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Theory of storage, inventory and volatility in the LME base metals

  • Geman, Hélyette
  • Smith, William O.
Registered author(s):

    The theory of storage, as related to commodities, makes two predictions involving the quantity of the commodity held in inventory. When inventory is low (i.e. a situation of scarcity), spot prices will exceed futures prices, and spot price volatility will exceed futures price volatility. Conversely, during periods of no scarcity, both spot prices and spot price volatility will remain relatively subdued. We test these predictions for the six base metals traded on the London Metal Exchange (aluminium, copper, lead, nickel, tin and zinc), and find strong validation for the theory. Including Chinese inventories reported by the Shanghai Futures Exchange strengthens the relationship further. We also introduce the concepts of excess volatility, inventory-implied spot price and inventory-implied spot volatility and illustrate some applications.

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    Article provided by Elsevier in its journal Resources Policy.

    Volume (Year): 38 (2013)
    Issue (Month): 1 ()
    Pages: 18-28

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    Handle: RePEc:eee:jrpoli:v:38:y:2013:i:1:p:18-28
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30467

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    7. Geman, Hélyette & Ohana, Steve, 2009. "Forward curves, scarcity and price volatility in oil and natural gas markets," Energy Economics, Elsevier, vol. 31(4), pages 576-585, July.
    8. Nguyen, Vu-Nhat & Geman, Hélyette, 2005. "Soybean Inventory and Forward Curve Dynamics," Economics Papers from University Paris Dauphine 123456789/1937, Paris Dauphine University.
    9. Clinton Watkins & Michael McAleer, 2006. "Pricing of non-ferrous metals futures on the London Metal Exchange," Applied Financial Economics, Taylor & Francis Journals, vol. 16(12), pages 853-880.
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