From CXO Advisory:
We occasionally select for retrospective review an all-time "best selling" research paper from the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the January 2006 paper entitled "The Tactical and Strategic Value of Commodity Futures" (download count over 2,400) by Claude Erb and Campbell Harvey. Commodity futures are derivative, short-maturity claims on real assets. In this paper, the authors explore the strategic and tactical opportunities that these derivatives present to investors. Using long-run commodity futures return data as available mostly through mid-2004, they conclude that:
- Over the long term, the average annualized excess returns (above the risk-free rate) on futures for individual commodities is approximately zero, and these returns are largely uncorrelated with one another. There is little evidence of long-term return persistence among individual commodity futures.
- However, an equally weighted and monthly rebalanced portfolio of different commodity futures has a statistically significant and reliable compound average annual excess return of about 4.5%. This rebalancing return derives from portfolio diversification, not from fundamental influences such as inflation, economic growth or risk premiums.
- Over the period December 1982 through May 2004, the average excess return for commodities with a positive roll return (in contango) is 4.2%, compared to -4.6% for commodities with a negative roll return (in backwardization). But, the volatility of commodity futures returns comes mostly from variation in spot return, and this volatility swamps the roll return over this period....MORE