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The Tactical and Strategic Value of Commodity Futures

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  • Claude B. Erb
  • Campbell R. Harvey

Abstract

Historically, commodity futures have had excess returns similar to those of equities. But what should we expect in the future? The usual risk factors are unable to explain the time-series variation in excess returns. In addition, our evidence suggests that commodity futures are an inconsistent, if not tenuous, hedge against unexpected inflation. Further, the historically high average returns to a commodity futures portfolio are largely driven by the choice of weighting schemes. Indeed, an equally weighted long-only portfolio of commodity futures returns has approximately a zero excess return over the past 25 years. Our portfolio analysis suggests that the a long-only strategic allocation to commodities as a general asset class is a bet on the future term structure of commodity prices, in general, and on specific portfolio weighting schemes, in particular. In contrast, we provide evidence that there are distinct benefits to an asset allocation overlay that tactically allocates using commodity futures exposures. We examine three trading strategies that use both momentum and the term structure of futures prices. We find that the tactical strategies provide higher average returns and lower risk than a long-only commodity futures exposure.

Suggested Citation

  • Claude B. Erb & Campbell R. Harvey, 2005. "The Tactical and Strategic Value of Commodity Futures," NBER Working Papers 11222, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:11222
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    References listed on IDEAS

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    1. Nijman, T.E. & Swinkels, L.A.P., 2003. "Strategic and Tactical Allocation to Commodities for Retirement Savings Schemes," Discussion Paper 2003-20, Tilburg University, Center for Economic Research.
    2. Frans A. de Roon & Theo E. Nijman & Chris Veld, 2000. "Hedging Pressure Effects in Futures Markets," Journal of Finance, American Finance Association, vol. 55(3), pages 1437-1456, June.
    3. John H. Cochrane, 1999. "New facts in finance," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 36-58.
    4. Gerald R. Jensen & Robert R. Johnson & Jeffrey M. Mercer, 2000. "Efficient use of commodity futures in diversified portfolios," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 20(5), pages 489-506, May.
    5. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    6. Robert W. Kolb, 1992. "Is normal backwardation normal?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 12(1), pages 75-91, February.
    7. Gary Gorton & K. Geert Rouwenhorst, 2004. "Facts and Fantasies about Commodity Futures," NBER Working Papers 10595, National Bureau of Economic Research, Inc.
    8. Fernholz, Robert & Shay, Brian, 1982. " Stochastic Portfolio Theory and Stock Market Equilibrium," Journal of Finance, American Finance Association, vol. 37(2), pages 615-624, May.
    9. Treynor, Jack L & Black, Fischer, 1973. "How to Use Security Analysis to Improve Portfolio Selection," The Journal of Business, University of Chicago Press, vol. 46(1), pages 66-86, January.
    10. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
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    Citations

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    Cited by:

    1. Gary Gorton & K. Rouwenhorst, 2005. "A Note on Erb and Harvey (2005)," Yale School of Management Working Papers amz2595, Yale School of Management, revised 01 May 2006.
    2. Batten, Jonathan A. & Ciner, Cetin & Lucey, Brian M., 2010. "The macroeconomic determinants of volatility in precious metals markets," Resources Policy, Elsevier, vol. 35(2), pages 65-71, June.
    3. Gary Gorton & K. Geert Rouwenhorst, 2004. "Facts and Fantasies about Commodity Futures," NBER Working Papers 10595, National Bureau of Economic Research, Inc.
    4. Diego Bastourre & Jorge Carrera & Javier Ibarlucia, 2010. "Commodity Prices: Structural Factors, Financial Markets and Non-Linear Dynamics," BCRA Paper Series, Central Bank of Argentina, Economic Research Department, number 06 edited by Jorge Carrera, December.
    5. Hamza, Olfa & Kortas, Mohamed & L'Her, Jean-Francois & Roberge, Mathieu, 2006. "International equity portfolios: Selecting the right benchmark for emerging markets," Emerging Markets Review, Elsevier, vol. 7(2), pages 111-128, June.
    6. Bastourre, Diego, 2008. "Cambio fundamental o especulación financiera en los mercados de commodities? Un modelo con ajuste no lineal al equilibrio
      [Structural break or financial speculation in commodity markets? A multivar
      ," MPRA Paper 9910, University Library of Munich, Germany.
    7. Jaime Casassus & Pierre Collin-Dufresne & Bryan R. Routledge, 2005. "Equilibrium Commodity Prices with Irreversible Investment and Non-Linear Technology," NBER Working Papers 11864, National Bureau of Economic Research, Inc.
    8. Egelkraut, Thorsten M. & Woodard, Joshua D. & Garcia, Philip & Pennings, Joost M.E., 2005. "Portfolio Diversification with Commodity Futures: Properties of Levered Futures," 2005 Conference, April 18-19, 2005, St. Louis, Missouri 19047, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    9. Diego Bastourre, 2008. "Inversores Financieros en los Mercados de Commodities: Un Modelo con Dinámica de Ajuste no Lineal al Equilibrio," Department of Economics, Working Papers 072, Departamento de Economía, Facultad de Ciencias Económicas, Universidad Nacional de La Plata.
    10. Dietrich Domanski & Alexandra Heath, 2007. "Financial investors and commodity markets," BIS Quarterly Review, Bank for International Settlements, March.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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