Is the Convenience Yield a Good Indicator for a Commodity’s Criticality?

Abstract

For some commodities, the strong increase in demand over the last decade will have major impact on their future availability. Thus, the importance of assessing a commodity’s criticality by means of criticality indicators continuously increases. In the literature, numerous indicators for criticality are proposed (e.g., spot prices, the Herfindhal-Hirschmann Index, etc.). In order to address some of the major shortcomings of these existing indicators, especially regarding their predictive power, we propose to use the convenience yield of commodity futures as criticality indicator. In the paper we aimed to test the applicability of the convenience yield as indicator for a commodity’s future criticality. Therefore we used historical convenience yields from 3, 15, and 27 months futures contracts for five major industrial metals. We compared the convenience yields at the beginning of the contracts with known criticality indicators until the time of maturity. We found evidence that the convenience yield in general has predictive power on the static stock lifetime (i.e. inventory volume / turnover) and future spot prices. Furthermore we show evidence that with some restrictions the convenience yield suits to be an applicable indicator for a commodity’s criticality.