Interest in commodities as an investable asset class has increased in recent years, as investors have been attracted to the potential for both return enhancement and reduction of volatility that commodity futures can offer. While these benefits of commodities are often highlighted by investors with exposure to natural resources or advisors suggesting an allocation for their clients, evidence for such benefits is often limited to a correlation statistic or historical returns.
Several academic studies have been conducted on the historical performance of commodity futures, and countless hours have been spent attempting to better understand the risk/return profile of this asset class. Many of these studies are responsible for the significant increase in interest in commodities as an asset class, as they have quantified the improvements that adding commodity exposure to a traditional stock-and-bond portfolio can make. Below, we profile six academic studies that changed the way investors view commodities:
1. Commodity Futures Prices: Some Evidence On Forecast Power, Premiums, and the Theory of Storage
Authors: Eugene Fama and Kenneth French
Originally Published: 1987
Fama and French may be known best for the development of a three factor model to describe market behavior, but the duo also spent a fair amount of time researching the performance of commodity markets. In 1987 Fama and French published an article in the Journal of Business that analyzed two models of commodity futures prices, examining the impact of interest rate changes, storage costs, and convenience yields on prices.
2. Seasonal and Stochastic Effects In Commodity Forward Curves
Authors: Svetlana Borovkova and Helyette Geman
Originally Published: 2006
This paper takes a new look at a model for understanding how forward curves of commodities exhibiting seasonality can be explained. This work gets into the weeds of energy markets, but arrives at some interesting conclusions regarding the factors that can be used to predict and explain prices.
3. On the Behavior of Commodity Prices
Authors: Angus Deaton and Guy Laroque
Originally Published: 1992
This paper analyzes the factors that impact commodity prices, investigating the skewness and occurrence of significant short-term shifts in prices of certain commodities. This study also includes insights on the high degree of autocorrelation among commodities in “normal” environments.
4. Facts and Fantasies About Commodity Futures
Authors: Gary Gorton and K. Geert Rouwenhorst
Originally Published: 2005
This seminal work highlighted the potentially appealing attributes of commodities as an asset class, based on the construction of an equally-weighted index of commodity futures monthly returns over a 45-year period. Among the returns reached by the authors are that fully-collateralized commodity futures have historically offered the same return and Sharpe ratio as equities, while exhibiting negative correlations to stocks and bonds.
5. The Fundamentals of Commodity Futures Returns
Authors: Gary Gorton, K. Geert Rouwenhorst, and Fumio Hayashi
Originally Published: 2007
This follow-up to the 2005 paper has shaped the way that investors have approached commodities in recent years. In this study, the trio of researchers came up with a methodology that takes into account, among other factors, the level of physical inventories for various commodities. The conclusions reached in this document have shaped the way many of the most recent commodity products are constructed, and emphasizes the price signals that can be gleaned from physical inventory.
6. The Tactical and Strategic Value of Commodity Futures
Authors: Claude B. Erb and Campbell R. Harvey
Originally Published: 2005
This paper asks some critical questions of the concept of commodities as an asset class, noting that futures contracts have been an inconsistent hedge against inflation historically and that the historically high average returns to a commodity futures portfolio are driven largely by choice of weighting schemes. The paper goes on to analyze three trading strategies using both momentum and term structure of futures prices.
Disclosure: No positions at time of writing.
