Interest rates, commodity prices, and the cost‐of‐carry model

Abstract

PurposeThe purpose of this paper is to examine the nexus between interest rate changes and commodity spot prices.Design/methodology/approachThe cost‐of‐carry model of simultaneous equilibrium in commodity spot and futures prices is employed to gauge the effects induced by interest rate changes. Results depend crucially on the type of expectations that prevail for the commodity market in question.FindingsUnder mean‐reverting expectations, an increase (decrease) in the interest rate will cause the spot price to drop (increase) and commodity suppliers to dishoard (hoard) inventories. Under invariant expectations, the change in the interest rate induces no change in the spot price and no hoarding/dishoarding behavior among commodity suppliers. Under momentum expectations, an increase (decrease) in the interest rate will cause the spot price to increase (drop) and suppliers to hoard (dishoard) inventories.Practical implicationsThe effects of monetary policy actions on commodity spot prices can be gauged employing the simple model developed here.Originality/valueA novel application of the cost‐of‐carry model is presented.