Commodities as an asset class…

In their work, first published in 2004 (revised 2005) titled “Facts and Fantasies about Commodity Futures”, Gary Gorton, of Wharton School, and K. Geert Rouwenhorst, of Yale make an interesting case for commodities. From their abstract:

While the risk premium on commodity futures is essentially the same as equities, commodity futures returns are negatively correlated with equity returns and bond returns. The negative correlation between commodity futures and the other asset classes is due, in significant part, to different behavior over the business cycle. In addition, commodity futures are positively correlated with inflation, unexpected inflation, and changes in expected inflation.

Commodities as an investment pose a problem for traditional value investors. An investment can be analyzed by splitting into its components: income potential and capital appreciation. While traditional value investors necessarily focus on some sort of discounting of cash flow, liquidation value, etc. they (we? still undecided) might be doing themselves a disservice.

The question then becomes how to value the uncertain capital appreciation. Volatility models don’t seem to work quite right these days. This paper suggests that even without leverage, using an equally weighted portfolio could lead to an interesting investment opportunity. Coupled with the recent postings on Esterlings insights into the impact of starting inflation and valuation on stocks, it would be interesting to see the performance of this portfolio against the Y-curve proposed by Esterling. Then we’d be able to look at performance in inflationary, deflationary, and price-stability environments.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=560042

Last 5 posts by Yaron Sadan

categories Commodities/Futures, Strategy/Allocation | Yaron Sadan | datetime December 25, 2008 12:30 am

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