Investors often use the argument that there is no need to hold commodity futures because you can get the same general commodity exposure from equity markets. Unfortunately, the exposures in commodity futures are not the same as exposures in commodity equities. The differences are mainly with the timing of price moves.
Commodity futures will represent the short-term supply and demand for a commodity conditional on the current inventory situation. The futures market is associated with a contract that has a specific expiration. Hence, it has to reflect the impact on price to that expiration date. Commodity equities, if they are true commodity equities and related to the production of a commodity, will represent the combination of discounted present value of reserves held by the company and the discounted earnings as measured by the difference between future price and marginal cost of production. Unfortunately, many define commodity equity companies with a much broader definition to include commodity intermediaries.
There can be short-term factors which cause commodity futures to move while there is a little movement in commodity stocks. This will be especially the case if a price move is expected to be temporary. For example, there can be a temporary short-term shock which can effect futures which will not cause a change in the valuation of the equity which is discounting long-term cash flows. The stock will move with short-term price changes, but the value of the firm will be associated with the long-term price at which the commodity can be sold after it is extracted.
The Samuelson price effect states that nearby futures prices will be more volatile than more distant futures. Similarly, the futures will be effected by inventory risk premium or changes in the convenience yield. These short-term disturbances will not effect the long-term discounting of reserves. Equities are also inherently an option and will be valued by the long-term volatility and the amount of in-the-moneyness. Hence, the risk factor or volatility of the nearby futures will be driven by different variables than from the long-term price.
Equities can be affected by a set of factors which will not be expressed in the futures market, firm or industry specific risks. These firm specific risks can be diversified away through holding a broader portfolio within the industry, but they still exist. These can represent opportunities which are different from futures markets. For example, the recent nationalization of oil production in Argentina. Argentine took control of YPF on April 16, seizing 51 percent of the company’s shares from Spain’s Repsol YPF. YPF has since been under government oversight until a general shareholder's meeting names new management. These types of firm governance regulatory risks can be diversified away in larger portfolio but will still have an impact on investors. This impact on oil prices was minimal as measured through the futures market.
There can also be common short-term factors such as a mining disaster or a strike that will affect individual companies and can also have an effect on general prices.
There can be a trade-off between long-term and short-term risks hence there can be a place for both commodity futures and equities, by these are not perfect substitutes within the real asset space.
Commodity futures will represent the short-term supply and demand for a commodity conditional on the current inventory situation. The futures market is associated with a contract that has a specific expiration. Hence, it has to reflect the impact on price to that expiration date. Commodity equities, if they are true commodity equities and related to the production of a commodity, will represent the combination of discounted present value of reserves held by the company and the discounted earnings as measured by the difference between future price and marginal cost of production. Unfortunately, many define commodity equity companies with a much broader definition to include commodity intermediaries.
There can be short-term factors which cause commodity futures to move while there is a little movement in commodity stocks. This will be especially the case if a price move is expected to be temporary. For example, there can be a temporary short-term shock which can effect futures which will not cause a change in the valuation of the equity which is discounting long-term cash flows. The stock will move with short-term price changes, but the value of the firm will be associated with the long-term price at which the commodity can be sold after it is extracted.
The Samuelson price effect states that nearby futures prices will be more volatile than more distant futures. Similarly, the futures will be effected by inventory risk premium or changes in the convenience yield. These short-term disturbances will not effect the long-term discounting of reserves. Equities are also inherently an option and will be valued by the long-term volatility and the amount of in-the-moneyness. Hence, the risk factor or volatility of the nearby futures will be driven by different variables than from the long-term price.
Equities can be affected by a set of factors which will not be expressed in the futures market, firm or industry specific risks. These firm specific risks can be diversified away through holding a broader portfolio within the industry, but they still exist. These can represent opportunities which are different from futures markets. For example, the recent nationalization of oil production in Argentina. Argentine took control of YPF on April 16, seizing 51 percent of the company’s shares from Spain’s Repsol YPF. YPF has since been under government oversight until a general shareholder's meeting names new management. These types of firm governance regulatory risks can be diversified away in larger portfolio but will still have an impact on investors. This impact on oil prices was minimal as measured through the futures market.
There can also be common short-term factors such as a mining disaster or a strike that will affect individual companies and can also have an effect on general prices.
There can be a trade-off between long-term and short-term risks hence there can be a place for both commodity futures and equities, by these are not perfect substitutes within the real asset space.
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