we
show that the economic linkages contain valuable
have witnessed in the first decade of this century
information useful to understand how the conveni-
have urged investors such as traders to pay more
ence yield of energy commodity behaves.
attention to the non-ferrous metal market. For this
Although there are some studies examining the
reason, disentangling the dynamic relationship
relationship among the prices of industrial metals,
between the futures/forward prices of a shorter
there is no extensive study which expands the theory
maturity and a distant contract is also of great inter-
of storage by applying the notion of relative scarcity.
est to those market participants. This study tests
While Adhikari and Putnam (2014) incorporate a
whether information regarding the supply/demand
notion of economic linkages into their study of the
condition of economically linked commodities helps
theory of storage, they do not directly address the
explain how the two futures/forward contracts with
impact of ‘relative’ scarcity on the convenience yield
different maturity dates are related.
of major industrial metals. To obtain a comprehen-
The theory of storage traditionally aims to explain
sive understanding of how the convenience yield of
the benefits of possessing a physical asset or a short-
base metals is related to the economic linkages
term futures contract, proxied by a notion of con-
among other metals, we have to identify each eco-
venience yield, based on its own scarcity level.
nomic relationship that exists among metals. For
However, the consumption decision of a commodity
example, both copper and aluminium are common
is also affected by the market conditions of other
electrical conductors for cables, lead and zinc are
economically related commodities. In other words,
often mined from the same deposit, and alloys such

CONTACT Akihiro Omura akihiro.omura@griffithuni.edu.au Department of Accounting, Finance and Economics, Griffith Business School, Griffith
University, Brisbane, Queensland 4111, Australia
© 2016 Informa UK Limited, trading as Taylor & Francis Group
 2 A. OMURA ET AL.
as brass are a composite of a number of different
industrial metals. We argue that these economic
relationships should play an important role in deter-
mining the benefits of possessing a physical metal or
a shorter term futures contract. In other words, the
convenience yield of a metal is determined not only
by its own scarcity but also by the dynamic relation-
ship with other closely related metals. By extending
the basic idea of Casassus, Liu, and Tang (2013) to
the industrial metals market, we examine whether
the relative scarcity of metals against other metals
helps understand the behaviour of their perceived
convenience yields. In particular, we conduct a study
on six major base metals, namely, aluminium, cop-
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per, lead, nickel, tin and zinc.
Our examination of empirical convenience yields
and relative scarcity is important and useful for three
main reasons. First, it provides valuable information
to market participants such as metal producers and
commodity traders whether they should also con-
cern the relative scarcity of a metal, in addition to
the absolute scarcity measured by its own scarcity
level, when they establish their inventory and invest-
ment strategies associated with non-ferrous metals.
Based on the report of Metal Bulletin (2013), it can
be estimated that major copper smelters receive less
than 10% of the metal’s value from mining firms as a
processing fee (based on the copper price ranged
between 5000 and 10,000 USD/MT (metric tonne)).
Hence, in order to implement effective inventory
strategies, it is crucial for producers to understand
how perceived benefits of holding physical metals, as
opposed to selling immediately, are determined.
Second, our article also provides valuable infor-
mation to policymakers. The London Metal
Exchange (LME), the largest industrial metal
exchange in the world, is imposing a new warehouse
rule related to the withdrawal time in order to
improve the accessibility of inventories. It is sug-
gested to ask warehouses to increase net load-out
of metals if thresholds queue at a warehouse exceed
50 days (LME 2013). The existing rule is 100 days.
The proposed rule reflects the requests from the
physical industry especially for aluminium and cop-
per. In particular, it is criticized by industrial users
that the inventories in some warehouses are not
1
Our study also shows that economic linkages between two metals can be important in determining the convenience yield of one metal but not for the
other metal. For instance, the relationship between aluminium and copper is shown to affect the convenience yield of copper but not of aluminium.
readily accessible (Troszkiewicz and Kolesnikova
2013). In some cases, it takes up to 2 years to with-
draw a metal from a warehouse (Erheriene 2015). If
the prices of industrial metals are also determined by
the supply/demand environment of other metals, the
withdrawal constraint imposed on the aluminium or
copper market may also destruct other base metals
from settling at their equilibrium prices. Hence, our
study can provide further justification for the LME
to impose this new rule.
Third, our study contributes to further general-
izing the options-based approach framework in the
context of convenience yield approximation. We
employ the options-based approach proposed and
developed by Heinkel, Howe, and Hughes (1990)
and Milonas and Thomadakis (1997) to estimate
the perceived convenience yield of industrial metals.
The options approach has received attention in
recent years, for example, Dockner, Eksi, and
Rammerstorfer (2015), Hochradl and
Rammerstorfer (2012), Lin and Duan (2007),
Omura et al. (2015), Omura and West (2015) and
West (2012).
Through rationalizing the economic relationships
among base metals, we identify a number of eco-
nomic linkages. Our analysis uncovers statistically
significant economic linkages in determining the
convenience yield of non-ferrous metals. The
observed time-varying characteristics of these rela-
tionships have important practical implications for
stockists, producers and traders. In particular, some
of our relative scarcity variables are more significant
during backwardation periods. This is probably
because as the perceived benefits of immediate pos-
session of a physical metal are higher during back-
wardation, market participants pay more attention
to the supply/demand environment of economically
related commodities. Our analysis can help market
participants to choose which economic linkages they
should concern, in addition to the absolute scarcity,
when they attempt to quantify the benefits of obtain-
ing a physical base metal.1
The remainder of the study is structured as fol-
lows. Sections 2 provides a background of the study
and the hypothesis developed through reviewing
past relevant literature. Section 3 presents the data

and method of the study. Sections 4 and 5 report our
empirical results and discuss the findings. Section 6
concludes.
II. Background and research hypothesis
Convenience yield, the theory of storage and
economic linkages
Kaldor (1939) introduces the notion of convenience
yield to explain the spread between spot and futures
prices. He claims that possessing physical assets
allows the holders to make use of them whenever
they wish to. From this reason, a ‘benefit’ of conve-
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nience is awarded to spot prices. Moreover, the
possession of the asset can be a benefit as it mitigates
the risk arising from a possible stock-out. A conve-
nience yield represents all these benefits enjoyed by
owning the actual asset.
One important requirement in eliminating arbit-
rage opportunities is that the convenience yield
should be non-negative (Liu and Tang 2010;
Stepanek, Walter, and Rathgeber 2013; Geman and
Smith 2013). A negative value implies that the
futures contract of a commodity is priced higher
than the relevant spot contract after considering a
necessary cost of storing it. Hence, market partici-
pants can obtain a riskless profit by buying an asset
in the spot market and immediately selling it in the
futures market. In addition, Routledge, Seppi, and
Spatt (2000) demonstrate that since inventory is
bound by zero, benefits of possessing storable com-
modities, which is represented by convenience yield,
equate to a timing option whose value should be
non-negative. This non-negative requirement also
implies that convenience yields (net of storage
costs) cannot be less than the inverse value of the
cost of storage (Omura and West 2015).
Since convenience yields cannot be directly
observed, the cost-of-carry approach is often used
to quantify the convenience yield. The method esti-
mates convenience yield by taking the difference
between the spot (shorter maturity futures contract)
and futures (distant futures contract) prices after
adjusting for necessary carrying charges such as
interest, storage costs and insurance premia.
However, because of the model structure, the cost-
of-carry model can obtain economically implausible
negative values (Stepanek, Walter, and Rathgeber
APPLIED ECONOMICS 3
2013), especially when appropriate carrying charges
including storage costs are not factored in.
This issue is avoided by following Heinkel, Howe,
and Hughes (1990) and Milonas and Thomadakis
(1997) who consider convenience yield as a value
of contingent claim for a payoff from a call option.
In particular, Milonas and Thomadakis (1997)
employ a method of Fischer (1978) to estimate the
convenience yield of three agricultural commodities
and copper by regarding convenience yields as call
options. Kocagil (2004), Lin and Duan (2007) and
West (2012) apply a similar approach which is a
modification of the Black and Scholes (1973) options
price model.
The theory of storage introduced and developed
by Working (1948, 1949) and Brennan (1958) links
the behaviour of convenience yield to the scarcity
level of the commodity. In the context of this theory,
convenience yield is a negative and decreasing func-
tion of its own inventory level. This is because the
inventory absorbs demand and supply shocks on
spot prices but a decrease in the inventory level
amplifies the risk of stock-out and the volatility of
future spot prices as inventory is bounded by zero
(Deaton and Laroque 1992; Gorton, Hayashi, and
Rouwenhorst 2013).
The theory of storage seeks to explain the benefit
of possessing a physical asset using the supply/
demand environment of the same asset (Casassus,
Liu, and Tang 2013). However, as information of an
economically linked commodity helps explain the
supply/demand of other commodities, such a rela-
tionship should also provide valuable information to
understand how convenience yield of the commod-
ity behaves. In particular, many commodities are
produced/extracted/refined from other commodities
(e.g. gasoline is extracted from crude oil), can be
replaced by other commodities (natural gas is a
substitute of coal in the electricity making), have
the same end users (the largest user of palladium
and rubber is the automobile industry), or together
get transformed to a final product (e.g. alloys are
made up of multiple metals).
While some researchers such as Cortazar, Milla,
and Severino (2008) and Chng (2009, 2010) concern
these economic linkages and examine how they are
related to commodity prices, we attribute the initial
development of applying the notion of the relative
scarcity in the context of the theory of storage to
 4 A. OMURA ET AL.
Casassus, Liu, and Tang (2013). In theory, two com-
modities are in (1) a production relationship if one is
produced by processing the other commodity, (2) a
substitution relationship if one can be replaced by
the other commodity, (3) a complementary relation-
ship if an increase in the production/consumption of
one also increases production/consumption of the
other commodity. The relative scarcity level is mea-
sured by the spot price-ratio between the economic-
ally linked two commodities. Following Casassus,
Liu, and Tang (2013), the following paragraphs
explain, using energy commodities as an example,
how those three possible relationships affect the
convenience yield of a commodity.
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Crude oil is an input of gasoline, and the two are
linked through the production relationship. A
demand shock on gasoline stimulates its price to
rise if the inventory does not sufficiently absorb
this shock. Such a shock also stimulates the demand
of crude oil (in order to extract gasoline); however, if
inventory is plentiful, the price of crude oil would
not change. This means that the relative scarcity of
gasoline against crude oil is high and causes an
increase in the current price-level ratio (spot price
of gasoline divided by crude oil). Nevertheless, this
shock will be eventually absorbed by an increase in
the production of gasoline, causing a decrease in the
expected price of gasoline and thereby, increase in its
current convenience yield. In addition, if an increase
in the price-level ratio is caused by an easing supply/
demand environment of crude oil, the production
margin of gasoline will increase as the producers’
margin in the short term is mainly determined by
the difference between the prices of two. When this
happens, producers will attempt to take the advan-
tage by storing a fraction of new production of gaso-
line. As a result, this causes an increase in the
projected inventory level of gasoline and fall in its
expected price. Thus, its convenience yield increases.
Similarly, the relative scarcity of coal against nat-
ural gas which is its substitute can cause an increase
in the convenience yield of coal. When the price-
level ratio (coal over natural gas) increases due to a
positive demand shock on coal, there will be more
incentives to substitute natural gas for coal. This will
cause projected coal inventory to increase and its
expected price to fall. Lastly, for the complementary
relationship, both gasoline and diesel are extracted
from crude oil and the production of either
commodity increases/decreases as the production of
the other changes. A positive demand shock on
gasoline causes its price to inflate but the price of
diesel should be suppressed. This results in an
increasing price-level ratio (gasoline over diesel).
To satisfy the demand, suppliers increase the pro-
duction of gasoline. However, this will cause the
projected inventory level to return back to the equi-
librium level. As a result, the expected price of gaso-
line will fall below the current level and thereby the
convenience yield will increase.
Non-ferrous metals and economic linkages
Adhikari and Putnam (2014) conduct a study by
applying the theory of storage on some major base
metals (aluminium, lead, nickel, tin and zinc) and
also incorporating the idea of economic linkages.
However, they do not (1) specifically identify which
metal is economically linked with other metals, (2)
directly address the impact of relative scarcity, or (3)
take into account of storage costs in estimating the
convenience yield. Instead, they examine how con-
venience yield of a metal is related to its own and
other metals’ inventory levels, and the open interest
obtained from the CRB. Adhikari and Putnam
(2014), therefore, do not address which metals are
economically related, nor do they comprehensively
capture the impact of ‘relative’ scarcity of one metal
against others. Through economic rationalization
stated in the following paragraphs, we identify
major economic linkages for each metal against
other metals.
Firstly, non-ferrous metals are produced by smelt-
ing and refining ores or recycled metals (also known
as secondary or scrap metal), and therefore there is a
production relationship among those raw materials
and the refined metals. While reliable price series of
ores are rarely available, information regarding the
price of secondary metals is often publically avail-
able. In relation to the relative scarcity of metals
arising from the production relationship, Xiarchos
and Fletcher (2009) find evidence that the primary
markets of copper, lead and zinc are related to the
secondary market in the U.S.A.
Secondly, a number of non-ferrous metals can be
substituted by each other. For example, for corrosion
resistance, stainless steel or aluminium can be replaced
with galvanized steel in some cases (Nippon Steel &

Sumitomo Metal Corporation 2012). In addition, cop-
per cables used in the electricity power network, auto-
mobiles and electronic equipment can be substituted,
although not completely, with aluminium cables and
vice versa. Furthermore, electrodes of batteries are
commonly made of alloys, and there exists a substitu-
tion relationship among metals used in those alloys (in
some cases also a complementary relationship). With
utilization of the advantage of material, lead acid bat-
teries are widely used for motor starter in the auto-
mobile industry. Lithium-ion and nickel-ion batteries
are also commonly used in many industries, especially
for applications where high-energy density is required.
For example, lithium-ion batteries are used to power
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electronics such as smartphones and electric vehicles
(Apple 2015; Nissan 2013). Also, as a recent trend,
hybrid vehicles, where nickel-ion cells have been a
popular electricity power source, are also starting to
shift to higher capacity lithium-ion batteries (Toyota
2014; Ford 2012).
Thirdly, complementary relationships also exist
among non-ferrous metals (Adhikari and Putnam
2014). This is because final products of metals
often take the form of alloys. For example, brass is
an alloy made mainly of copper and zinc, and solder
is an alloy of lead and tin. Stainless steel is also
defined as a steel which contains more than 10.5%
of chromium; however, nickel is often added to
increase functionalities of the metal such as a higher
corrosion resistance. From this sense, the two metals
are complements of each other. Furthermore, it is
common that multiple metals are extracted from the
same ore. In particular, zinc and lead are often
mined from the same deposit and hence at this
type of mine, production of the two metals is com-
plement of each other.
Based on the explanations above, we identify var-
ious sets of economic linkages for the six major base
metals, as presented in Table 1. In a number of cases,
Table 1. Economic linkages among base metals.
Types of the economic linkage
Production
Aluminium Al scrap (raw material)
Copper Cu scrap (raw material)
Lead
Nickel
Tin
Zinc
Note: Al is aluminium, Cu is copper, Cr is chromium, Pb is lead, Li is lithium, Ni is nickel, Sn is tin and Zn is zinc.
APPLIED ECONOMICS 5
a metal can substitute and at the same time comple-
ment the production/consumption of another metal,
so we combine the categories of substitution and
complementary into one to avoid misspecification.
In the case of batteries, nickel hydroxide, lithium
manganate and lithium nickel oxide are some of
the popular positive-electrode materials for high-
capacity batteries. Hence, there are both substitution
and complementary relationships existing between
nickel and lithium. The price-level ratio is used in
our study as a proxy for relative scarcity of a metal
against another metal, which is in line with Casassus,
Liu, and Tang (2013).
The theory of storage, traditionally, aims to
explain the convenience yield of a commodity
by using its own supply/demand condition.
However, there are economic linkages among
commodities and those relationships should also
directly impact the benefits that can be enjoyed
by owning a physical asset. In the case of the
non-ferrous metal market, it is evident that pro-
duction, substitution and complementary rela-
tionships exist. It is paramount for producers,
stockists, manufacturers and traders to under-
stand whether those economic linkages among
non-ferrous metals play an important role in
determining the perceived convenience yields of
major base metals.
Our review of past literature identifies the pre-
sence of a research gap that needs to be filled, and
our study thus poses a research question: ‘Do
economic linkages among non-ferrous metals
affect the convenience yield of those metals?’ To
answer this question, we propose the following
hypothesis.
H1. Relative scarcity of a non-ferrous metal has a
positive relationship with its perceived conve-
nience yield.
Substitution/Complementary
Cu (cable), Ni (alloy), Zn (alloy)
Al (cable), Zn (alloy)
Ni (battery), Lithium (battery), Zn (by-product), Sn (alloy)
Al (alloy), Pb (battery), Cr (alloy), Li (battery), Zn (alloy)
Pb (alloy)
Al (alloy), Cu (alloy), Pb (by-product)
 6 A. OMURA ET AL.

III. Data and methodology Also, following Mensi et al. (2013), we use the S&P
500 index values to represent the equity market.
Daily spot and futures prices of metals including the
Both are obtained from Bloomberg.
secondary metals, and inventory data are obtained from
In addition, we incorporate the impact of hed-
DataStream and Bloomberg for the period January
ging, wherever data are available, on the convenience
2000–March 2015 (lithium price data are available
yield. Hedging pressure in futures markets is likely
from September 2008). Similarly to Stepanek, Walter,
to affect the price of commodity (Hirshleifer 1990;
and Rathgeber (2013), the warehouse rental prices
Roon, Nijman, and Veld 2000), thus we include such
obtained from the LME are used as proxies for the
a factor in this study. In many cases, hedging pres-
storage cost of each non-ferrous metal employed in
sure is measured by (net commercial open-interest
the analysis. We use 3-month U.S. Treasury bills to
positions)/(total number of hedge positions) and the
represent near-term interest rates. This is consistent
relevant up-to-date historical data for copper is pub-
with the past studies, for example, Stepanek, Walter,
lically available at the COMEX. By assuming that
and Rathgeber (2013) and Liu and Tang (2010).
hedgers in the different geographical locations have
Also, we employ three control variables in the
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a similar hedging need, we employ COMEX open-

study to isolate overall effects of commodity and
interest positions to measure the hedging pressure.
equity markets on the convenience yield, as a num-
We convert weekly open-interest positions into
ber of studies including Mensi et al. (2013) indicate
monthly averages to synchronize with other monthly
the presence of statistically significant relationships
average variables in the study.
among individual commodity markets, and overall
Table 2 presents descriptive statistics of monthly
commodity and equity markets. In particular, we use
changes in the data (except for the hedging pres-
the Thomson Reuters/Jefferies CRB index as a proxy
sure). It shows that the convenience yields and
for the overall commodity market development as
inventories, in general, are more volatile than the
this index comprises 19 major commodities includ-
spot prices. Also, the equity and the commodity
ing crude oil, gas, metals and live stocks and is one
market indices tend to be less volatile.
of the most traded commodity indexes in the world.

Table 2. Descriptive statistics.

Mean Median SD Kurtosis Skewness Minimum Maximum
CY Al 0.15 −0.25 21.86 2.76 0.13 −56.69 62.97
CY Cu 0.93 0.75 20.59 3.28 0.31 −48.97 67.12
CY Pb 0.93 1.76 16.87 2.63 −0.06 −42.98 39.84
CY Ni 0.32 −2.02 21.74 4.78 0.83 −46.96 94.11
CY Sn 0.33 −2.57 20.19 3.88 0.83 −45.37 71.47
CY Zn 0.29 −0.95 17.75 4.73 0.41 −64.39 62.93
Invent. Al 0.90 0.05 6.24 4.97 0.60 −13.63 23.76
Invent. Cu −0.48 −1.37 13.99 5.16 0.60 −39.20 64.79
Invent. Pb 0.12 −0.42 12.19 4.69 0.21 −36.27 47.35
Invent. Ni 1.24 2.32 16.26 6.99 −0.29 −76.20 60.04
Invent. Sn 0.02 0.11 13.74 5.68 −0.08 −55.05 52.45
Invent. Zn 0.35 0.54 7.77 5.18 0.10 −29.46 28.17
Spot Al 0.03 0.17 5.14 4.68 −0.58 −21.07 14.16
Spot Cr 0.58 0.07 7.51 64.60 −5.62 −76.98 21.87
Spot Cu 0.64 1.10 6.95 8.35 −0.84 −35.42 22.87
Spot Pb 0.73 1.05 7.84 5.06 −0.71 −29.24 23.18
Spot Li −0.21 0.00 3.31 11.40 −0.91 −16.01 12.52
Spot Ni 0.28 −0.15 9.02 4.13 −0.35 −38.13 24.06
Spot Sn 0.60 0.10 6.59 3.76 −0.21 −23.84 15.64
Spot Zn 0.30 0.45 6.71 5.01 −0.40 −29.18 23.37
Scrap Al 0.16 0.34 4.31 11.61 −1.59 −26.39 12.44
Scrap Cu 0.62 0.61 6.03 8.29 −1.06 −31.25 18.91
CRB 0.33 0.35 2.70 8.11 −1.15 −13.70 6.43
U.S. Equity 0.21 1.00 3.97 9.22 −1.60 −22.81 11.35
Hedge Cu −2.09 −1.65 19.19 2.45 −0.26 −53.45 36.18
Note: The table represents the descriptive statistics of the data used in the study. The numerical values are monthly changes in those variables (except
hedging pressure) and are in the percentage form. CY is the convenience yield, Invent. is the inventory at the LME, Spot indicates for the spot price, and
Scrap indicates for the spot scrap price of the relevant metal. Al is aluminium, Cu is copper, Pb is lead, Li is lithium, Cr is chromium, Ni is nickel, Sn is tin, Zn
is zinc, CRB is the CRB index and U.S. Equity is the S&P 500 index, Hedge Cu is the hedging pressure of copper futures calculated as net commercial
position/(commercial long position + commercial short position) at the COMEX. The sample period is January 2000–March 2015 (lithium price data starts
from September 2008).
 APPLIED ECONOMICS 7

 
In theory, convenience yields should be bound by SðtÞ Max FðT Þ  1; 0 (4)
zero. However, the conventional cost-of-carry
approach used by researchers such as Fama and where FðT Þ ¼ SðtÞ =Fðt;T Þ . Using Ito’s lemma allows us
French (1988) is limited by the output of negative to establish following solution
convenience yields, though the model is elegant and CYi;t;T ¼ Sði;tÞ N ðd1 Þ  Fðt;T Þ N ðd2 Þ (5)
simple. The model aims to estimate convenience
yield by taking the difference between prices of two where
forward contracts with different maturities after  
ln FðT Þ þ σ 2c τ=2
adjusting for necessary costs associated with carrying d1 ¼ pffiffiffi
σc τ
the asset. It is evident from a recent study by
 
Stepanek, Walter, and Rathgeber (2013), that even pffiffiffi ln FðT Þ  σ 2c τ=2
after accounting for storage costs provided by the d2 ¼ d1  σ c τ ¼ pffiffiffi
σc τ
LME and the time value of money, negative conve-
and
nience yields can be still obtained when the cost-of-
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carry approach is used.
As mentioned above, applying the options-based
approach of Heinkel, Howe, and Hughes (1990) and
Milonas and Thomadakis (1997) can avoid negative
convenience yield estimates. This study follows an
approach similar to Milonas and Thomadakis
(1997), Kocagil (2004), Lin and Duan (2007),
Omura et al. (2015), Omura and West (2015) and
West (2012), which is an extension of the Black–
Sholes option pricing model, to estimate conveni-
ence yields. In particular, we express the conveni-
ence yield observed at time t as


CYt;T ¼ Max SðtÞ  Fðt;TÞ ; 0 (1)
where CYt;T is the convenience yield from time t to
T. SðtÞ ¼ SðtÞ þ Wðt;TÞ with SðtÞ as the spot price at
time t, Wðt;T Þ the storage cost from time t to T and
Fðt;TÞ is the price observed at time t of a futures
contract which matures at time T. In this study, we
employ the three month futures contracts traded on
the LME. This study assumes that both the spot
price and the forward price are stochastic and follow
standard diffusion processes (i.e. a geometric
Brownian motion),
dSðtÞ ¼ μS SðtÞ dt þ σ S SðtÞ dzS (2)
dFðt;T Þ ¼ μF Fðt;TÞ dt þ σ F Fðt;TÞ dzF (3)
where the subscripts S and F represent the spot and
the futures tenor for each contract type, respectively.
Furthermore, this study makes an assumption that
the diffusion terms dzS and dzF are uncorrelated,
and that zS and zF follow a Wiener process. The
associated boundary condition is also defined as
σ 2c ¼ σ 2S ðtÞ þ 2σ S ðtÞ σ Fðt;T Þ ρSðtÞFðt;T Þ þ σ 2Fðt;TÞ (6)
σ c is the volatility of the convenience yield, σ S ðtÞ and
σ Fðt;TÞ are the volatilities of the spot and futures
prices, respectively, ρSðtÞFðt;T Þ is the correlation coef-
ficient between spot and futures contracts, and τ is
the time period until the maturity of the forward
contract. We assume that the spot price is the near-
est available tenor and the forward price is repre-
sented by the 3-month futures contract price. The
volatility figures applied in the convenience yield
estimation are computed by combining the expo-
nentially weighted moving average (EWMA) for
the Parkinson (1980) volatility estimator. Let σ 2tþ1jt
be a volatility estimated by EWMA, λ be an expo-
nential weight coefficient,
X
1
σ 2tþ1jt ¼ ð1  λÞ λi Rti 0<λ<1 (7)
i¼0
where the subscript t þ 1jt illustrating a forecast at
time t + 1 is based on the available information up to
and including time t, and
2
ðxHL Þ PHti
Rti ¼ ti t ¼ ln
and xHL (8)
4  ln2 PLti
where PHt is the intraday high price, and PLt is the
intraday low price. We use λ ¼ 0:94 as commonly
done in the literature and the validity of its empirical
rule is justified by J.P. Morgan and Reuters (1996).
For the purpose of conducting regression analysis,
we first estimate daily convenience yields and then
average them to obtain monthly values.
We use well-established methods: bivariate and
multivariate vector autoregressive (VAR) models
 8 A. OMURA ET AL.

and the associated Granger-causality tests to exam- position + commercial short position) of the copper
ine the relationship between convenience yield of a futures at the COMEX. As the levelled hedging
metal and the relative scarcity measure. A similar pressure dataset is found to be stationary, we use
method is used by Hameed (1997) and Rossi (2012) the levelled data for this variable. The number of lags
in their asset pricing-related studies. The general in the VAR is first selected based on the Akaike
form of the VAR system in this study is information criterion (AIC), Bayesian information
0 1 0 1 0 1 10 1 criterion and Hannan and Quinn information criter-
Δy1;t c1 β1;1 β11;h Δy1;t1 ion. However, as in a number of cases serial correla-
B : C B : C B :: C
B C B C B : : CB : C tion is observed in the residual series, we add extra
B C¼@ AþB B CBB
C
C
@ : A C
: A@ : A lags until this issue is solved.
: @ :
::
Δyh;t ch β1h;1 β1h;h Δyh;t1
0 k 10 1 IV. Results
β1;1 βk1;h Δy1;tk
B :: C
B : : CB : C The Augmented Dickey–Fuller test (Dickey and
þ ::: þ B CBB
C
B : C@ : C
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@ : A A Fuller 1979) is first applied to examine the stationar-

:: k
βh;1 βh;h
k Δyh;tk
0 1
ε1;t
B : C
þB @
C
A
: change figures, apart from the hedging pressure
εh;t
(9)
where Δyi;t is the monthly log difference in the vari-
able h (unless noted otherwise) at time t and εh;t is
an error term. We use monthly change figures to
overcome unit root issues inherent in the data
(except for the hedging pressure term as it is found
to be stationary at the levelled form). In particular,
for bivariate VAR estimation, the convenience yield
 metal and the relevant relative scarcity or inventory
variable for metal i is computed as ln CYi;t;T =
CYi;t1;T1 , and the relative scarcity variable for
metal i in relation to metal j is computed as
 
ln Si;t =Sj;t ln½Si;t1 =Sj;t1 where i Þ j and St
denotes the spot price at time t. We interchangeably
describe this variable as the price-ratio in this study.
Furthermore, for multivariate VAR model estima-
tion, we incorporate four other control variables. In
particular, we employ (1) the inventory level variable
for metal i to control for own scarcity levels, com-
 
puted as ln Ii;t =Ii;t1 where I is the inventory prox-
ied by the LME warehouse inventory, (2) the
Thomson Reuters/Jefferies CRB index variable to
partial out the effect of overall commodity market
conditions, which is computed as ln½CRBt =CRBt1 ,
(3) the S&P 500 index to isolate the impact of the
equity market condition, which is computed as
ln½S Pt =S Pt1  and (4) the hedging pressure mea-
sured by net commercial position/(commercial long
ity of the considered variables (the results are avail-
able upon request). The test statistics are estimated
based on the modified AIC and all the variables
become stationary when converted into monthly
where the levelled data are found to be stationary.
The remainder of this section reports our results of
the VAR and associated Granger-causality tests. We
provide a comprehensive interpretation and discus-
sion of our results in the later discussion section.
Bivariate VAR results
First, we conduct bivariate (convenience yield of a
variable) VAR tests. The results are reported in
Table 3 (we report the results for models which use
the convenience yield variable as a dependent vari-
able. Detailed results are available upon request).
The results indicate that many of the inventory vari-
ables have one or more significant negative lagged
coefficient/s at the 10% significance level. This is
consistent with the conventional notion of the the-
ory of storage.
It is found that fourteen relative scarcity variables
(price-ratios) have a significant positive lagged coef-
ficient/s at the 10% significance level. Similar results
are obtained from the bivariate Granger-causality
test displayed in Table 4. To be more specific, eleven
relative scarcity variables appear to Granger-cause
the convenience yield of the relevant metal at the
10% significance level. When it comes to the actual
impact of change in the level of relative scarcity on
the convenience yield, for those models with the
 APPLIED ECONOMICS 9

Table 3. Bivariate VAR (results for the models which have the convenience yields as dependent variables).
Explanatory variable
Constant Lag 1 Lag 2 Lag 3 Lag 4 Lag 5
Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value)
(a)
CY Aluminium versus
Inventory 0.008 (0.61) −0.751* (0.06) −0.481 (0.35) 0.603 (0.13)
Relat. Cu 0.003 (0.85) −0.239 (0.50) 0.373 (0.30)
Relat. Ni 0.003 (0.83) 0.441*** (0.01) 0.110 (0.62)
Relat. Zn 0.001 (0.95) −0.329 (0.32) −0.079 (0.81)
Relat. Scrap 0.002 (0.88) 0.517 (0.30) −0.235 (0.64)
CY Copper versus
Inventory 0.012 (0.43) −0.169 (0.20) 0.096 (0.53) 0.048 (0.71)
Relat. Al 0.007 (0.65) 0.833** (0.01) 0.154 (0.64)
Relat. Zn 0.010 (0.52) 0.185 (0.54)
Relat. Scrap 0.012 (0.44) 0.774 (0.10) 1.103** (0.03) 0.715 (0.18) 0.502 (0.33) −0.086 (0.86)
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CY Lead versus
Inventory 0.012 (0.33) −0.200 (0.11) −0.196 (0.15) 0.310** (0.01)
Relat. Ni 0.009 (0.49) 0.258* (0.08)
Relat. Li −0.015 (0.37) −0.046 (0.84) 0.479** (0.03)
Relat. Zn 0.008 (0.51) 0.386* (0.07)
Relat. Sn 0.010 (0.41) 0.351* (0.06) −0.105 (0.57)
CY Nickel versus
Inventory 0.001 (0.86) −0.256** (0.04) 0.114 (0.39) −0.301** (0.03) 0.129 (0.33) 0.175 (0.14)
Relat. Al −0.002 (0.90) 0.565** (0.02) −0.016 (0.95)
Relat. Pb 0.004 (0.80) 0.565*** (0.00)
Relat. Li −0.013 (0.47) 0.680*** (0.01) −0.025 (0.93) −0.204 (0.43) 0.180 (0.38)
Relat. Cr 0.002 (0.91) 0.185 (0.24)
Relat. Zn 0.002 (0.92) 0.433* (0.07)
(b)
CY Tin versus
Inventory 0.003 (0.84) −0.234** (0.04)
Relat. Pb 0.003 (0.82) 0.448** (0.03)
CY Zinc versus
Inventory 0.006 (0.67) −0.364* (0.07) −0.086 (0.67)
Relat. Al 0.002 (0.88) 0.659** (0.01) −0.079 (0.77)
Relat. Cu 0.005 (0.73) 0.169 (0.52)
Relat. Pb 0.005 (0.71) 0.221 (0.29)
Relat. Ni 0.002 (0.87) 0.403** (0.03) 0.082 (0.68) −0.135 (0.46)
Note: The table reports the results of the bivariate VAR
! !
Δy1;t c1 β11;1 β11;2 Δy1;t1 β11;1 β11;2 Δy1;tk ε1;t
¼ þ þ ::: þ þ
Δy2;t ch β12;1 β12;2 Δy2;t1 β12;1 β12;2 Δy2;tk ε2;t

where Δy1 is the monthly change in the convenience yield of a metal in each model and Δy2 is the monthly change in the other variable in the model. The
table reports the results for the models having Δy1 as an explained variable and does not report the coefficients of autoregressive variables. Inventory is
the monthly change in the inventory figures from the LME for the explained variable. Relat. Al, Relat. Cr, Relat. Cu, Relat. Pb, Relat. Ni, Relat. Sn, Relat. Zn and
Relat. Scrap in rows below the subheading of CY . . . versus. indicate which metal is used to create a relative scarcity variable and each row reports the
result of the bivariate VAR having such relative scarcity variable. For example, Aluminium under the heading of CY Zinc versus. represents a relative scarcity
of zinc to aluminium and it is computed as the spot price of zinc divided by the spot price of aluminium. All variables are in the natural log monthly
change form. The standard errors in the results are adjusted for the small sample-size and degree-of-freedom in estimating the error variance–covariance
matrix. ***, **, * denote the significance level at 1%, 5% and 10%, respectively.

significant results, a 1 percentage point increases in
the lagged price-ratio results in 0.3 to 1.1 percentage
points increase in the convenience yield.
Since our sample incorporates the recent global
financial crisis (GFC) period, we also conduct subsam-
ple Granger-causality tests. We follow Souček and
Todorova (2013) in selecting the GFC period (July
2008 to December 2009). The results are shown in
Table 4. Interestingly, we find that fewer relevant scar-
city variables Granger-cause the relevant convenience
yield variable, at the 10% significance level, after July
2008. In contrast, we find a slightly larger number of
 10 A. OMURA ET AL.

Table 4. Bivariate Granger-causality test (p-values).

Granger-causality test results
January 2000–June 2008 July 2008–March 2015 January 2010–March 2015 Full sample period
CY Aluminium versus
Relat. Copper 0.74 0.64 0.18 0.55
Relat. Nickel 0.07* 0.00*** 0.11 0.07*
Relat. Zinc 0.33 0.27 0.01*** 0.53
Relat. Scrap 0.70 0.77 0.68 0.49
CY Copper versus
Relat. Aluminium 0.00*** 0.31 0.48 0.01**
Relat. Zinc 0.75 0.39 0.16 0.54
Relat. Scrap 0.10* 0.16 0.10 0.25
CY Lead versus
Relat. Nickel 0.05** 0.22 0.13 0.08*
Relat. Lithium ‒ 0.08* 0.45 0.08*
Relat. Zinc 0.00*** 0.20 0.14 0.07*
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Relat. Tin 0.03** 0.15 0.42 0.17

CY Nickel versus
Relat. Aluminium 0.01*** 0.14 0.06* 0.06*
Relat. Lead 0.00*** 0.05* 0.29 0.00***
Relat. Lithium ‒ 0.08* 0.03** 0.08*
Relat. Chromium 0.01*** 0.02** 0.03** 0.24
Relatt Zinc 0.11 0.11 0.05** 0.07*
CY Tin versus
Relat. Lead 0.05** 0.37 0.26 0.03**
CY Zinc versus
Relat. Aluminium 0.01*** 0.87 0.01** 0.05**
Relat. Copper 0.17 0.60 0.42 0.52
Relat. Lead 0.40 0.92 0.13 0.28
Relat. Nickel 0.08* 0.37 0.08* 0.10
Note: The table reports the results of the Granger-causality test results based on the bivariate VAR
! !
Δy1;t c1 β11;1 β11;2 Δy1;t1 β11;1 β11;2 Δy1;tk ε
¼ þ þ ::: þ þ 1;t
Δy2;t ch β12;1 β12;2 Δy2;t1 β12;1 β12;2 Δy2;tk ε2;t

where Δy1 is the monthly change in the convenience yield of a metal in each model and Δy2 is the monthly change in the other variable in the model. The
table reports the test results which use Δy1 as an explained variable and the relative scarcity variables as an explanatory variable. For instance, Relat.
Copper under the subheading of CY Aluminium versus represents relative scarcity of aluminium to copper (computed as the spot price of aluminium
divided by the spot price of copper) and the numerical values in the subsequent columns indicate the p-values of the Granger-causality tests which use
the convenience yield of aluminium as the explained variable and its relative scarcity level to copper as the explanatory variable in the VAR model. CY is
the convenience yield of an indicated metal in the table. All the variables used in each model are in the natural log monthly change form. The standard
errors in the VAR results are adjusted for the small sample-size and degree-of-freedom in estimating the error variance–covariance matrix. The second row
in the table indicates the estimation period. ***, **, * denote the significance level at 1%, 5% and 10%, respectively.

significant causal relationships, compared with the
full-sample period when the tests are conducted on
the period before the GFC. In addition, we observe a
slightly fewer number of significant results (seven), for
the period after January 2010. The results may be
directly affected by the fact that limited number of
observations is available for the period after the GFC.
Effect of contango and backwardation
We also divide our sample based on the relative price
level of spot contract against futures contract. In parti-
cular, we separate the data into periods of contango
and backwardation (determined by the interest-
adjusted spread between futures and spot contracts)
and reconduct the Granger-causality tests based on the
bivariate VAR. When the market is backwarded, the
relationship between the convenience yield of a metal
and other economically linked metals may draw more
attention of the market compared with the period of
contango. This is because, during backwardation per-
iods, perceived benefits of immediate possession of a
physical metal are considered to be higher. The results
are presented in Table 5. We display the test results
showing whether relative scarcity variables Granger-
cause convenience yield of a focused metal or not.
 APPLIED ECONOMICS 11

Table 5. Bivariate Granger-causality test on contango and back- during contango periods. A similar trend is also
wardation periods (p-values). observed when contango and backwardation periods
Contango Backwardation are judged based on the simple spread without consid-
CY Aluminium versus ering the time value of money. In addition, while no
Relat. Copper 0.26 0.97
economically significant Granger-causality test results
Relat. Nickel 0.10* 0.36
Relat. Zinc 0.78 0.16 are obtained in the previous bivariate VAR tests for
Relat. Scrap 0.88 0.15 relative scarcity of zinc against either of copper or lead,
CY Copper versus when the test is conducted for backwardation periods,
Relat. Aluminium 0.16 0.05* both price-ratios are found to have a significant impact
Relat. Zinc 0.06* 0.65
on the convenience yield of zinc. This is probably
Relat. Scrap 0.55 0.19
because the coefficients of those variables are negative
CY Lead versus
Relat. Nickel 0.45 0.16 during contango periods, offsetting the significant posi-
Relat. Lithium 0.11 ‒ tive impacts during backwardation times.
Relat. Zinc 0.40 0.04**
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Relat. Tin 0.35 0.02**

CY Nickel versus Multivariate VAR results
Relat. Aluminium 0.26 0.01***
Relat. Lead 0.18 0.00*** Next, we further check the robustness of our result by
Relat. Lithium 0.09* ‒ adding control variables into the bivariate VAR mod-
Relat. Chromium 0.06* 0.01***
Relat. Zinc 0.24 0.03**
els. The control variables that we select in this study
CY Tin versus
are (1) the own inventory level to take into account of
Relat. Lead 0.20 0.17 the effect of absolute scarcity level, (2) the S&P 500
CY Zinc versus index to control for the influence of the equity mar-
Relat. Aluminium 0.77 0.03** ket, (3) the CRB index to control the effect of the
Relat. Copper 0.30 0.07* overall commodity market behaviour and (4) the
Relat. Lead 0.10* 0.04**
Relat. Nickel 0.26 0.4)
hedging pressure whenever relevant data are available.
Note: The table reports the results of the Granger-causality tests based on The multivariate VAR results (Table 6) show that
the bivariate VAR
!
there are thirteen relative scarcity variables which
Δy1;t c1 β11;1 β11;2 Δy1;t1 have statistically significant lagged coefficient esti-
¼ þ þ :::
Δy2;t ch β12;1 β12;2 Δy2;t1
! mates at the 10% level. However, of those, three
β11;1 β11;2 Δy1;tk ε1;t models (aluminium-to-zinc, lead-to-zinc, nickel-to-
þ þ
β12;1 β12;2 Δy2;tk ε2;t
lithium) contain a negative lagged coefficient esti-
where Δy1 is the monthly change in the convenience yield of a metal in each
model and Δy2 is the monthly change in the other variable in the model. The mate. Similarly to the previous bivariate tests, we
table reports the test results which use Δy1 as an explained variable and the conduct the Granger-causality tests based on the
relative scarcity variables as an explanatory variable. For instance, Relat.
Copper under the subheading of CY Aluminium versus represents relative results obtained in the multivariate VAR. Table 7
scarcity of aluminium to copper (computed as the spot price of aluminium displays the results for the tests with a null-hypothesis
divided by the spot price of copper) and the numerical values in the
subsequent columns indicate the p-values of the Granger-causality tests ‘relative scarcity variable does not Granger-cause con-
which use the convenience yield of aluminium as the explained variable venience yield of a focused metal’. We find ten sig-
and its relative scarcity level to copper as the explanatory variable in the VAR
model. CY is the convenience yield of an indicated metal in the table. All the nificant causal relationships at the 10% level.2 We will
variables used in each model are in the natural log monthly change form.
Data are divided into contango and backwardation periods, determined by
further discuss our results in the following section.
interest-adjusted futures price–spot price at time t. The standard errors in the
results are adjusted for the small sample-size and degree-of-freedom in
estimating the error variance–covariance matrix. ***, **, * denote the sig-
nificance level at 1%, 5% and 10%, respectively. V. Discussion
Our results broadly support the presence of relative
There is a total of ten causal relationships, significant scarcity that affects the perceived convenience yield
at the 10% level, found during backwardation, but only of major base metals. The results are summarized in
half of the number of significant results are obtained Table 8. Nevertheless, no strong pattern among the
2
We also test whether the significant relationships can be observed in recent years by controlling for various factors; however, the model does not converge.
This is possibly because the sample sizes are not large enough.
 12 A. OMURA ET AL.

Table 6. Multivariate VAR tests with one relative scarcity variable in each model.
(a)
CY Al Coef. (p-val.) CY Al Coef. (p-val.) CY Al Coef. (p-val.)
Con. 0.013 (0.44) Con. 0.014 (0.40) Con. 0.009 (0.56)
Own Var. Own Var. Own Var.
Lag1 −0.185** (0.03) Lag1 −0.161* (0.05) Lag1 −0.180** (0.01)
Lag2 −0.161* (0.06) Lag2 −0.154* (0.08) Lag2 ‒ ‒
Lag3 −0.009 (0.91) Lag3 −0.017 (0.85) Lag3 ‒ ‒
Lag4 ‒ ‒ Lag4 −0.053 (0.53) Lag4 ‒ ‒
Invent. Invent. Invent.
Lag1 −0.819* (0.05) Lag1 −0.867** (0.05) Lag1 −0.880** (0.01)
Lag2 −0.631 (0.24) Lag2 −0.754 (0.16) Lag2 ‒ ‒
Lag3 0.690 (0.11) Lag3 1.022* (0.06) Lag3 ‒ ‒
Lag4 ‒ ‒ Lag4 −0.418 (0.34) Lag4 ‒ ‒
Relat. Cu Relat. Zn Relat. Ni
Lag1 −0.274 (0.48) Lag1 −0.614* (0.09) Lag1 0.380* (0.08)
Lag2 0.477 (0.25) Lag2 0.066 (0.86) Lag2 ‒ ‒
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Lag3 0.086 (0.82) Lag3 −0.274 (0.45) Lag3 ‒ ‒

Lag4 ‒ ‒ Lag4 0.283 (0.40) Lag4 ‒ ‒
CRB CRB CRB
Lag1 0.392 (0.63) Lag1 0.178 (0.82) Lag1 0.461 (0.47)
Lag2 −0.116 (0.90) Lag2 −0.146 (0.87) Lag2 ‒ ‒
Lag3 −0.218 (0.78) Lag3 0.375 (0.67) Lag3 ‒ ‒
Lag4 ‒ ‒ Lag4 −0.157 (0.84) Lag4 ‒ ‒
U.S. U.S. U.S.
Lag1 −0.762* (0.10) Lag1 −0.641 (0.18) Lag1 −0.676 (0.13)
Lag2 −0.187 (0.69) Lag2 −0.256 (0.59) Lag2 ‒ ‒
Lag3 0.161 (0.72) Lag3 0.173 (0.72) Lag3 ‒ ‒
Lag4 ‒ ‒ Lag4 −0.791* (0.09) Lag4 ‒ ‒
CY Al Coef. (p-val.) CY Pb Coef. (p-val.) CY Pb Coef. (p-val.)
Con. 0.012 (0.44) Con. 0.007 (0.58) Con. −0.024 (0.19)
Own Var. Own Var. Own Var.
Lag1 −0.234*** (0.01) Lag1 −0.150* (0.07) Lag1 −0.237* (0.05)
Lag2 −0.166* (0.06) Lag2 ‒ ‒ Lag2 −0.225* (0.06)
Invent. Invent. Invent.
Lag1 −0.680* (0.09) Lag1 −0.192* (0.08) Lag1 −0.037 (0.89)
Lag2 −0.251 (0.55) Lag2 ‒ ‒ Lag2 −0.449 (0.87)
Relat. Scrap Relat. Ni Relat. Li
Lag1 0.533 (0.30) Lag1 0.260* (0.08) Lag1 −0.225 (0.46)
Lag2 −0.158 (0.75) Lag2 ‒ ‒ Lag2 0.136 (0.64)
CRB CRB CRB
Lag1 0.339 (0.66) Lag1 0.376 (0.47) Lag1 −0.078 (0.93)
Lag2 −0.158 (0.83) Lag2 ‒ ‒ Lag2 0.664 (0.46)
U.S. U.S. U.S.
Lag1 −0.747* (0.10) Lag1 0.475 (0.17) Lag1 0.843 (0.16)
Lag2 −0.264 (0.56) Lag2 ‒ ‒ Lag2 0.451 (0.40)
(b)
CY Pb Coef. (p-val.) CY Pb Coef. (p-val.) CY Ni Coef. (p-val.)
Con. 0.008 (0.51) Con. 0.007 (0.55) Con. 0.003 (0.88)
Own Var. Own Var. Own Var.
Lag1 −0.235*** (0.01) Lag1 −0.231*** (0.01) Lag1 −0.144* (0.09)
Lag2 −0.167** (0.04) Lag2 −0.199** (0.02) Lag2 ‒ ‒
Invent. Invent. Invent.
Lag1 −0.343*** (0.01) Lag1 −0.343*** (0.01) Lag1 −0.173 (0.10)
Lag2 −0.072 (0.54) Lag2 −0.050 (0.66) Lag2 ‒ ‒

(Continued )
 APPLIED ECONOMICS 13

Table6. (Continued).
Relat. Zn Relat. Sn Relat. Al
Lag1 0.453** (0.04) Lag1 0.318* (0.08) Lag1 0.583** (0.02)
Lag2 −0.477** (0.03) Lag2 −0.155 (0.39) Lag2 ‒ ‒
CRB CRB CRB
Lag1 −0.704 (0.22) Lag1 −0.539 (0.35) Lag1 0.222 (0.73)
Lag2 1.464** (0.01) Lag2 1.495** (0.01) Lag2 ‒ ‒
U.S.A. U.S.A. U.S.A.
Lag1 0.553 (0.11) Lag1 0.471 (0.17) Lag1 -0.461 (0.30)
Lag2 0.344 (0.32) Lag2 0.346 (0.32) Lag2 ‒ ‒
CY Ni Coef. (p-val.) CY Ni Coef. (p-val.) CY Ni Coef. (p-val.)
Con. −0.003 (0.87) Con. −0.005 (0.82) Con. 0.001 (0.98)
Own Var. Own Var. Own Var.
Lag1 −0.107 (0.25) Lag1 −0.353*** (0.01) Lag1 −0.165* (0.06)
Lag2 0.002 (0.98) Lag2 0.087 (0.53) Lag2 −0.046 (0.59)
Lag3 −0.100 (0.28) Lag3 0.151 (0.30) Lag3 −0.148* (0.08)
Lag4 −0.204** (0.03) Lag4 -0.202 (0.13) Lag4 −0.214** (0.01)
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Lag5 0.018 (0.85) Lag5 ‒ ‒ Lag5 −0.088 (0.31)

Invent. Invent. Invent.
Lag1 −0.215* (0.10) Lag1 −0.419 (0.46) Lag1 −0.196 (0.13)
Lag2 0.143 (0.31) Lag2 −0.027 (0.97) Lag2 0.157 (0.26)
Lag3 −0.340** (0.02) Lag3 −1.885** (0.01) Lag3 −0.288** (0.04)
Lag4 0.116 (0.40) Lag4 2.305*** (0.00) Lag4 0.052 (0.70)
Lag5 0.164 (0.20) Lag5 ‒ ‒ Lag5 0.211* (0.08)
Relat. Zn Relat. Li Relat. Cr
Lag1 0.180 (0.53) Lag1 0.578 (0.18) Lag1 0.305 (0.11)
Lag2 −0.106 (0.72) Lag2 0.470 (0.22) Lag2 0.207 (0.27)
Lag3 −0.433 (0.12) Lag3 −0.895** (0.01) Lag3 −0.068 (0.71)
Lag4 0.360 (0.21) Lag4 0.070 (0.84) Lag4 0.994 (0.57)
Lag5 −0.297 (0.28) Lag5 ‒ ‒ Lag5 0.312* (0.07)
CRB CRB CRB
Lag1 0.289 (0.72) Lag1 −0.373 (0.72) Lag1 −0.180 (0.82)
Lag2 0.072 (0.93) Lag2 1.335 (0.17) Lag2 −0.273 (0.75)
Lag3 0.106 (0.90) Lag3 0.965 (0.36) Lag3 0.247 (0.78)
Lag4 1.370 (0.12) Lag4 −0.487 (0.58) Lag4 1.444 (0.11)
Lag5 −0.972 (0.21) Lag5 ‒ ‒ Lag5 −0.692 (0.40)
U.S. U.S.A. U.S.A.
Lag1 −0.142 (0.77) Lag1 −0.113 (0.88) Lag1 −0.264 (0.58)
Lag2 −0.113 (0.82) Lag2 −1.406** (0.04) Lag2 −0.294 (0.54)
Lag3 0.398 (0.40) Lag3 0.192 (0.76) Lag3 0.337 (0.48)
Lag4 −0.694 (0.14) Lag4 0.333 (0.58) Lag4 −0.497 (0.29)
Lag5 0.706 (0.13) Lag5 ‒ ‒ Lag5 0.655 (0.17)
(c)
CY Ni Coef. (p-val.) CY Sn Coef. (p-val.) CY Zn Coef. (p-val.)
Con. 0.005 (0.74) Con. 0.000 (0.99) Con. 0.004 (0.76)
Own Var. Own Var. Own Var.
Lag1 −0.142* (0.09) Lag1 −0.048 (0.54) Lag1 −0.122 (0.11)
Lag2 ‒ ‒ Lag2 ‒ ‒ Lag2 −0.095 (0.21)
Invent. Invent. Invent.
Lag1 −0.154 (0.15) Lag1 −0.192 (0.10) Lag1 −0.146 (0.51)
Lag2 ‒ ‒ Lag2 ‒ ‒ Lag2 −0.203 (0.37)
Relat. Pb Relat. Pb Relat. Al
Lag1 0.524*** (0.01) Lag1 0.324 (0.13) Lag1 0.583* (0.06)
Lag2 ‒ ‒ Lag2 ‒ ‒ Lag2 −0.263 (0.36)

(Continued )
 14 A. OMURA ET AL.

Table6. (Continued).
CRB CRB CRB
Lag1 0.410 (0.52) Lag1 1.109* (0.07) Lag1 0.036 (0.96)
Lag2 ‒ ‒ Lag2 ‒ ‒ Lag2 −0.274 (0.67)
U.S. U.S.A. U.S.A.
Lag1 −0.433 (0.33) Lag1 −0.028 (0.95) Lag1 −0.084 (0.83)
Lag2 ‒ ‒ Lag2 ‒ ‒ Lag2 0.668* (0.08)
CY Zn Coef. (p-val.) CY Zn Coef. (p-val.) CY Zn Coef. (p-val.)
Con. 0.005 (0.69) Con. 0.007 (0.60) Con. 0.004 (0.75)
Own Var. Own Var. Own Var.
Lag1 −0.092 (0.22) Lag1 −0.122 (0.12) Lag1 −0.105 (0.16)
Lag2 ‒ ‒ Lag2 −0.105 (0.17) Lag2 ‒ ‒
Invent. Invent. Invent.
Lag1 −0.386** (0.04) Lag1 −0.324 (0.11) Lag1 −0.289 (0.12)
Lag2 ‒ ‒ Lag2 −0.047 (0.82) Lag2 ‒ ‒
Relat. Cu Relat. Pb Relat. Ni
−0.015
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Lag1 (0.96) Lag1 0.164 (0.46) Lag1 0.315* (0.08)

Lag2 ‒ ‒ Lag2 0.190 (0.39) Lag2 ‒ ‒
CRB CRB CRB
Lag1 0.032 (0.96) Lag1 0.087 (0.89) Lag1 0.162 (0.76)
Lag2 ‒ ‒ Lag2 −0.482 (0.44) Lag2 ‒ ‒
U.S.A. U.S.A. U.S.A.
Lag1 0.113 (0.76) Lag1 −0.007 (0.99) Lag1 0.201 (0.59)
Lag2 ‒ ‒ Lag2 0.671* (0.08) Lag2 ‒ ‒
(d)
CY Cu Coef. (p-val.) CY Zn Coef. (p-val.) CY Cu Coef. (p-val.)
Con. 0.006 (0.70) Con. 0.004 (0.79) Con. 0.006 (0.69)
Own Var. Own Var. Own Var.
Lag1 −0.377*** (0.00) Lag1 −0.322*** (0.00) Lag1 −0.227*** (0.00)
Lag2 −0.260*** (0.01) Lag2 −0.171** (0.05) Lag2 ‒ ‒
Lag3 −0.063 (0.49) Lag3 0.008 (0.92) Lag3 ‒ ‒
Lag4 −0.018 (0.83) Lag4 ‒ ‒ Lag4 ‒ ‒
Invent. Invent. Invent.
Lag1 −0.128 (0.38) Lag1 −0.066 (0.63) Lag1 0.008 (0.95)
Lag2 0.162 (0.32) Lag2 0.091 (0.55) Lag2 ‒ ‒
Lag3 0.020 (0.90) Lag3 0.087 (0.52) Lag3 ‒ ‒
Lag4 0.213 (0.14) Lag4 ‒ ‒ Lag4 ‒ ‒
Hedge Hedge Hedge
Lag1 0.236 (0.27) Lag1 0.047 (0.81) Lag1 −0.107 (0.21)
Lag2 −0.362 (0.23) Lag2 −0.138 (0.62) Lag2 ‒ ‒
Lag3 0.210 (0.49) Lag3 −0.071 (0.72) Lag3 ‒ ‒
Lag4 −0.320 (0.13) Lag4 ‒ ‒ Lag4 ‒ ‒
Relat. Scrap Relat. Al Relat. Zn
Lag1 1.038** (0.02) Lag1 0.797** (0.03) Lag1 0.062 (0.85)
Lag2 1.377** (0.02) Lag2 0.122 (0.75) Lag2 ‒ ‒
Lag3 1.216** (0.04) Lag3 −0.509 (0.16) Lag3 ‒ ‒
Lag4 0.723 (0.15) Lag4 ‒ ‒ Lag4 ‒ ‒
CRB CRB CRB
Lag1 −0.662 (0.43) Lag1 −0.551 (0.48) Lag1 0.427 (0.51)
Lag2 0.800 (0.42) Lag2 1.004 (0.25) Lag2 ‒ ‒
Lag3 0.108 (0.91) Lag3 0.328 (0.66) Lag3 ‒ ‒
Lag4 0.357 (0.67) Lag4 ‒ ‒ Lag4 ‒ ‒
U.S.A. U.S.A. U.S.A.
Lag1 0.078 (0.87) Lag1 −0.504*** (0.01) Lag1 0.165 (0.70)
Lag2 0.281 (0.54) Lag2 0.130 (0.48) Lag2 ‒ ‒

(Continued )
 APPLIED ECONOMICS 15

Table6. (Continued).
Lag3 −0.194 (0.67) Lag3 −0.294 (0.11) Lag3 ‒ ‒
Lag4 0.276 (0.55) Lag4 ‒ ‒ Lag4 ‒ ‒
Note: The tables report the results of the multivariate VAR
0 1 0 1 0 1 1 0 k 1
Δy1;t c1 β1;1 β11;h 0 Δy1;t1 1 β1;1 βk1;h 0 Δy1;tk 1 0 ε1;t 1
B : C B : C B : :: : CB : C B : :: : CB : C B : C
B C B C B C@ A þ ::: þ B C@
@ : A¼@ : Aþ@ : : A : @ : : A :
Aþ@
:
A
:: Δy :: Δy ε
Δyh;t ch βh;1 βh;h
1 1
h;t1 βh;1 βh;h
k k
h;tk h;t

where Δyh is the monthly change in the variable h. The table reports the regression results which use the monthly change in the convenience yield
of a metal that the model focuses as an explained variable, and a relative scarcity variable and other control variables as the explanatory
variables. The multivariate VAR models used in the table are developed from the above bivariate VAR by incorporating the control variables. CY is
the monthly change in the convenience yield of an indicated metal. Inventory is the monthly change in the inventory figures from the LME for
the explained variable, CRB is the monthly change in the CRB index and U.S.A. is the monthly change in the S&P 500 index. A relative scarcity
variable is indicated by Relat. and the subsequent word in the table. For instance, Relat. Al under the subheading of CY Zinc is the relative
scarcity of zinc to aluminium (computed as the spot price of zinc divided by the spot price of aluminium). Own Var. indicates for the
autoregressive variable. Con. is the constant term. Hedge is the hedging pressure of copper futures proxied by net commercial position/
(commercial long position + commercial short position) at the COMEX. All the variables, except the hedging pressure, are in monthly log change
figures. The standard errors in the results are adjusted for the small sample-size and degree-of-freedom in estimating the error variance–
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covariance matrix. ***, **, * denote the significance level at 1%, 5% and 10%, respectively.

results in our study is found when the tests are
conducted for different time periods. This indicates
that the relationships can be time varying as the
importance of other metals to an industrial metal
changes over time. Furthermore, unlike energy com-
modities such as crude oil, thermal coal and natural
gas, it requires some time for one metal to be sub-
stituted by other metals. Hence, our results especially
for the substitution relationship are likely to be dri-
ven by the expectations of market participants.
These expectations depend heavily on which indus-
try the market participants are paying attention to,
further justifying why our significant results change
over time.
Economic implications
The time-varying characteristic of the relation-
ships allows us to derive several economic impli-
cations in determining the convenience yield of a
metal.
(1) In order to quantify the benefits of possessing
physical aluminium especially during contango
periods (which represent 70% of our sample
dataset period), it is recommended for market
participants including producers, stockists, man-
ufacturers and traders to pay close attention to
the relative market condition against nickel.
(2) The economic linkage with aluminium offers
meaningful information regarding the
behaviour of convenience yield of copper dur-
ing backwardation periods. However, during
contango periods, the convenience yield of
copper is better explained by the price-ratio
against zinc.
(3) For lead, many of the economic linkages
are shown to be less significant after the
GFC. However, our backwardation/con-
tango subsample test shows that it is
recommended to observe the relative scar-
city against tin and zinc during the back-
wardation period, which represents about
40% of our sample.
(4) When it comes to nickel, market participants
are required to observe the behaviour of the
price-ratios for most of the economically
linked metals; however, during contango,
information about lithium and chromium is
more effective than others. In relation to the
results obtained for convenience yield of
nickel, as the market size of this metal is
relatively small compared to aluminium, cop-
per, lead and zinc, this may have caused the
nickel market to be easily affected by the
economic linkages to other metals. In parti-
cular, trading volume of the nickel futures at
the LME (2014) is merely a few per cent of the
overall market.
(5) The price-ratios against aluminium and
nickel, in general, have been playing an
important role in determining the
 16 A. OMURA ET AL.

Table 7. Multivariate Granger-causality test (p-values). metals (Fedorinova and Khrennikov 2012; Maverick
Full sample period 2014). The price ratio of aluminium over copper (at
CY Aluminium versus the LME) has gone up from slightly above 1 to more
Relat. Copper 0.59 than 4 over the last one and a half decades. This has
Relat. Nickel 0.08*
prompted products like high voltage cables for the
Relat. Zinc 0.42
Relat. Scrap 0.54 electricity supply industry to substitute copper with
CY Copper versus aluminium. Furthermore, industries including the
Relat. Aluminium 0.04** automobile industry where reducing weight of the
Relat. Zinc 0.85 products is becoming crucial are also replacing the
Relat. Scrap 0.06*
cables made of red metal with aluminium. Hence,
CY Lead versus
since the replacement is proceeding from copper to
Relat. Nickel 0.08*
Relat. Lithium 0.72
aluminium, perceived importance of the economic
Relat. Tin 0.19 linkage in determining the benefits of owning a
Relat. Zinc 0.03** physical metal differs among the two metals.
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CY Nickel versus
Relat. Aluminium 0.02**
Relat. Lead 0.01*** Battery-related metals
Relat. Lithium 0.03**
Relat. Chromium 0.10* Our study incorporates three battery-related economic
Relat. Zinc 0.48 linkages (lead, lithium and nickel) and it is shown that
CY Tin versus those relationships are important in determining the
Relat. Lead 0.13 convenience yield of lead and nickel. Interestingly,
CY Zinc versus while the relative scarcity of lead against both nickel
Relat. Aluminium 0.16
Relat. Copper 0.96
and lithium obtain significant results in explaining the
Relat. Lead 0.39 convenience yield of lead in the post-GFC period, the
Relat. Nickel 0.08* price-ratio against lithium is shown to be important in
Note: The table reports the results of the Granger-causality tests conducted understanding the behaviour of convenience yield of
based on the multivariate VAR in Table 6. Rows with a subheading Relat.
. . . report the p-values of Granger-causality tests with a null-hypothesis of nickel during the same period. This is possibly because
‘the relative scarcity variable of indicated metal does not Granger-cause (1) as a recent trend, nickel-ion batteries in some
convenience yield of a focused metal’.
industries are being replaced by lithium-ion batteries,
(2) nickel and lithium are interrelated by both substi-
convenience yield of zinc but during con- tution and complementary relationships.
tango, it is recommended to concern the rela-
tionship with lead.
Economic linkages between zinc and other
We further explore why the identified economic industrial metals
linkages yield different results. We focus on the results The convenience yield of zinc is found to be affected
obtained from the bi- and multivariate full-sample tests by the economic linkage against aluminium in the
and our rationale is mainly based on the difference in bivariate study and against nickel in the multivariate
the economic importance of a linkage to a metal. study. On the other hand, our full-sample period test
does not provide a significant result for relative
scarcity against copper or lead.
Aluminium and copper
We argue that this is possibly due to the fact that
The results indicate that the economic linkage galvanizing steel, the largest consuming industry for
between aluminium and copper is important in zinc, can be substituted by aluminium alloys and stain-
determining the perceived convenience yield of cop- less steel in some cases. From this reason, the market is
per but not of aluminium. In recent years for the paying more attention to the relative scarcity against
cable industry, replacement of copper with alumi- those metals. On the other hand, the relationship
nium is proceeding in various industries in response between zinc and copper is mainly driven by the brass
to the widening in the price gap between the two and bronze industry which only represents one-third of
 APPLIED ECONOMICS 17

Table 8. Summary of results.

Bivariate Multivariate
- July 2008 July 2008 - January 2010 - Full Cont Back Full
CY Aluminium versus
Relat. Cu ✗ ✗ ✗ ✗ ✗ ✗ ✗
Relat. Ni ✓ ✓ ✗ ✓ ✓ ✗ ✓
Relat. Zn ✗ ✗ ✓ ✗ ✗ ✗ ✗
Relat. Scrap ✗ ✗ ✗ ✗ ✗ ✗ ✗
CY Copper versus
Relat. Al ✓ ✗ ✗ ✓ ✗ ✓ ✓
Relat. Zn ✗ ✗ ✗ ✗ ✓ ✗ ✗
Relat. Scrap ✓ ✗ ✗ ✗ ✗ ✗ ✓
CY Lead versus
Relat. Ni ✓ ✗ ✗ ✓ ✗ ✗ ✓
Relat. Li ‒ ✓ ✗ ✓ ✗ ‒ ✗
Relat. Zn ✓ ✗ ✗ ✓ ✗ ✓ ✗
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Relat. Sn ✓ ✗ ✗ ✗ ✗ ✓ ✓
CY Nickel versus
Relat. Al ✓ ✗ ✓ ✓ ✗ ✓ ✓
Relat. Pb ✓ ✓ ✗ ✓ ✗ ✓ ✓
Relat. Li ‒ ✓ ✓ ✓ ✓ ‒ ✓
Relat. Cr ✓ ✓ ✓ ✗ ✓ ✓ ✓
Relat. Zn ✗ ✗ ✓ ✓ ✗ ✓ ✗
CY Tin versus
Relat. Pb ✓ ✗ ✗ ✓ ✗ ✗ ✗
CY Zinc versus
Relat. Al ✓ ✗ ✓ ✓ ✗ ✓ ✗
Relat. Cu ✗ ✗ ✗ ✗ ✗ ✓ ✗
Relat. Pb ✗ ✗ ✗ ✗ ✓ ✓ ✗
Relat. Ni ✓ ✗ ✓ ✗ ✗ ✗ ✓
Note: The table reports the summary of the Granger-causality test results. CY . . . versus indicates that the following rows employ convenience yield of
indicated metal. Rows with a subheading Relat. . . . report the p-values of Granger-causality tests with a null-hypothesis of ‘the relative scarcity variable of
indicated metal does not Granger-cause convenience yield of a focused metal’. Cont stands for contango and Back stands for backwardation. A tick
indicates that the result is significant at the 10% level.

the galvanising demand (ILZSG 2014). A similar result
is obtained when relative scarcity of copper against zinc
is used to explain the convenience yield of copper.
Furthermore, as zinc and lead can be extracted
from the same deposit, the relationship between the
two is likely to be complementary. Although no com-
prehensive information on the proportion of zinc
produced from the ores which also contain lead is
available, the importance of such a relationship is
expected to have a direct impact on our results.
Economic linkages between primary and secondary
metals
Lastly, we incorporate the economic linkages between
primary and secondary metals of copper and alumi-
nium. It is found that, especially for aluminium, many
of our test results do not support the significance of this
relationship. We use the producer price index (PPI) in
the U.S.A. to proxy the secondary metal market.
However, countries like Japan and China also actively
recycle non-ferrous metals and therefore the PPI in the
U.S.A. may not well represent the overall scrap market.
VI. Concluding remarks
It is evident that possessing a physical asset offers
various benefits that cannot be enjoyed through
entering a futures contract. Studies related to the
theory of storage, traditionally, focus on explaining
those benefits of a commodity by observing the
behaviour of its own inventory levels, in other
words, the absolute scarcity level. However, the sup-
ply/demand environment of commodities is often
economically related to the production and con-
sumption behaviour of other commodities. For this
 18 A. OMURA ET AL.
reason, the convenience yield of a commodity
should be affected by the dynamic relationship with
those related commodities.
We successfully identify thirteen sets of economic
linkages for six major base metals, namely, alumi-
nium, copper, lead, nickel, tin and zinc. We examine
whether those economic linkages play an important
role in determining the perceived level of conveni-
ence yield. We employ a well-established VAR
model and Granger-causality test approaches, both
bivariately and multivariately, to verify the signifi-
cance of the relationships. Our study obtains mixed
but interesting results which generally support the
presence of statistically positive economic linkages
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among base metals.
Overall, in addition to this general finding, a
number of important implications can be derived
from our results. First, the significance of the rela-
tionship between metals can change over time. There
are sets of relationships existing during a certain
subsample period, but not occurring in other sub-
sample periods. This is reasonable because the appli-
cations that market participants consider as
important can change over time. These results offer
crucial and highly practical implications to market
participants who are seeking to value the benefits of
obtaining a physical metal.
Second, it is found that the intensity of the influ-
ence of the price-ratio on the convenience yield
defers depending on how important the linkage is
to the metal under consideration. In particular, our
results show that a linkage between two metals, A
and B, has a significant explanatory power over the
convenience yield of metal A but not over metal B.
For example, the null-hypothesis of no significant
relationship cannot be rejected when the price ratio
between aluminium and copper is tested against the
convenience yield of aluminium, but can be rejected
in a number of models when the ratio is tested
against the convenience yield of copper. This differ-
ence in the results can be attributed to a recent trend
of replacing copper with aluminium in some indus-
tries thanks to the widening in the price gap between
the two metals.
Our findings have practical implications to var-
ious stakeholders. Firstly, producers, stockists,
manufacturers and traders can improve the preci-
sion of estimating the perceived convenience yield
of major base metals using our findings. In
addition to alerting them regarding the general
importance of the relative scarcity level, by utilis-
ing the time-varying characteristics of the relation-
ships between convenience yield and the price-
ratio, especially during contango and backwarda-
tion periods, market participants would know
which economic linkage they should refer to in
order to measure the benefits of possessing a phy-
sical metal.
Secondly, as the benefits of physically owning a
metal are found to be also affected by the scarcity
level against other metals, a withdrawal constraint at
warehouses for some metals that the LME concerns
can also cause the deviation of the prices of other
economically related metals from their equilibrium
prices. Thus, our study can potentially help the LME
to justify its proposal to implement a new withdra-
wal rule. A future study direction could be to further
generalize our findings and apply similar tests to
other regional commodities such as agricultural
products.
Disclosure statement
No potential conflict of interest was reported by the
author(s).
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