Tuesday, November 19, 2013

"The disappearance of the roll yield has killed the case for commodities" (Not)

Sweet headline from Abnormal Returns.
I added the "Not" for the same reason I intro'd the Oct. 6 FT article "Commodity hedge funds face bleak future" with:
Thus sayeth the FT.
The thing I don't get about these whiny little commod (no 'e', yet) artists is the apparent failure to understand the words hedge or macro.
Dudes, you can go long or short. And do it in multiple, disparate commodities anywhere in the world.

Unless of course the folks who were proclaiming commodities an asset class were simply full of it and were nothing more than longside trend followers charging alpha sized 2-and-20 for what was actually leveraged beta....
The practitioner can still produce very acceptable returns but it is definitely not 2008 where one could kick back, talk smart and smoke fat cigars as the funds for investment just rolled in and the long-only index funds played the role of liquidity provider.
To be honest though, I have no idea what I was thinking when I wrapped-up with this:
...And then you've got the whole high-water-mark thing where managers don't get paid until they've made back the losses, at least to the benchmark point, making it very rational for said manager to decide they would not be working for free, fold the tent and move on to hot snail spa treatments, or whatever the latest fad is.
"Here at L'escargot we believe the outer you should be a reflection of the slimy mollusc that is the inner you..."
Via the Social Science Research Network:

Implications of Financialization for Commodity Investors: The Case of Roll Yields

Adam Zaremba

Poznań University of Economics

November 4, 2013


The paper concentrates on the benefits of passive commodity investments in the context of the phenomenon of financialization. I investigate the changes in the commodity futures’ roll returns and their implications for commodity investors

The paper is composed of several parts. First, I describe the attributes of commodity investments and their benefits in the portfolio optimization. Second, I define the phenomenon of the finanzialization and develop my research hypothesis. The third section includes a description of data sources, research methods employed and an introduction of a new measure of the level financialization. Next, I present the results of the empirical analysis, which consists of two main stages. In the first stage, I perform the regression analysis to assess the impact of financialization on the commodity markets. In the second stage, I simulate the mean-variance spanning tests to examine the benefits of commodity investments before and after accounting for the impact of financialization. The empirical research is based on asset classes’ returns and other related variables from years 1990-2012.

The performed research indicate that the market financialization may significantly contribute to the fall down of expected roll returns. Moreover, because of the drop in the roll yields, the inclusion of the commodity futures in the traditional stock-bond portfolio appears to be no longer reasonable.
Free download (40 page PDF)

HT: Abnormal Returns 

There are three sources of potential profit in commodities:
1) Changes in the spot price
2) Interest income: You only have to put up a fraction of the position's value to buy futures, and the rest can be invested in Treasuries.
3) The roll yield: Futures contracts expire each month, and if you wish to maintain a position short-term you must sell the expiring contract and buy the next month's contract when that occurs. If the next month contract is priced higher, you lose money: that's contango. If it's priced lower, you make money: that's backwardation.
When one of the sources isn't producing you have to be good at another but it is possible.
Or as one of my mentors used to say, "Just be right".
(and be the best damn risk manager you can be)