Bloomberg commodities index still in contango

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grok87
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Bloomberg commodities index still in contango

Post by grok87 » Sun Mar 11, 2018 8:59 am

Not sure if these reports have been posted yet
...
https://data.bloomberglp.com/promo/site ... Charts.pdf
...
Page 18 shows the state of backwardation/contango by commodity.
Right now energy and livestock appear to be in backwardation (downward sloping forward curve which means you generally benefit from positive roll yield) whereas other commodities are generally still in contango (the reverse of backwardation).

Overall the bloomberg commodity index bcom is still in contango.

I would be interested in making a small allocation to commodities once they move broadly into backwardation. But we are not there yet i don't think. I could, i suppose, look for an energy or livestock specific commodity fund. Or a fund that has a strategy selecting commodities that are in backwardation. But i don't think any good cheap ones exist...

Cheers,
Grok
Keep calm and Boglehead on. KCBO.

Valuethinker
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Re: Bloomberg commodities index still in contango

Post by Valuethinker » Sun Mar 11, 2018 9:36 am

I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.

And we are at the late stages of an economic expansion, by all rights-- converging on the longest expansion on record in history (the 1990s one) I believe. Thus, commodity prices should start to rise, as they do in any late stage of cycle-- potential supply just cannot keep up with demand.

A major caveat is that China is so important to commodity prices now that that single factor might overwhelm any other. I am still of the camp that China has built up the largest property & infrastructure bubble in history, and it's going to be really unpleasant whilst they unwind it. But strangely my record as a forecaster is not 100 per cent ;-).

hilink73
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Re: Bloomberg commodities index still in contango

Post by hilink73 » Sun Mar 11, 2018 10:07 am

Valuethinker wrote:
Sun Mar 11, 2018 9:36 am
I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.

And we are at the late stages of an economic expansion, by all rights-- converging on the longest expansion on record in history (the 1990s one) I believe. Thus, commodity prices should start to rise, as they do in any late stage of cycle-- potential supply just cannot keep up with demand.

A major caveat is that China is so important to commodity prices now that that single factor might overwhelm any other. I am still of the camp that China has built up the largest property & infrastructure bubble in history, and it's going to be really unpleasant whilst they unwind it. But strangely my record as a forecaster is not 100 per cent ;-).

So, anybody calling a commodities bottom?
Paging Dr. Grap, paging Dr. Grap ... ;-)

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Sun Mar 11, 2018 10:31 am

Valuethinker wrote:
Sun Mar 11, 2018 9:36 am
I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.
That’s a interesting idea. I wonder how how one could measure such a thing...
Keep calm and Boglehead on. KCBO.

staythecourse
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Re: Bloomberg commodities index still in contango

Post by staythecourse » Sun Mar 11, 2018 10:31 am

Didn't read past 2 paragraphs to understand this is financial porn and an advertising campaign. That shouldn't be difficult to figure out. Yes. to the above poster it is more beneficial to purchase ANYTHING before it goes up. Would you rather have bought U.S. stocks in the flat 2000's or the hot 2010's? Waiting for something to go up to purchase is a terrible idea.

If one wants to play the commodities game (especially if one is betting on oil) I would recommend tracking the goldman sachs index (GSCI). It is cap weighted and thus 60-75% is weighted to oil. The other advantage is unlike ALL other CCF funds it is the only one that is not market to market so no short term CG every year on the profit. So it is the most reasonable in a taxable account.

Good luck.

(p.s. The unfortunate thing is most of the funds available have only been around as long as the commodities market has been down (2006+) so we have no clue if they are even a suitable mousetrap for this space)
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

Valuethinker
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Re: Bloomberg commodities index still in contango

Post by Valuethinker » Sun Mar 11, 2018 12:02 pm

edited
Last edited by Valuethinker on Sun Mar 11, 2018 12:04 pm, edited 2 times in total.

Valuethinker
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Re: Bloomberg commodities index still in contango

Post by Valuethinker » Sun Mar 11, 2018 12:03 pm

grok87 wrote:
Sun Mar 11, 2018 10:31 am
Valuethinker wrote:
Sun Mar 11, 2018 9:36 am
I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.
That’s a interesting idea. I wonder how how one could measure such a thing...
I suspect things like Google queries.

But also the financial press generally. And you hear about institutional investors cutting their commitment to commodities (Harvard, etc.).

I don't know if this is the Capitulation phase, but it feels like it. On the other hand, a bad idea in investing is just a bad idea, regardless of whether you capitulate or not.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Sun Mar 11, 2018 7:18 pm

Valuethinker wrote:
Sun Mar 11, 2018 12:03 pm
grok87 wrote:
Sun Mar 11, 2018 10:31 am
Valuethinker wrote:
Sun Mar 11, 2018 9:36 am
I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.
That’s a interesting idea. I wonder how how one could measure such a thing...
I suspect things like Google queries.

But also the financial press generally. And you hear about institutional investors cutting their commitment to commodities (Harvard, etc.).

I don't know if this is the Capitulation phase, but it feels like it. On the other hand, a bad idea in investing is just a bad idea, regardless of whether you capitulate or not.
I found a recent article about your point that harvard is cutting its investments in commodities/natural resources...
https://www.bloomberg.com/news/articles ... eucalyptus

so do the opposite of what Harvard does? I like it!
Keep calm and Boglehead on. KCBO.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Sun Mar 11, 2018 7:27 pm

staythecourse wrote:
Sun Mar 11, 2018 10:31 am
Didn't read past 2 paragraphs to understand this is financial porn and an advertising campaign. That shouldn't be difficult to figure out. Yes. to the above poster it is more beneficial to purchase ANYTHING before it goes up. Would you rather have bought U.S. stocks in the flat 2000's or the hot 2010's? Waiting for something to go up to purchase is a terrible idea.

If one wants to play the commodities game (especially if one is betting on oil) I would recommend tracking the goldman sachs index (GSCI). It is cap weighted and thus 60-75% is weighted to oil. The other advantage is unlike ALL other CCF funds it is the only one that is not market to market so no short term CG every year on the profit. So it is the most reasonable in a taxable account.

Good luck.

(p.s. The unfortunate thing is most of the funds available have only been around as long as the commodities market has been down (2006+) so we have no clue if they are even a suitable mousetrap for this space)
thanks.

1) agree with your "advertising campaign" point. I'm mostly interested in the data provided on page 18 of the document etc.

2) is the etf you are referencing that might be good for a taxable account GSG? looks like it is pretty tax efficient according to morningstar.
http://performance.morningstar.com/fund ... ture=en_US
i think it does issue K-1's though- personally i'm not interested in the tax filing hassle of that...
http://etfdb.com/etf-tax-efficiency/etf ... sue-a-k-1/
Keep calm and Boglehead on. KCBO.

staythecourse
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Re: Bloomberg commodities index still in contango

Post by staythecourse » Sun Mar 11, 2018 8:37 pm

grok87 wrote:
Sun Mar 11, 2018 7:27 pm
staythecourse wrote:
Sun Mar 11, 2018 10:31 am
Didn't read past 2 paragraphs to understand this is financial porn and an advertising campaign. That shouldn't be difficult to figure out. Yes. to the above poster it is more beneficial to purchase ANYTHING before it goes up. Would you rather have bought U.S. stocks in the flat 2000's or the hot 2010's? Waiting for something to go up to purchase is a terrible idea.

If one wants to play the commodities game (especially if one is betting on oil) I would recommend tracking the goldman sachs index (GSCI). It is cap weighted and thus 60-75% is weighted to oil. The other advantage is unlike ALL other CCF funds it is the only one that is not market to market so no short term CG every year on the profit. So it is the most reasonable in a taxable account.

Good luck.

(p.s. The unfortunate thing is most of the funds available have only been around as long as the commodities market has been down (2006+) so we have no clue if they are even a suitable mousetrap for this space)
thanks.

1) agree with your "advertising campaign" point. I'm mostly interested in the data provided on page 18 of the document etc.

2) is the etf you are referencing that might be good for a taxable account GSG? looks like it is pretty tax efficient according to morningstar.
http://performance.morningstar.com/fund ... ture=en_US
i think it does issue K-1's though- personally i'm not interested in the tax filing hassle of that...
http://etfdb.com/etf-tax-efficiency/etf ... sue-a-k-1/
Yes GSG is the one I am referencing. In the prospectus it talks about investing in CERFS which are 5 year contracts. That is how they avoid the market to market (each calendar year) taxation which makes ALL the gains of commodity funds taxed at short term tax rates if held in taxable. So VERY inefficient except for GSG. I did hold it for one year VERY early in my investing lifetime and can vouch for the taxation to be only as LTCG on sale with no market to market taxation.

Many folks argue which index to follow anyways. It seems if you are trying to counterbalance the volatility of equities (the holy grail) then GSCI makes a great index due to its HIGH volatility. If you want a more well balanced diversified fund then there are several others out there. I do remember the Yale guys who wrote the seminal article on commodities starting their own fund, but don't know how/ if it still exists. Believe it had Summerhaven in the name or something like that. That one was an active diversified fund.

When one invests in CCF, like any asset class, I think it is important to understand why you are doing it. If it is for diversification, counterbalance to high equities, or for protection for unexpected inflation.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Sun Mar 11, 2018 10:01 pm

Valuethinker wrote:
Sun Mar 11, 2018 12:03 pm
I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.

But also the financial press generally. And you hear about institutional investors cutting their commitment to commodities (Harvard, etc.).
You can read about the
Harvard commodities fiasco
, but I'm curious why backwardation makes for an attractive entry into a commodities investment.
Index fund investor since 1987.

lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Sun Mar 11, 2018 10:23 pm

jalbert wrote:
Sun Mar 11, 2018 10:01 pm
Valuethinker wrote:
Sun Mar 11, 2018 12:03 pm
I suppose the time to get interested in commodities is precisely now, when the market is just not interested in them.

But also the financial press generally. And you hear about institutional investors cutting their commitment to commodities (Harvard, etc.).
You can read about the
Harvard commodities fiasco
, but I'm curious why backwardation makes for an attractive entry into a commodities investment.
Why backwardation makes an attractive entry? You mean beyond the obvious?

Explaining it for those who might not know: that means in the absence of the futures curve changing, you get a positive carry return from roll yield. When you sell off one futures contract to buy the next-dated contract the next contract is at a lower price than the one you sold. So buy low, sell high. (e.g. let's say it's July and it's getting close to settlement for your July contract, so then you close that position and go long the August contract, where spot is $50, the July is trading at $49.9, and the August is trading at $49)

That said, if I recall correctly, that backwardation/contango (in the colloquial sense of the futures curve being downwards/upwards sloping, rather than relative to expected future spot price) signal has not actually been that predictive of forward return.

Yup, I found it. It was just a quick-and-dirty regression done in an AQR white paper I saw (2016 Capital Market Assumptions, page 6):
https://www.aqr.com/-/media/AQR/Documen ... ptions.pdf

So maybe it's not that obvious. Also I'm sure Valuethinker has some other ideas.

staythecourse
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Re: Bloomberg commodities index still in contango

Post by staythecourse » Sun Mar 11, 2018 11:27 pm

lack_ey wrote:
Sun Mar 11, 2018 10:23 pm
Explaining it for those who might not know: that means in the absence of the futures curve changing, you get a positive carry return from roll yield. When you sell off one futures contract to buy the next-dated contract the next contract is at a lower price than the one you sold. So buy low, sell high. (e.g. let's say it's July and it's getting close to settlement for your July contract, so then you close that position and go long the August contract, where spot is $50, the July is trading at $49.9, and the August is trading at $49)
That is a pretty good explanation. So in that vain the near forward contract should approximate the spot price as it comes due. This really means the best way to make money (at least with oil) is to have an UNEXPECTED supply demand disruption usually from some geopolitical turmoil (thanks to the Middle East issues this will always be a concern). If, in fact, that did happen it usually also triggers an unexpected inflationary period (1970's oil embargo for example). Vanguard did a paper on unexpected inflationary hedges and found that commodities did show positive returns in the SHORT term (think 3 months) and then that "insurance" went away (likely as monetary policies changes to combat the inflationary pressures). SO one would be holding commodities that have terrible returns long term just as insurance for these uncommon UNEXPECTED inflationary periods. And even if it does what it is supposed to do during those periods they are not that helpful for long as they help only in the short run. It would seem liquidity and a long time horizon may be a better substitute in those situations then waiting for backwardation, no?

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Sun Mar 11, 2018 11:43 pm

staythecourse wrote:
Sun Mar 11, 2018 11:27 pm
SO one would be holding commodities that have terrible returns long term just as insurance for these uncommon UNEXPECTED inflationary periods.
Historical return rolling commodities futures contracts long would be far from terrible. Going forward, maybe different.
staythecourse wrote:
Sun Mar 11, 2018 11:27 pm
And even if it does what it is supposed to do during those periods they are not that helpful for long as they help only in the short run.
Well, it can be the short run under which inflation expectations shift drastically. In theory you might be able to then rebalance from the hopefully significantly appreciated commodities futures into the probably quite depressed nominal bonds.
staythecourse wrote:
Sun Mar 11, 2018 11:27 pm
It would seem liquidity and a long time horizon may be a better substitute in those situations then waiting for backwardation, no?
The futures curve is different for every commodity. Generally you could just choose the ones you want. You don't have to wait for the whole index to flip.

In theory, cyclically there may be some risk premium in some, if you're hedging price uncertainty for the commodity producers under certain conditions (or historically, on average).

Many of the actual commodity ETPs are contango/backwardation-aware, in that they choose futures at least in part based on these considerations. For many it's only a slight tweak, though, and some just use longer-dated contracts when the roll yield is negative. But that's a tradeoff, as longer-out contracts are less sensitive to spot price movements and probably stand to gain less in a real surprise on the upside for prices.

Though really, you don't have to stop there—you could go long or short based on roll yield as well as price momentum and... actually, if we want to be fancier, we could use assets other than commodities too and wait, now you're running a managed futures fund! :wink: Or without the other assets, that's pretty much what a CTA (commodities trading advisor) does, or what they've typically done on average.

Of course, if you're no longer biased long, you're losing the potential unexpected inflation protection. And I use "protection" kind of loosely.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Sun Mar 11, 2018 11:50 pm

Explaining it for those who might not know: that means in the absence of the futures curve changing, you get a positive carry return from roll yield.
I don't think it is a free lunch. You get a positive carry, but wouldn't the value of the commodities being held also be expected to fall?
Index fund investor since 1987.

Dudley
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Re: Bloomberg commodities index still in contango

Post by Dudley » Mon Mar 12, 2018 4:44 am

grok87 wrote:
Sun Mar 11, 2018 8:59 am
I could, i suppose, look for an energy or livestock specific commodity fund. Or a fund that has a strategy selecting commodities that are in backwardation. But i don't think any good cheap ones exist...
The ETF BCI supposedly tracks the Bloomberg index with ER=0.29 (relatively low cost for commodity funds) and is K1 free, however the fund is fairly small. How do you view it ?

long_gamma
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Re: Bloomberg commodities index still in contango

Post by long_gamma » Mon Mar 12, 2018 5:46 am

lack_ey wrote:
Sun Mar 11, 2018 11:43 pm

Though really, you don't have to stop there—you could go long or short based on roll yield as well as price momentum and... actually, if we want to be fancier, we could use assets other than commodities too and wait, now you're running a managed futures fund! :wink: Or without the other assets, that's pretty much what a CTA (commodities trading advisor) does, or what they've typically done on average.
Agree with your post. Not a big fan of long only commodities fund.
lack_ey wrote:
Sun Mar 11, 2018 11:43 pm

Of course, if you're no longer biased long, you're losing the potential unexpected inflation protection. And I use "protection" kind of loosely.
Doesn't price momentum signal mitigate price jump because of unexpected inflation protection?
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Mon Mar 12, 2018 11:56 am

Dudley wrote:
Mon Mar 12, 2018 4:44 am
grok87 wrote:
Sun Mar 11, 2018 8:59 am
I could, i suppose, look for an energy or livestock specific commodity fund. Or a fund that has a strategy selecting commodities that are in backwardation. But i don't think any good cheap ones exist...
The ETF BCI supposedly tracks the Bloomberg index with ER=0.29 (relatively low cost for commodity funds) and is K1 free, however the fund is fairly small. How do you view it ?
I think BCD also looks interesting but i’m Waiting for more backwardation
There’s a couple of other new funds with low e.r.s and no k-1s
Keep calm and Boglehead on. KCBO.

lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Mon Mar 12, 2018 12:03 pm

jalbert wrote:
Sun Mar 11, 2018 11:50 pm
Explaining it for those who might not know: that means in the absence of the futures curve changing, you get a positive carry return from roll yield.
I don't think it is a free lunch. You get a positive carry, but wouldn't the value of the commodities being held also be expected to fall?
On average, yes, but in the example I was assuming the curve would be constant.

Generally the futures curve for these types of commodities (where storage is not cheap, there is potentially limited and variable supply and inventory, etc.) should not necessarily reflect market estimates of future spot prices.

On average if the curve is downwards sloping this adds to returns.

long_gamma wrote:
Mon Mar 12, 2018 5:46 am
lack_ey wrote:
Sun Mar 11, 2018 11:43 pm

Of course, if you're no longer biased long, you're losing the potential unexpected inflation protection. And I use "protection" kind of loosely.
Doesn't price momentum signal mitigate price jump because of unexpected inflation protection?
I don't know if I'm interpreting this correctly, but my point is just that long commodities futures returns are correlated with inflation changes. If you're trading commodities long and short based on price momentum or any other kind of signals, you're not as net long as someone who's purely long.

Maybe that didn't address what you were asking at all.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Mon Mar 12, 2018 5:58 pm

I'm far from having commodities expertise, so correct me if I'm wrong, but I would expect a market to be in backwardation when there is a supply-demand imbalance favoring a high spot price that the market expects to be temporary.Timing an investment at that point will win if the imbalance lasts long enough for the positive carry to more than compensate for the expected loss of commodity value.

Backwardation is a tailwind for someone who is long the commodity, but the tailwind is future backwardation, so you have to predict the future to benefit. Saying the market has been in backwardation in recent months in no way precludes a steep drop in spot price at any point in time, and shift to contango when the investment value has dropped. In fact, it seems like backwardation expresses a pessimistic market view for the spot price.

Plrase correct if I'm missing something.
Last edited by jalbert on Tue Mar 13, 2018 12:22 am, edited 2 times in total.
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grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Mon Mar 12, 2018 6:19 pm

jalbert wrote:
Mon Mar 12, 2018 5:58 pm
I'm far from having commodities expertise, so correct me if I'm wrong, but I would expect a market to be in backwardation when there is a supply-demand imbalance favoring a high spot price that the market expects to be temporary.Timing an investment at that point will win if the imbalance lasts long enough for the positive carry to more than compensate for the expected loss of commodity value.

Backwardation is a tailwind for soneone who is long the commodity, but the tailwind is future backwardation, so you have to predict the future to benefit. Saying the market has been in backwardation in recent months in no way precludes a steep drop in spot price at any point in time, and shift to contango when the investment value has dropped. In fact, it seens like backwardation expresses a pessimistic market view for the spot price.

Plrase correct if I'm missing something.
i think that all sounds like the way i think about it as well.

the mental image i have of the classic backwardated market is farming in the old days. Lots of small farmers who are concerned about being able to sell their harvest at a good price so they can pay their mortgage.

Say corn is trading at $2 a bushel today, spot price, and the harvest is not for 3 months. Farmers may opt to "sell" their crop at $1.95 a bushel today to avoid the risk that the spot price may be at $1.50 or lower in 3 months. So basically selling "deflation" insurance to farmers.
Keep calm and Boglehead on. KCBO.

lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Mon Mar 12, 2018 6:24 pm

jalbert wrote:
Mon Mar 12, 2018 5:58 pm
I'm far from having commodities expertise, so correct me if I'm wrong, but I would expect a market to be in backwardation when there is a supply-demand imbalance favoring a high spot price that the market expects to be temporary.Timing an investment at that point will win if the imbalance lasts long enough for the positive carry to more than compensate for the expected loss of commodity value.

Backwardation is a tailwind for soneone who is long the commodity, but the tailwind is future backwardation, so you have to predict the future to benefit. Saying the market has been in backwardation in recent months in no way precludes a steep drop in spot price at any point in time, and shift to contango when the investment value has dropped. In fact, it seens like backwardation expresses a pessimistic market view for the spot price.

Plrase correct if I'm missing something.
First, terminology: colloquially, people refer to backwardation as the condition of a downwards-sloping futures curve (longer-out expiry has lower value) and correspondingly contango as an upwards-sloping futures curve. But academics use the terms to mean the conditions where futures prices are trading below or above the expected spot price on that date. That's the definition more commonly used in more technical contexts and especially if the phrasing "normal backwardation" is used (as opposed to just "backwardation").

Clearly there's a difference between the definitions if spot prices are expected to change. The issue with the academic definition is that expected future spot prices are unobservable, though they can be estimated in some ways, from the futures curve to surveys and whatever else. I'm sure there's a lot of literature on this.

As you say, a downwards-sloping curve could imply expected spot price declines, especially if the current spot price is temporarily elevated from a temporary supply shock or something of that nature. However, that is not necessarily the case in a number of scenarios, and the market could legitimately be in normal backwardation. If on average we expect more interest from producers for hedging relative to speculators or consumers on the long side, then normal backwardation seems... normal. Fundamentally to some degree I expect relative interest being short and long to have changed the last 20 years, though many investors are off the bandwagon these days, so maybe it could shift again at least to some extent.

There are certain conditions (amount of commodity production, level of inventory at different times, cost of holding, upwards vs. downwards sloping futures curve, etc.) under which the futures curve is more predictive of future spot prices, and others under which it's less so and probably more indicative of some kind of insurance/risk premium.

The historical record is that on average a downwards-sloping curve has been a bit predictive of higher future forward returns.

This is very roughly analagous to the bond market yield curve though different in key ways, where we see that an upwards-sloping yield curve is predictive of higher forward excess bond returns and that the expectations hypothesis for forward rates has pretty much been empirically debunked. I think in commodities it's not quite as clear-cut, though.

I'm not an expert either and am waiting for somebody to potentially correct me in turn. Third time's the charm?

heyyou
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Re: Bloomberg commodities index still in contango

Post by heyyou » Mon Mar 12, 2018 9:39 pm

These days, I'm happy to just hold equities for long periods since they have historically outgrown inflation.
Patience is fullness.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Tue Mar 13, 2018 9:03 am

heyyou wrote:
Mon Mar 12, 2018 9:39 pm
These days, I'm happy to just hold equities for long periods since they have historically outgrown inflation.
Patience is fullness.
Agree with the focus on outgrowing inflation. Or to say the same thing with different words. I want a positive expected real return from anything I invest in.

That’s why I’m holding off for now on commodities until substantial backwardation develops.
Keep calm and Boglehead on. KCBO.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Tue Mar 13, 2018 11:55 am

Why should the expected real return of a commodity be anything other than zero, recent historical backwardation or otherwise?
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lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Tue Mar 13, 2018 12:16 pm

jalbert wrote:
Tue Mar 13, 2018 11:55 am
Why should the expected real return of a commodity be anything other than zero, recent historical backwardation or otherwise?
It shouldn't, but what does backwardation have to do with it? IIRC in All About Asset Allocation Rick Ferri showed about a -1% historical long-term real return of spot prices, probably influenced by technological advances and usage of replacement materials/goods. It's got to be a little worse now if you update through the last several years.

Or wait, if you meant futures for a commodity, that depends on the strategy and exposure. Funds can earn a return on collateral, though depending on the risk-free rate that may not be positive in real terms. A fund could earn a return from rebalancing commodities futures contracts, among other things, and it could be selective with respect to which futures are used (front-month or further out, depending).

If you have normal backwardation on average, then there's positive roll yield, a carry return on top of the spot and collateral returns. This is plausible if you are earning a risk premium by insuring commodity producers against the risk of price declines.

If there is too much long interest then you would have reason to suspect negative carry and potentially a nonzero real return in the other direction (depending on return of collateral, depending how that is invested—though that's not really "commodities," is it? and also the risk-free rate, etc).

Or did you mean something more like "substantially away from [greater than?] zero"?

In any case, depending on correlation with other assets, correlation and magnitude of changes with unexpected inflation, etc., even a low-return asset (even negative real, if you believe that) could have some plausible role depending on aims.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Tue Mar 13, 2018 12:32 pm

It shouldn't, but what does backwardation have to do with it?
I don't know, that was my original question that led to lengthy explanations. I seriously doubt that someone can use technical analysis to improve expected return of a commodities investment. And timing an investment based on recent historical backwardation is technical analysis. I also seriously doubt that mom and pop farmers willing to sell futures contracts at a discount are on the other side of the trades.

While commodities can reduce portfolio variance, including an investment that has an expected real return of zero is a drag on the real return of a portfolio.
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lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Tue Mar 13, 2018 12:47 pm

jalbert wrote:
Tue Mar 13, 2018 12:32 pm
It shouldn't, but what does backwardation have to do with it?
I don't know, that was my original question that led to lengthy explanations. I seriously doubt that someone can use technical analysis to improve expected return of a commodities investment. And timing an investment based on recent historical backwardation is technical analysis. I also seriously doubt that mom and pop farmers willing to sell futures contracts at a discount are on the other side of the trades.

While commodities can reduce portfolio variance, including an investment that has an expected real return of zero is a drag on the real return of a portfolio.
That's not technical analysis, at least in the way I usually see the term. It's not about price movement but carry... more like "fundamental" analysis. Would you say that market timing stocks based on P/E or dividend yield is technical analysis? I think technical analysis usually refers to price or return trends, though I suppose not always necessarily.

Though really, when people talk about commodities trading, it's usually more about price/momentum trading, so actually unabashedly technical analysis. You're familiar with all the research on trend following / time-series momentum (regardless of what you think of it going forward)? This is primarily what commodity trading advisors (CTAs) have done, and a big part of managed futures funds. You say you doubt somebody can use technical analysis to improve expected return in these, but this is exactly what people have been trading on for better or worse.

I'm also a little puzzled by the "recent" and "historical" qualifiers you keep using for backwardation. We can directly observe today's futures curve. What do we need recent historical data for? If you're asking about commodities contracts more broadly, the whole point of grok87's post is that most commodities are still in contango.

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Re: Bloomberg commodities index still in contango

Post by jalbert » Tue Mar 13, 2018 1:31 pm

Being in backwardation is a property of the status quo and recent history. The spot price could fall tomorrow and the market switch to contango.

I define technical analysis as using historical data about a security to predict future returns. I understand that momentum trades are technical trades. I'm not sold on momentum research. I think excess return from momentum trades may well be wiped out on a small number of days when trends reverse sharply, but it is not easy to capture that in historical samples, leading to incorrect statistical conclusions.
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alfaspider
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Re: Bloomberg commodities index still in contango

Post by alfaspider » Tue Mar 13, 2018 2:40 pm

jalbert wrote:
Tue Mar 13, 2018 1:31 pm
Being in backwardation is a property of the status quo and recent history. The spot price could fall tomorrow and the market switch to contango.

I define technical analysis as using historical data about a security to predict future returns. I understand that momentum trades are technical trades. I'm not sold on momentum research. I think excess return from momentum trades may well be wiped out on a small number of days when trends reverse sharply, but it is not easy to capture that in historical samples, leading to incorrect statistical conclusions.
I don't think the definition of technical analysis is really how most people use the term. My understanding is that technical analysis is defined by using nothing but historical price trends of the security or commodity to predict future returns. It's all about looking for patterns on a chart.

By contrast, a "fundamentals" analysis would also necessarily use historical data about the security, but would look at things like prior earnings, debt repayments, dividends, etc.- not just what the price was at a prior time.

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Re: Bloomberg commodities index still in contango

Post by jalbert » Tue Mar 13, 2018 3:00 pm

That's fair. I'm still highly skeptical that I could use information in the public domain to improve expected return of commodities trades.
Index fund investor since 1987.

long_gamma
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Re: Bloomberg commodities index still in contango

Post by long_gamma » Tue Mar 13, 2018 4:33 pm

lack_ey wrote:
Mon Mar 12, 2018 12:03 pm

I don't know if I'm interpreting this correctly, but my point is just that long commodities futures returns are correlated with inflation changes. If you're trading commodities long and short based on price momentum or any other kind of signals, you're not as net long as someone who's purely long.

Maybe that didn't address what you were asking at all.
It was rhetorical question, which didn't quite come out well.

It is true that in managed futures investors are not net long as long only commodity investors, but it captures other asset classes reaction to the unexpected inflation (like negative reaction of both stocks and bonds to the unexpected inflation)
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grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Tue Mar 13, 2018 5:08 pm

jalbert wrote:
Tue Mar 13, 2018 3:00 pm
That's fair. I'm still highly skeptical that I could use information in the public domain to improve expected return of commodities trades.
This link seems to suggest a decent link between commodity returns and roll return (ie what should be a positive source of return if there is backwardation)

https://quantpedia.com/Blog/Details/ana ... ast-decade

Cheers,
Grok
Keep calm and Boglehead on. KCBO.

lack_ey
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Re: Bloomberg commodities index still in contango

Post by lack_ey » Tue Mar 13, 2018 5:25 pm

grok87 wrote:
Tue Mar 13, 2018 5:08 pm
jalbert wrote:
Tue Mar 13, 2018 3:00 pm
That's fair. I'm still highly skeptical that I could use information in the public domain to improve expected return of commodities trades.
This link seems to suggest a decent link between commodity returns and roll return (ie what should be a positive source of return if there is backwardation)

https://quantpedia.com/Blog/Details/ana ... ast-decade

Cheers,
Grok
According to that data, roll return is correlated with some of the other drivers of return, and the analysis uses overlapping periods over a not-that-long window. We need to be careful about interpreting results like that. That's a bit more descriptive of what happened over that period than actually predictive.

Have you studied the underlying paper and looked at the data?

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Re: Bloomberg commodities index still in contango

Post by jalbert » Tue Mar 13, 2018 7:15 pm

grok87 wrote:
Tue Mar 13, 2018 5:08 pm
jalbert wrote:
Tue Mar 13, 2018 3:00 pm
That's fair. I'm still highly skeptical that I could use information in the public domain to improve expected return of commodities trades.
This link seems to suggest a decent link between commodity returns and roll return (ie what should be a positive source of return if there is backwardation)

https://quantpedia.com/Blog/Details/ana ... ast-decade
Actually if you read carefully, roll return and collateral interest income were the primary drivers of return in the period based on the commodity spot price values over the period in question. There is no guarantee the spot prices will cooperate to enable that in the future. And there is no guarantee backwardation will continue over your holding period.
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grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Tue Mar 13, 2018 7:21 pm

lack_ey wrote:
Tue Mar 13, 2018 5:25 pm
grok87 wrote:
Tue Mar 13, 2018 5:08 pm
jalbert wrote:
Tue Mar 13, 2018 3:00 pm
That's fair. I'm still highly skeptical that I could use information in the public domain to improve expected return of commodities trades.
This link seems to suggest a decent link between commodity returns and roll return (ie what should be a positive source of return if there is backwardation)

https://quantpedia.com/Blog/Details/ana ... ast-decade

Cheers,
Grok
According to that data, roll return is correlated with some of the other drivers of return, and the analysis uses overlapping periods over a not-that-long window. We need to be careful about interpreting results like that. That's a bit more descriptive of what happened over that period than actually predictive.

Have you studied the underlying paper and looked at the data?
i don't like overlapping returns either. but it is a 45 year period 1970-2015.
Keep calm and Boglehead on. KCBO.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Tue Mar 13, 2018 7:26 pm

What does the strong negative correlation between price return and both income return and roll return tell you?
Index fund investor since 1987.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Tue Mar 13, 2018 7:30 pm

jalbert wrote:
Tue Mar 13, 2018 7:15 pm
grok87 wrote:
Tue Mar 13, 2018 5:08 pm
jalbert wrote:
Tue Mar 13, 2018 3:00 pm
That's fair. I'm still highly skeptical that I could use information in the public domain to improve expected return of commodities trades.
This link seems to suggest a decent link between commodity returns and roll return (ie what should be a positive source of return if there is backwardation)

https://quantpedia.com/Blog/Details/ana ... ast-decade
Actually if you read carefully, roll return and collateral interest income were the primary drivers of return in the period based on the commodity spot price values over the period in question. There is no guarantee the spot prices will cooperate to enable that in the future. And there is no guarantee backwardation will continue over your holding period.
so my idea is to 1) wait until material backwardation develops before investing in a fund like BCD http://www.etf.com/BCD 2) and then get out when commodities flip back into contango.

I realize there are no guarantees. But the way i look at it i only want to be exposed to commodities if i am getting paid to take risk (by the expected roll return from their being in backwardation).
Keep calm and Boglehead on. KCBO.

ThrustVectoring
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Re: Bloomberg commodities index still in contango

Post by ThrustVectoring » Tue Mar 13, 2018 7:34 pm

jalbert wrote:
Tue Mar 13, 2018 11:55 am
Why should the expected real return of a commodity be anything other than zero, recent historical backwardation or otherwise?
In some markets, you're performing a valuable service - using your capital to take on the risk of variable future commodity prices so that producers of said commodities de-risk their operations. If it costs you $1.50 now to plant a bushel of corn and the futures price at harvest is $1.90, you can short the contract and plant with your mind at ease. If the expected price at harvest is $1.95, well, the certainty of the profit is worth five cents a bushel to you, so you're happy to let someone else bear the risk of corn price movements.

In other words, your capital is providing price insurance to productive businesses, so your participation in the market is rewarded (as long as it helps bring futures prices closer to expected spot prices).

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Thu Mar 15, 2018 10:29 am

ThrustVectoring wrote:
Tue Mar 13, 2018 7:34 pm
jalbert wrote:
Tue Mar 13, 2018 11:55 am
Why should the expected real return of a commodity be anything other than zero, recent historical backwardation or otherwise?
In some markets, you're performing a valuable service - using your capital to take on the risk of variable future commodity prices so that producers of said commodities de-risk their operations. If it costs you $1.50 now to plant a bushel of corn and the futures price at harvest is $1.90, you can short the contract and plant with your mind at ease. If the expected price at harvest is $1.95, well, the certainty of the profit is worth five cents a bushel to you, so you're happy to let someone else bear the risk of corn price movements.

In other words, your capital is providing price insurance to productive businesses, so your participation in the market is rewarded (as long as it helps bring futures prices closer to expected spot prices).
Agree that is should work that wAy. But I think one argument I have heard is that there are too many institutional (and retail) investors eager to be the “someone else bear[ing] the Risk” and that the reward/Risk has gotten out of whack. Hence contango etc.

Harvard pulling out is a good sign. Maybe in 5 years we will be back to backwardation then. I’m willing to be patient...
Keep calm and Boglehead on. KCBO.

Dudley
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Re: Bloomberg commodities index still in contango

Post by Dudley » Fri Mar 16, 2018 2:33 pm

grok87 wrote:
Mon Mar 12, 2018 11:56 am
Dudley wrote:
Mon Mar 12, 2018 4:44 am
The ETF BCI supposedly tracks the Bloomberg index .. How do you view it ?
I think BCD also looks interesting but i’m Waiting for more backwardation
What are the pros and cons of BCI vs BCD ? Thanks

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Fri Mar 16, 2018 4:47 pm

Dudley wrote:
Fri Mar 16, 2018 2:33 pm
grok87 wrote:
Mon Mar 12, 2018 11:56 am
Dudley wrote:
Mon Mar 12, 2018 4:44 am
The ETF BCI supposedly tracks the Bloomberg index .. How do you view it ?
I think BCD also looks interesting but i’m Waiting for more backwardation
What are the pros and cons of BCI vs BCD ? Thanks
bcd seems to have done a better job of tracking the average commodity market fund. it targets longer dated (1 year?) futures contracts i think.
Keep calm and Boglehead on. KCBO.

Dudley
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Re: Bloomberg commodities index still in contango

Post by Dudley » Sat Mar 17, 2018 7:45 am

grok87 wrote:
Fri Mar 16, 2018 4:47 pm
Dudley wrote:
Fri Mar 16, 2018 2:33 pm
grok87 wrote:
Mon Mar 12, 2018 11:56 am
Dudley wrote:
Mon Mar 12, 2018 4:44 am
The ETF BCI supposedly tracks the Bloomberg index .. How do you view it ?
I think BCD also looks interesting but i’m Waiting for more backwardation
What are the pros and cons of BCI vs BCD ? Thanks
bcd seems to have done a better job of tracking the average commodity market fund. it targets longer dated (1 year?) futures contracts i think.
BCD has only $6.5M AUM vs BCI $150M. I think that could be concerning.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Sat Mar 17, 2018 8:08 am

Dudley wrote:
Sat Mar 17, 2018 7:45 am
grok87 wrote:
Fri Mar 16, 2018 4:47 pm
Dudley wrote:
Fri Mar 16, 2018 2:33 pm
grok87 wrote:
Mon Mar 12, 2018 11:56 am
Dudley wrote:
Mon Mar 12, 2018 4:44 am
The ETF BCI supposedly tracks the Bloomberg index .. How do you view it ?
I think BCD also looks interesting but i’m Waiting for more backwardation
What are the pros and cons of BCI vs BCD ? Thanks
bcd seems to have done a better job of tracking the average commodity market fund. it targets longer dated (1 year?) futures contracts i think.
BCD has only $6.5M AUM vs BCI $150M. I think that could be concerning.
thanks, i didn't notice that!
Keep calm and Boglehead on. KCBO.

staythecourse
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Re: Bloomberg commodities index still in contango

Post by staythecourse » Sat Mar 17, 2018 8:15 am

grok87 wrote:
Tue Mar 13, 2018 7:30 pm
so my idea is to 1) wait until material backwardation develops before investing in a fund like BCD http://www.etf.com/BCD 2) and then get out when commodities flip back into contango.

I realize there are no guarantees. But the way i look at it i only want to be exposed to commodities if i am getting paid to take risk (by the expected roll return from their being in backwardation).
Wait isn't that the goal of ALL commodity investors? Doesn't that fit into the idea of speculation which is why many frown on commodity investing in the first place (those on the floor in movies)?

Interestingly, you should run some numbers when something like oil is in contango vs. backwardation in a balanced portfolio of stocks/ bonds/ cash to find out what its effect may be to the entire portfolio on a MPT approach. Would be interesting to see those results. Do you know if someone has done that analysis. It may prove you correct that in a traditional balanced portfolio that is does matter if in contago or backwardation or it may show significant benefit even in contago.

Good luck.

p.s. I don't have to remind you, but remember NOT to look at an addition of an asset class in isolation, but how it affects the entire portfolio.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Sat Mar 17, 2018 9:00 am

staythecourse wrote:
Sat Mar 17, 2018 8:15 am
grok87 wrote:
Tue Mar 13, 2018 7:30 pm
so my idea is to 1) wait until material backwardation develops before investing in a fund like BCD http://www.etf.com/BCD 2) and then get out when commodities flip back into contango.

I realize there are no guarantees. But the way i look at it i only want to be exposed to commodities if i am getting paid to take risk (by the expected roll return from their being in backwardation).
Wait isn't that the goal of ALL commodity investors? Doesn't that fit into the idea of speculation which is why many frown on commodity investing in the first place (those on the floor in movies)?

Interestingly, you should run some numbers when something like oil is in contango vs. backwardation in a balanced portfolio of stocks/ bonds/ cash to find out what its effect may be to the entire portfolio on a MPT approach. Would be interesting to see those results. Do you know if someone has done that analysis. It may prove you correct that in a traditional balanced portfolio that is does matter if in contago or backwardation or it may show significant benefit even in contago.

Good luck.

p.s. I don't have to remind you, but remember NOT to look at an addition of an asset class in isolation, but how it affects the entire portfolio.
thanks for the good luck wishes. same to you.

i don't know if someone has done that analysis. it's an interesting question.

re your p.s., you probably DO need to remind me!
:)
i've actually gotten less enthusiastic about those sort of analyses- i.e. looking how mixes of asset classes would have performed based on PAST correlations etc.

my current thinking is roughly:

1) I want a positive expected return from all my investments

2) i don't know how correlations will play out in the future.

3) that being said i still think it makes sense to spread my investments into asset classes that i believe are fundamentally different. US Stocks, International Stocks, Real Estate, Treasuries, TIPs. Basically Swensen's approach...

i have no idea how commodities will play out in the future correlation-wise. But if i'm not getting a expected roll return, ie. backwardation, i find it hard to understand why i would expect a positive real return. I get that the spot price should keep up with inflation, maybe. but if there is negative roll return, isn't that roughly similar to buying tips at a negative real yield, which i wouldn't do...
Keep calm and Boglehead on. KCBO.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Wed Mar 21, 2018 3:17 am

The article for which you posted a link above suggested that roll return was strongly negatively correlated with spot price.. I think that means that when a commodity is in backwardation, the nominal expected return of the commodity itself is negative, and the futures trading strategy will only have a positive return if the spot price unexpectedly rises or stays flat, or the roll return exceeds the loss from a falling spot price.
Index fund investor since 1987.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Wed Mar 21, 2018 7:09 am

jalbert wrote:
Wed Mar 21, 2018 3:17 am
The article for which you posted a link above suggested that roll return was strongly negatively correlated with spot price.. I think that means that when a commodity is in backwardation, the nominal expected return of the commodity itself is negative, and the futures trading strategy will only have a positive return if the spot price unexpectedly rises or stays flat, or the roll return exceeds the loss from a falling spot price.
Thanks. I think that's right. Again i'm after a positive real return, i.e. outpacing inflation.

I found the article frustrating as it just gives the correlation matrix not the full regression results. If they gave the full regression results (these would be problematic anyway since overlapping 10 year periods were used) one could see what the "betas" on the various variables were.

Then we could see whether historically the scenario you outline is what one might expect. i.e. "when a commodity is in backwardation, the nominal expected return of the commodity itself is negative.... but [perhaps] the roll return exceeds the loss from a falling spot price[?]"

Intuitively though that fits with my mental model of when i want to invest in commodity futures. i.e. when Commodity producers (think corn farmers) are worried about falling prices, the curve is in backwardation, they are willing to pay up for price insurance for the coming harvest and i am selling it to them. and then as events play out corn prices "do" fall but not as much as was feared and i make money off the roll.

But i don't think we are there yet, and possibly we may never get there or not for a long while.

cheers,
grok
Keep calm and Boglehead on. KCBO.

grok87
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Re: Bloomberg commodities index still in contango

Post by grok87 » Wed Mar 21, 2018 7:22 am

here is an update of the bloomberg write-up i posted for another month. I think the data in this new link is as of march 1st.
...
https://data.bloomberglp.com/promo/site ... Charts.pdf
...
Currently backwardation (+) and contango (-) stand as follows: (see page 23)

overall..............-1.9% (i.e. contango)
energy.............. +3.7% (i.e. backwardation)
livestock............-0.6%
industrial metals..-1.1%
precious metals...-3.1%
agriculture.........-4.9%

so aside from energy all the major commodity sectors are in contango.

cheers,
grok
Keep calm and Boglehead on. KCBO.

jalbert
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Re: Bloomberg commodities index still in contango

Post by jalbert » Wed Mar 21, 2018 1:38 pm

Intuitively though that fits with my mental model of when i want to invest in commodity futures. i.e. when Commodity producers (think corn farmers) are worried about falling prices, the curve is in backwardation, they are willing to pay up for price insurance for the coming harvest and i am selling it to them. and then as events play out corn prices "do" fall but not as much as was feared and i make money off the roll.
Or they fall further than projected. On average, I think it will balance out, and the long term expected real return of commodities is zero.
Index fund investor since 1987.

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