Concurrent Relations of Commodity Futures

Literatures have focused on the relationship between basis, cost of storage and convenience yield, as given by the Theory of Storage. However, the relations among futures contracts should be considered as a whole, upon discussion of futures-spot relationships: futures curve reflects inventory level and the risk premium and thus the dynamics of future spot price. Here the predictive ability of the futures curve over future spot price dynamics is empirically proven. When the futures curve is highly volatile, market participants’ expectation on inventory and risk premium vary. As this discrepancy widen, spot inventory is deemed unstable. Thus, spot price rises for a short time. But then, as inventory restores itself, spot mean reverts, making a sharp market correction. An investment strategy that predicts spot price crashes using the futures curve is devised. Equal weight portfolio of 26 commodities is used. Results corroborate the conjecture; it predicts major market crashes. Result indicates that contemporary relations among futures contracts are crucial in futures-spot relationships. This result expands the view offered by the Theory of Storage by highlighting the importance of relationship among futures contracts.