Momentum
strategies work with commodity futures, but a closer examination shows that the
same momentum strategies are not effective with commodity spot prices. This
result, that the cash price action is not mirrored in the futures prices, seems
odd. Of course, the futures are expectational markets, but the cross-sectional
behavior in spot should be represented to a similar degree in futures.
Alternatively, spot commodity prices shows strong mean-reverting effects while
commodity futures do to show this same behavior. These are the conclusions of
research in the new paper, Momentum and Mean-reversion in Commodity Spot and Futures
Markets, by Chaves and Viswanathan. This research suggests that the
momentum effect must be embedded in the basis or how the futures markets move
relative to cash.
A number
of researchers have found momentum effects in commodity markets so it would
seem like a natural question to determine whether it is driven by behavior in
the spot prices. The researchers find it is not, but they do find that spot
prices are mean-reverting which does seems consistent with the old adage,
"the solution to low prices is low prices."
The only
difference between the cash and futures prices is with the basis, which
measures the link between the cash and futures, so this seems to be the natural
place to look for why these differences between spot and futures exist. The
researchers replicate earlier work by Fama-French to show that there is a risk premium
in futures which could be an explanation for these results.
Using
cross-sectional analysis, the researchers find that mean-reverting strategies
do not work in futures because the futures seem to reflect the reversal in
price. However, there are opportunities for momentum in futures price when
there is a large positive basis.
The
authors offer some explanations for these interesting results, but I regard
their work as preliminary. If anything, their work suggests a puzzle in the
price dynamics of futures over spot. My view is that futures reflect the
dynamics of storage and convenience yield in ways that are clearly not
reflected in spot prices, but this will require more analysis to find the
underlying relationships.
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