COMMODITY INDICES
These results show that convenience yields
TABLE 5: COMMODITY RETURNS
trend higher the lower the level of inventories. Put
another way, the convenience yield rises as the
The 6 DBLCI Components and an estimation of convenience yield*
market's precariousness increases. This makes
Total Spot Roll Collateral Storage Convenience
Returns Returns Returns Returns Costs Yield
intuitive sense since in tightening market condi-
20.17% 5.95% 8.99% 4.84% 22.05% 35.88%
tions consumers attach a greater benefit to the
13.89% 5.34% 3.59% 4.84% 22.05% 30.48%
physical ownership of a commodity. Oil is the
-0.96% -1.44% -1.96% 4.84% 6.31% 9.19%
most obvious example since if production ceased
0.99% 0.42% -5.69% 4.84% 0.01% -0.84%
today the consequences would be felt within a
1.17% -2.21% -1.03% 4.84% 11.91% 15.72%
-3.68% -2.03% -5.84% 4.84% 9.97% 8.97%
matter of days, if not hours.
* Convenience yield = Roll returns + storage costs + collateral returns.
The gold market is at the other extreme. It
Source: DB Global Markets Research; Past performance is not necessarily indicative of future results.
would take several years for the world to exhaust
available gold reserves on current demand trends. This reflects the
Figure 6: Commodity Convenience Yields vs %
fact that annual gold consumption amounts to approximately 3,300
Usage of Stocks per day 1988 – 2004
tonnes per annum while total above ground stocks (private plus pub-
lic sector holdings) amounts to more than 145,000 tonnes. In the
absence of additional new mine supply the world would consequent-
ly only run out of gold after 16,000 days or sometime after 2048. As
a result, any disruptions to gold mine production would have only a
marginal effect on the convenience yield. This positive relationship
between convenience yield and consumption of stock per day is
highlighted in Figure 6.
It is worth remembering that the convenience yield will vary over
time as and when there is an increase in stocks above or below
'requirements'. Indeed the convenience yield is likely to rise very
sharply when there is a reduction of stocks below requirements as
Source: DB Global Markets Research
occurred across the industrial metals complex between 2003 and
2004 when all LME metal curves flipped from contango to back- Where inventories are plentiful and the
wardation. convenience yield is low so too is the
One can therefore consider the slope of the forward price term volatility, for example gold.
structure as an indication of the current supply of storage such that
a continuing decline in inventory levels implies an even steeper back- Conclusion
wardation and vice versa. Commodity index returns are a func-
tion of spot, roll and collateral returns.
Explaining Backwardation & Contango Via Convenience Yield Since spot returns across the various
Rearranging one of the formulas derived earlier to solve for the roll individual commodity indices are typi-
yield [the difference between the spot and forward price] we find that: cally strongly positive correlated, see
Table 1 (page 36), the varying perform-
Formula 4:
ance of total returns across the com-
Roll Yield = Convenience Yield – Interest Rate – Storage Cost
modity index universe is highly depend-
ent on the rules governing the rolling
Consequently where the convenience yield exceeds the interest procedures for the individual commodi-
rate and storage costs, it implies a positive roll yield or a backwardat- ty futures contracts.
ed market. This is the main feature of the crude oil market and Investors should therefore pay close to
underpins why commodity investment and in particular investment
in the energy sector is a highly profitable strategy to undertake.
Figure 7: Commodity Curves & Convenience Yields
Conversely, where the convenience yield is low and overwhelmed by
interest rate and storage costs, the roll yield will be negative. A neg-
ative roll yield indicates that the spot prices is lower than the futures
price which historically has tended to a typical market structure of
the agriculture, precious and industrial metals markets, Figure 7.
Commodity Volatility & Convenience Yield
Since convenience yield is an indication of market precariousness,
it is also positively correlated with the level of volatility across vari-
ous commodity markets, Figure 8. Not surprisingly those markets
which have the lowest level of available inventory compared to con-
sumption and hence the highest convenience yields typically have
the highest levels of volatility, for example crude oil and heating oil.
Source: DB Global Markets Research
COMMODITIES NOW SEPTEMBER 2007 45
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