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2/3/2005
Facts and Fantasies about Commodity Futures by Gorton and Rouwenhorst,
reviewed by Charles Pennington
The claim of this paper is that a fully collateralized,
equal-weighted portfolio of long, nearest-month futures positions in
all the commodities in the Commodity Research Bureau (CRB) database
has performed as well as stocks during the 7/1959-3/2004 period.
Both stocks (the S&P) and commodity futures returned 11.02%
compounded annually over the period (It is apparently a coincidence
that these numbers are exactly the same). The standard deviation for
stocks was 14.9%; the standard deviation for commodity futures was
12.1%.
The authors emphasize that their findings apply only to commodity futures, and
not to spot prices. They find that futures outperform spot prices, returning
6.3% adjusted for CPI inflation vs returns
of 3.8% for spot prices, also adjusted for CPI inflation. (Note: I
actually extracted these numbers from a graph that the authors
presented. I can t find these numbers given explicitly in the
paper.)
It is not obvious that one should expect high returns from commodity
futures, or even that one shouldn't expect high returns from short
positions in commodity futures. The authors mention a prediction of
Keynes, that companies that produce commodities would have a strong
need to sell commodity futures short, in order to hedge. This
results in a risk premium for speculators taking long futures
positions. One could counter Keynes by arguing that many companies
use commodities as raw materials. Such companies would hedge by
taking long positions in futures markets, and that would result in a
risk premium for speculators taking the short side. The question of
whether there is a premium on the long or short side, or neither, is
therefore an experimental one.
The authors find several more attractive features of commodity
futures:
--The returns of commodity futures and stocks are negatively
correlated, with correlation -6% for quarterly returns.
--While quarterly returns in stocks have a -20% correlation with the
quarterly change in the CPI, the correlation between commodity
futures and the CPI is +14%.
-- During the 5% of the months of worst performance of equity
markets, when stocks fell by an average of 9.18%, commodity futures
experienced a positive return of 1.43%.
--Both stocks and bonds do poorly in the early stages of recession
(as defined by NBER), averaging -15.5% and -2.9% respectively, but
commodity futures do well, returning +3.5%.
The authors find similar conclusions when they compare the returns of
Japanese stocks and commodity futures denominated in yen.
Criticisms:
1) The authors have a survivorship bias problem of unknown magnitude.
They use only the CRB database. They state that some commodities
that were traded during at some point from 1959-present are no longer
traded now, and are no longer in the CRB database.
2) During the period of the study, the authors report that CPI
inflation adjusted spot prices returned 3.8%, while CPI adjusted
futures returns were 6.3%. I do not see any reason why spot prices,
over the long term, should appreciate faster than the CPI. Perhaps
the high increases in spot prices during this 44 year interval are
not indicative of what will happen going forward. If we subtract
this 3.8%, then the CPI un-adjusted returns for commodity futures
would be about 7.2%, less than the return of bonds, which was 7.7%.