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

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  • Geman, Hélyette
  • Smith, William O.

Abstract

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.

Suggested Citation

  • Geman, Hélyette & Smith, William O., 2013. "Theory of storage, inventory and volatility in the LME base metals," Resources Policy, Elsevier, vol. 38(1), pages 18-28.
  • Handle: RePEc:eee:jrpoli:v:38:y:2013:i:1:p:18-28
    DOI: 10.1016/j.resourpol.2012.06.014
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    References listed on IDEAS

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    1. repec:eee:jrpoli:v:54:y:2017:i:c:p:130-136 is not listed on IDEAS
    2. Stepanek, Christian & Walter, Matthias & Rathgeber, Andreas, 2013. "Is the convenience yield a good indicator of a commodity's supply risk?," Resources Policy, Elsevier, vol. 38(3), pages 395-405.
    3. repec:eee:jrpoli:v:52:y:2017:i:c:p:277-283 is not listed on IDEAS
    4. repec:eee:jrpoli:v:53:y:2017:i:c:p:300-316 is not listed on IDEAS
    5. repec:eee:intfin:v:51:y:2017:i:c:p:228-247 is not listed on IDEAS
    6. repec:eee:ecmode:v:70:y:2018:i:c:p:496-510 is not listed on IDEAS
    7. repec:eee:eneeco:v:70:y:2018:i:c:p:516-524 is not listed on IDEAS
    8. repec:eee:jbfina:v:84:y:2017:i:c:p:53-67 is not listed on IDEAS
    9. repec:eee:ecosta:v:4:y:2017:i:c:p:39-56 is not listed on IDEAS
    10. Omura, Akihiro & Todorova, Neda & Li, Bin & Chung, Richard, 2015. "Convenience yield and inventory accessibility: Impact of regional market conditions," Resources Policy, Elsevier, vol. 44(C), pages 1-11.
    11. Oglend, Atle & Kleppe, Tore Selland, 2017. "On the behavior of commodity prices when speculative storage is bounded," Journal of Economic Dynamics and Control, Elsevier, vol. 75(C), pages 52-69.
    12. Todorova, Neda & Worthington, Andrew & Souček, Michael, 2014. "Realized volatility spillovers in the non-ferrous metal futures market," Resources Policy, Elsevier, vol. 39(C), pages 21-31.
    13. Fernandez, Viviana, 2016. "Futures markets and fundamentals of base metals," International Review of Financial Analysis, Elsevier, vol. 45(C), pages 215-229.

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