Abstract
This paper investigates relationships between profits from dynamic trading strategies, risk premium, convenience yields, and net hedging pressures for commodity futures. The term structure of oil, gold, copper and soybeans futures markets contains predictive power for the corresponding term premium. However, only oil futures and soybean futures lead their spot premia. Significant momentum profits are identified in both outright futures and spread trading strategies when the spot premium and the term premium are used to form winner and loser portfolios. Profits from active strategies based on winner and loser portfolios are conditioned on market structure and net hedging pressure effects. Dynamic trading strategies based on contracts with extreme backwardation, extreme contango, and extreme hedging pressures are also tested. On average, spread trading outperforms outright futures trading in capturing the term structure risk and hedging pressure risk. Amongst such strategies, a long-short position in the long-term spread offers the greatest and most significant return and it offers the only exploitable trading profits conditional on past hedging pressure.
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