Commodity returns and macro drivers - business cycle and inflation

 

What drives commodity prices? This is an age-old question addressed in a paper which has looked 140 years of history across a wide set of commodity markets in the energy, agricultural, and metals markets. Their results are consistent with what you think if you applied business and monetary policy thinking. Industrial production and inflation are the two most important variables for predicting commodity returns. Track the business cycle and inflation and you will have some predictions for commodity returns. See, "Predictability in Commodity Markets: Evidence from More Than a Century".

Different commodities have variable sensitivities to macro data. Agriculture and metals are sensitive to industrial production, yet the energy complex is not sensitive to the business cycle. Commodities in general are sensitive to inflation.  Many of the factors tested are significant for in-sample tests but lose their significance out of sample. Commodities are more predictive during the business cycle expansion relative to a contraction.

Volatility can also be predicted, but not for agriculture out of sample. The general high volatility and seasonality for agriculture may be the reason for this poor predictability.

The overall number suggest that some macro variables can be linked with trend to improve commodity trading.