Facts & Fantasies About Commodity Futures
Introduction (Via Gary Gorton & K. Geert Rouwenhorst)
Commodity futures are still a relatively unknown asset class, despite being traded in the U.S. for over 100 years and elsewhere for even longer.1 This may be because commodity futures are strikingly different from stocks, bonds, and other conventional assets. Among these differences are: (1) commodity futures are derivative securities; they are not claims on long-lived corporations; (2) they are short maturity claims on real assets; (3) unlike financial assets, many commodities have pronounced seasonality in price levels and volatilities. Another reason that commodity futures are relatively unknown may be more prosaic, namely, there is a paucity of data.
The economic function of corporate securities such as stocks and bonds, that is, liabilities of firms, is to raise external resources for the firm. Investors are bearing the risk that the future cash flows of the firm may be low and may occur during bad times, like recessions. These claims represent the discounted value of cash flows over very long horizons. Their value depends on decisions of management. Investors are compensated for these risks. Commodity futures are quite different; they do not raise resources for firms to invest. Rather, commodity futures allow firms 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 exposures to actual commodities. Futures prices represent bets on the expected future spot price. Inventory decisions link current and future scarcity of the commodity and consequently provide a connection between the spot price and the expected future spot price. But commodities, and hence commodity futures, 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 some commonly raised questions: Can an investment in commodity futures earn a positive return when spot commodity prices are falling? How do spot and futures returns compare? What are the returns to investing in commodity futures, and how do these returns compare to investing in stocks and bonds? Are commodity futures riskier than stocks? Do commodity futures provide a hedge against inflation? Can commodity futures provide diversification to other asset classes? Many of these questions have been investigated by others but in large part with short data series applying to only a small number of commodities.