Commodities and cross-asset thinking

There is a growing view that commodities should not be considered separate or unique from other asset classes, but should be viewed within the larger context of risk premia in all markets. Hence, just like there is a carry premia in stocks or bonds, there is a carry premia in commodity futures. Just like there is momentum in other asset class, there is a momentum component in commodities. All markets are linked by a few risk premia like valuation, carry, and movement to name the major ones.

This does not mean that it easy to compare risk premia across market sectors but the framework for review of asset classes should be similar.

So what are the drivers of return or risk premia in commodity markets?An analysis of risk factors, including the futures basis, return momentum, volatility inflation, hedging pressure and liquidity shows some very interesting results. The main driver is the basis. This is similar to carry, dividend yield and yield spread in other asset classes. If you have one factor to focus on, this is it.

Commodity investing does not have to be difficult. It does not have to be special relative to other classes. This does not mean there is easy money to be made in commodities using just the basis, but you can figure out if you are facing headwinds or tailwinds.