[PPT] - The Fundamentals of The Fundamentals of Commodity Futures Returns PowerPoint Presentation

SLIDE 1

Yale School of Management

The Fundamentals of The Fundamentals of Commodity Futures Returns Commodity Futures Returns

Gary Gorton Gary Gorton

The Wharton School, University of Pennsylvania

Fumio Hayashi

Tokyo University

K. Geert Rouwenhorst

School of Management, Yale University

SLIDE 2

Yale School of Management

Commodity Futures, Stocks and Bonds

Inflation Adjusted Performance From 1959 to 2004

1,750 2,000 1,250 1,500 750 1,000

Commodity Futures

250 500

Stocks

1

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

Bonds

SLIDE 3

Yale School of Management

Risk and Return of Commodity Futures

Annualized Futures Risk Premiums and Stdev by Commodity 1990/12- 2006/12

25%

Gasoline RBOB Propane

20% 25%

p.a.)

Copper Soybean Meal Sugar Pork Bellies Platinum Heating Oil Nickel Crude Oil Natural Gas

10% 15%

emium (% p

Cocoa Soybeans Soybean Oil Oats Silver Live Cattle Lean Hogs Lumber Feeder Cattle Coffee Gold Zinc Lead Aluminum Tin

EW Index 0% 5%

age Risk Pre

Cotton Cocoa Wheat Corn Orange Juice Rough Rice

5%

0% 0% 10% 20% 30% 40% 50% 60%

Avera 2

10%

Sample Standard Deviation (% p. a.)

SLIDE 4

Yale School of Management

Explaining the Cross-section of Commodity p g y Futures Risk Premiums

Commodity futures are “insurance contracts” to transfer commodity price risk Insurance premiums are expected to be high when the amount of risk to be insured is high Modern Theory of Storage by DL (1992) predicts that expected spot price volatility is decreasing in inventories p p p y g Risk premium of commodity futures should be a negative f ti f i t i

3

function of inventories

SLIDE 5

Yale School of Management

D t Data

Futures Prices:

Commodity Research Bureau (CRB) y ( ) London Metals Exchange (LME)

Inventory Data:

US Department of Energy US Department of Agriculture NYBOT, LME warehouse stocks American Forest & Paper Association USDA Li t k d S d Di i i

4

USDA Livestock and Seed Division

SLIDE 6

Yale School of Management

I ith I t D t Issues with Inventory Data

Measurement Which inventories are relevant? Which inventories are relevant? Data revisions Publication lags Publication lags Statistical Issues Statistical Issues Trends: we applied a HP filter to the data Seasonality of inventories

5

Seasonality of inventories

SLIDE 7

Yale School of Management

Seasonality of Inventories: Corn (Table 2)

Seasonal Variation of Corn Inventories

Deviation of Inventories from Trend 1974/6-2006/12 50% 30% 50% 10% viation

10%

Percent Dev

30%

6

50%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

SLIDE 8

Yale School of Management

Seasonality of Inventories: Natural Gas

Seasonal Variation of Natural Gas Inventories

Deviation of Inventories from Trend 1975/9-2006/12 50% 30% 50% 10% viation

10%

Percent Dev

30%

7

50%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

SLIDE 9

Yale School of Management

Seasonality (Table 2)

Seasonality of Physical Inventories

R-squared of Regressing Detrended Inventories on Monthly Dummies 1 0.75 1 0.5 quared 0.25 R-sq

r m m c d l m n n a J r e t n s i l l s s e s e k r i l i l e e s l

8

C

p

p e r P l a t i n u m P a l l a d i u m Z i n c L e a d N i c k e l A l u m i n u m T i n C

t

t

n

C

c
a

O J L u m b e r C

f

f e e W h e a t C

r

n S

y

b e a n s S

y

b e a n O i l S

y

b e a n M e a l O a t s P

r

k B e l l i e s L i v e C a t t l e L e a n H

g

s F e e d e r C a t t l e M i l k B u t t e r H e a t i n g O i l C r u d e O i l G a s

l

i n e P r

p

a n e N a t u r a l G a s C

a

l

SLIDE 10

Yale School of Management

Risk Premiums and Inventory-Sorted Portfolios

Cumulative Returns Inventory Sorted Portfolios

Performance of Equally-weighted Portfolios 12/1990-12/2006

800

EW I d Hi h I t i L I t i

600

EW Index High Inventories Low Inventories Annualized Return 8.98% 4.62% 13.34% Volatility 8.93% 11.27% 10.80% Sharpe Ratio 0.55 0.05 0.86

400 200 1990 1992 1994 1996 1998 2000 2002 2004 2006

9

EW Index High Inventories Low Inventories

SLIDE 11

Yale School of Management

Returns and Characteristics of Portfolios Sorted on Relative Inventories (Table 5)

1969/12-2006/12 1986/1-2006/12 1990/12-2006/12 Panel A: Returns Relative to EW Index High Low H-L High Low H-L High Low H-L Mean

3.85

4.21

8.06
3.64

3.61

7.25
4.38

4.37

8.75

Standard Deviation 7.77 7.80 15.48 7.03 7.04 14.02 6.44 6.47 12.84 t -statistic (mean)

3.03

3.32

3.19
2.34

2.33

2.34
2.83

2.80

2.82

% Excess Return>0 42.57 56.53 43.47 41.04 57.37 42.23 41.67 57.29 43.23 l A f li Ch i i Panel B: Average Portfolio Characteristics High Low t -stat High Low t -stat High Low t -stat Prior 12m futures return 0.41 15.31

6.45

1.24 12.97

5.54

0.05 11.20

5.43

Prior 12m spot ret rn 6 00 9 78 2 58 5 00 8 85 2 39 5 33 8 59 1 95 Prior 12m spot return 6.00 9.78

2.58

5.00 8.85

2.39

5.33 8.59

1.95

Basis

7.78

4.61

14.51
6.86

4.51

11.40
8.81

2.79

13.14

Inventories 36.37

36.15

37.20

35.19

40.80

31.07

Volatility (+1) 23.40 23.86

1.15

23.75 23.90

0.27

23.84 23.46 0.66 Commercials

11 71
7 97
5 03
12 33
8 00
4 81

10

Commercials

11.71
7.97
5.03
12.33
8.00
4.81

Non-Commercials 5.59 5.28 0.58 6.01 5.66 0.53 Non Reportable 6.08 2.75 5.29 6.27 2.41 5.23

SLIDE 12

Yale School of Management

Testing the Traditional Theory of Storage

Basis and Normalized Inventories of Copper

1 0.5 0.75

ects)

Actual Fitted

0.25 0.5

seasonal effe

0.25

0.5 1 1.5 2 2.5 3 3.5 4

Basis (net of

0.75
0.5

11

Normalized Inventory

Copper is relatively easy to store…

SLIDE 13

Yale School of Management

Testing the Traditional Theory of Storage

Basis and Normalized Inventories for Crude Oil

1 0.5 0.75

ects)

Actual Fitted 0.25

f seasonal effe

0.25

0.5 1 1.5 2 2.5 3 3.5 4

basis (net of

0.75
0.5

Normalized Inventory

12

Normalized Inventory

Crude is relatively expensive to store

SLIDE 14

Yale School of Management

Basis and Inventories

Cubic Spline Regression of Basis on Inventories (Table 3)

Commodity slope at 1 t slope at 0.75 t difference t R-sq Metals group

0.051
2.46
0.118
6.01

0.067 4.70 Copper

0.032
0.61
0.153
2.76

0.121 5.64 0.41 Platinum

0.034
1.10
0.031
0.93
0.003
0.12

0.41 Palladium

0.045
1.46
0.032
1.26
0.013
1.03

0.19 Zinc

0.019
0.39
0.096
2.22

0.076 3.32 0.32 Lead

0.146
2.83
0.270
5.57

0.124 4.34 0.54 Nickel

0.039
1.06
0.136
4.13

0.096 5.95 0.55 Aluminum

0.057
1.64
0.094
2.86

0.037 2.16 0.25 Tin

0.001
0.02
0.093
3.03

0.092 5.06 0.40 S f 0 193 5 65 0 257 8 37 0 064 4 93 Softs group

0.193
5.65
0.257
8.37

0.064 4.93 Grains group

0.214
5.10
0.251
5.02

0.037 1.39 Meats group

0.598
7.03
0.602
6.27

0.004 0.12 Energies group

1.546
7.61
1.496
4.15
0.050
0.16

13

Inventory sensitivity varies across commodity groups

SLIDE 15

Yale School of Management

State of Inventories and the Basis State of Inventories and the Basis

Average Basis and Normalized Inventories

Monthly Data 1969/12-2006/12 30% 8 20% 4 6 10% to average 2 4 minus High

10%

0%

Copper Platinum Palladium Zinc Lead Nickel Aluminum Tin Cotton Cocoa OJ Lumber Coffee Wheat Corn Soybeans SoyOil SoyMeal Oats PorkBellies LiveCattle LeanHogs FeederCattle Milk Butter HeatOil CrudeOil UnleadedGas Propane NatGas Coal

Basis relative

2

statistic Low

20%

B

6
4

t-s

14

30%
8

High Inventory Low Inventory t-statistic

SLIDE 16

Yale School of Management

Returns and Characteristics of Portfolios Sorted on Futures Basis (Table 6)

1969/12-2006/12 1986/1-2006/12 1990/12-2006/12 Panel A: Returns Relative to EW Index High Low H-L High Low H-L High Low H-L Mean 5.42

4.82

10.23 5.04

4.70

9.74 5.71

5.86

11.57 Standard Deviation 7.76 7.93 15.58 6.87 7.13 13.93 6.08 6.08 12.10 t -statistic (mean) 3.98

3.44

3.73 3.55

3.14

3.36 4.04

4.10

4.08 % Excess Return>0 58.56 42.79 57.88 61.35 39.04 61.35 63.02 37.50 63.02 l A f li Ch i i Panel B: Average Portfolio Characteristics High Low t -stat High Low t -stat High Low t -stat Prior 12m futures return 21.02

5.11

12.93 19.68

5.40

12.99 17.50

5.93

10.56 Prior 12m spot ret rn 15 61 0 29 10 45 14 39 0 51 9 51 14 11 0 00 7 16 Prior 12m spot return 15.61 0.29 10.45 14.39

0.51

9.51 14.11 0.00 7.16 Basis 15.32

18.40

15.44

17.73

13.04

19.01

Inventories

14.87

15.31

17.08
13.78

15.95

13.65
9.34

19.09

13.76

Volatility (+1) 24.07 23.23 2.13 24.30 23.31 1.72 23.98 23.30 0.99 Commercials

8 94
10 34

1 46

9 87
10 01

0 13

15

Commercials

8.94
10.34

1.46

9.87
10.01

0.13 Non-Commercials 6.89 3.95 4.24 7.78 3.92 4.81 Non Reportable 2.38 6.12

7.00

2.52 5.73

5.99

SLIDE 17

Yale School of Management

State of Inventories and Prior Futures Returns

Prior 12-month Return and Normalized Inventories

Monthly Data 1969/12-2006/12 30% 8 20% ge 4 6 0% 10% ative to averag 2 w minus High

10%

0%

C

p

p e r P l a t i n u m P a l l a d i u m Z i n c L e a d N i c k e l A l u m i n u m T i n C

t

t

n

C

c
a

O J L u m b e r C

f

f e e W h e a t C

r

n S

y

b e a n s S

y

O i l S

y

M e a l O a t s P

r

k B e l l i e s L i v e C a t t l e L e a n H

g

s F e e d e r C a t t l e M i l k B u t t e r H e a t O i l C r u d e O i l U n l e a d e d G a s P r

p

a n e N a t G a s C

a

l

rior return rela

2

t-statistic Low

20%

P

6
4

16

30%
8

High Inventory Low Inventory t-statistic

SLIDE 18

Yale School of Management

Returns and Characteristics of Portfolios Sorted on Prior 12-month Futures Return (Table 7)

1969/12 2006/12 1986/1 2006/12 1990/12 2006/12 1969/12-2006/12 1986/1-2006/12 1990/12-2006/12 Panel A: Returns Relative to EW Index High Low H-L High Low H-L High Low H-L Mean 6.54

6.82

13.36 6.81

7.03

13.84 7.69

7.67

15.36 Standard Deviation 8.52 8.62 16.99 7.80 7.90 15.53 6.84 6.83 13.64 t -statistic (mean) 4.82

4.95

4.93 4.24

4.35

4.34 4.56

4.62

4.60 % Excess Return>0 58.78 42.34 58.11 61.35 39.44 60.96 64.58 35.42 64.58 Panel B: Average Portfolio Characteristics High Low t -stat High Low t -stat High Low t -stat Prior 12m futures return 32.62

16.65

31.57

17.14

29.40

17.79

Prior 12m spot return 26.22

10.43

23.52 25.54

11.70

24.16 25.37

11.23

20.33 Basis 6.73

9.96

19.15 6.94

9.30

17.97 5.03

11.08

14.73 Inventories

9.30

9.88

8.26
7.29

9.44

6.07
3.51

13.29

5.74

Volatility (+1) 24.10 23.28 1.71 24.43 23.24 1.83 24.37 22.97 1.83

17

Commercials

11.57
8.01
2.73
12.53
7.46
3.61

Non-Commercials 9.02 1.58 9.81 10.11 1.24 11.72 Non Reportable 2.74 6.18

4.31

2.67 5.89

3.67

SLIDE 19

Yale School of Management

Trading Strategies of Price-based Measures of Inventories

Cumulative Performance High Basis and Prior Return Portfolios

Performance of Equally-weighted Portfolios 12/1990-12/2006

1500

EW I d Hi h B i Hi h RS C bi ti

g g

1250

EW Index High Basis High RS Combination Annualized Return 8.98% 14.67% 16.67% 15.67% Volatility 8.93% 11.52% 11.42% 11.00% Sharpe Ratio 0.55 0.92 1.11 1.06

750 1000 500 250

18

1990 1992 1994 1996 1998 2000 2002 2004 2006

EW Index High Relative Strengh High Basis Combination Basis and RS

SLIDE 20

Yale School of Management

Returns and Characteristics of Portfolios Sorted on Prior 12-month Spot Return (Table 8)

1969/12-2006/12 1986/1-2006/12 1990/12-2006/12 Panel A: Returns Relative to EW Index High Low H-L High Low H-L High Low H-L Mean 6.73

7.12

13.85 8.55

8.82

17.37 7.87

8.16

16.03 Standard Deviation 8.69 8.58 17.19 8.53 8.34 16.83 6.71 6.78 13.44 t -statistic (mean) 4.77

5.09

4.95 4.79

5.07

4.94 4.36

4.55

4.47 % Excess Return>0 56.76 41.67 57.88 59.76 38.25 60.96 61.46 36.98 61.98 l A f li Ch i i Panel B: Average Portfolio Characteristics High Low t -stat High Low t -stat High Low t -stat Prior 12m futures return 28.61

12.79

18.13 27.98

13.58

22.84 25.99

14.41

20.56 Prior 12m spot ret rn 29 78 13 87 28 60 14 67 28 15 14 01 Prior 12m spot return 29.78

13.87

28.60

14.67

28.15

14.01

Basis 3.94

7.08

11.57 4.71

7.05

12.40 3.00

9.00

10.22 Inventories

3.00

3.27

2.77
2.25

4.09

2.51

1.56 8.17

2.57

Volatility (+1) 24.18 23.25 1.82 24.35 23.33 1.40 24.43 22.90 1.91 Commercials

13 02
6 45
6 29
14 03
5 83
7 80

19

Commercials

13.02
6.45
6.29
14.03
5.83
7.80

Non-Commercials 9.60 1.14 13.68 10.59 0.95 16.12 Non Reportable 3.68 5.04

1.87

3.78 4.53

0.93

SLIDE 21

Yale School of Management

Conditional Volatility and the Futures Basis

25%

Conditional Distributions of Commodity Futures Returns

Normalized Monthly Basis-sorted Returns (1990/12 - 2006/12)

20%

cy

Hi (20% Basis) Low (20% Basis)

Avg. Stdev. Skew. Kurt.

Hi Basis 0.0948 1.2264 0.3319 4.8894 Low Basis -0.0489 0.9350 0.3550 4.2030 10% 15%

ative Frequenc

5%

Rela

6.75%
4.50%
2.25%

0.00% 2.25% 0%

R t

20

4.50% 6.75%

Returns

SLIDE 22

Yale School of Management

Volatility of Characteristics Sorted Portfolios

li l ili t-test for Equality of Average Futures Return Volatility

f Commodities in High versus Low Portfolios

Characteristic

1969/12-2006/12 1986/1-2006/12 1990/12-2006/12 Panel A: De-meaned data Inventories

1.75
1.59
0.78

Basis 3.33 5.61 4.68 Prior 12-month futures return 2.77 3.42 3.49 Prior 12-month spot return 2.82 2.75 3.07 Prior 12 month spot return 2.82 2.75 3.07 Panel B: Raw data Inventories

1.15
0.27

0.66 Basis 2 13 1 72 0 99 Basis 2.13 1.72 0.99 Prior 12-month futures return 1.71 1.83 1.83 Prior 12-month spot return 1.82 1.40 1.91

21

SLIDE 23

Yale School of Management

Alternative Hypothesis: Hedging Pressure (Table 11) yp g g

Average Positions of Traders as % of Open Interest

CFTC Classifications 1986 - 2006 40 20 erest Commercials Non-Commercials Non-Reportable 20

f Open Inte

Copper Platinum Palladium Cotton Cocoa Sugar Orange Juice Lumber Coffee Wheat Corn Soybeans Soybean Oil Soybean Meal Oats Rough Rice Pork Bellies Live Cattle Lean Hogs Feeder Cattle Milk Heating Oil Crude Oil Unleaded Gas Propane Natural Gas

sition as % o

20

Net Pos 22

40

SLIDE 24

Yale School of Management

Hedging Pressure and Risk Premiums (Table 12)

R-squared of Futures Returns on Commercial Positions

CFTC data1986/12 - 2006/12

0 25 0.20 0.25 0.15 0.05 0.10 0.00

C

p

p e r C

t

t

n

C

c
a

W h e a t C

r

n y b e a n s b e a n O i l a n M e a l O a t s S u g a r k B e l l i e s S i l v e r e C a t t l e a n H

g

s g e J u i c e l a t i n u m L u m b e r e r C a t t l e C

f

f e e G

l

d l l a d i u m a t i n g O i l r u d e O i l a s

l

i n e g h R i c e P r

p

a n e u r a l G a s M i l k

23

C C C W S

y

b S

y

b e S

y

b e a S P

r

k B L i v e L e a n O r a n g e P l a L u F e e d e r C P a l l a H e a t C r u G a s R

u

g P r

N

a t u r

Contemporaneous Predictive

SLIDE 25

Yale School of Management

Summary and Conclusions Summary and Conclusions

We test several predictions of the Theory of Storage for a large cross- section of commodity futures using inventory data. We find that: Basis is negatively related to inventories g y Relationship is non-linear for many commodities Basis and prior returns are indicators for the state of inventories Inventories, the basis, and prior returns are correlated with Inventories, the basis, and prior returns are correlated with expected price volatility and predict future risk premiums We reject Hedging Pressure as an alternative explanation for commodity futures risk premiums

Future research:

Reconcile the empirical evidence with Modern Asset Pricing Theory

24