Strategies Based on Momentum and Term Structure in Financialized Commodity Markets

Abstract

(ProQuest: ... denotes formulae omitted.)1. IntroductionCommodity investments have gained huge popularity among investors over the last decade and there are several grounds for their rising recognition as an asset class. Commodities are especially highly valued for the strategic asset allocation, bringing such benefits as long-term equity-like risk premiums (Till, 2007a; Till, 2007b; Till, 2007c; Erb & Harvey, 2006; Gorton & Rouvenhorst, 2006), low correlation with other asset classes and diversification properties (Ankrim & Hensel, 1993; Becker & Finnerty, 1994; Kaplan i Lummer ,1998; Anson ,1999, Jensen, Johnson & Mercer 2000, Abanomey & Mathur, 2001; Georgiev, 2001; Gorton & Rouwenhorst, 2006), hedge against a tail risk (Deaton & Laroque, 1992; Armstead & Venkatraman, 2007), positive skewness (Gorton & Rouwenhorst 2006) and inflation hedging abilities (Erb & Harvey, 2006; Adams et al., 2008; Zaremba, 2014a).In addition, they provide investors with an easy access exposure to passive and cheap strategies in commodity markets due to the proliferation of ETFs and index products.Recent research and market practices suggest that commodities are not only useful in terms of strategic asset allocation, but also bring benefits in form of tactical asset allocation within this asset class. Basically, there are two most prominent strategies of achieving abnormal returns in commodity markets.The first one is a momentum investing strategy, according to which commodities with the highest historical returns outperform the market in the future, while futures with the worst returns underperform the market (Miffre & Rallis, 2007; Gorton, Hayashi, & Rouwenhorst, 2013; Fuertes, Miffre & Rallis, 2010; Fuertes, Miffre & Fernandez-Perez, 2014). Commodity investors can profit from the momentum effect, for instance, by going long the top performers and shorting the market laggards. The momentum effect was documented in stocks (Jegadeesh & Titman, 1993; Liew & Vassalou, 2000; Griffin, Ji, & Martin, 2003; Chui, Wei, & Titman, 2010; Fama & French, 2012;), bonds (Ansess, Moskowitz & Pedersen, 2013), currencies (Shleifer & Summers, 1990; Kho, 1996; LeBaron, 1999) and even domestic equity markets (Asness, Liew, & Stevens, 1997; Bhojraj & Swaminathan, 2006, Zaremba & Konieczka, 2014). The profitability of momentum investing strategy in commodity markets is proved in numerous studies (Erb & Harvey, 2006, Gorton, Hayashi, & Rouwenhorst, 2013, Miffre & Rallis, 2007; Gorton, Hayashi, & Rouwenhorst, 2013; Fuertes, Miffre & Rallis, 2010; Fuertes, Miffre & Fernandez-Perez, 2014). Although it is currently one of the most researched phenomenon in the field of finances, no consensus has been reached on the sources of its effectiveness. Possible explanations relate to market microstructure (Osler, 2000), risk management techniques (Garleanu & Pedersen, 2007) and behavioral biases (Kahneman & Tversky, 1974; Shefrin, & Statman, 1985; Froot, Scharfstein, & Stein 1992; Barberis, Schleifer, & Vishny, 1998; De Long, Shleifer, Summers, & Waldmann, 1990; Bikhchandani, Hirshleifer, & Welch, 1992).Another well documented strategy is based on a shape of a term structure in commodity markets. The concept underlying this investment technique is related to the hedging pressure hypothesis (Keynes, 1930; Working, 1949; Hirschleifer, 1990; Basu & Miffre, 2013) which tries to explain the shape of term structure and the source of risk premium in commodity markets. According to this concept, a risk premium is a price of insurance born by market hedgers and transferred to market speculators. If short positions are taken by the majority of hedgers, a downward pressure might be exerted on futures prices, resulting in a downside sloping of a curve. Beneficiaries of such backwardated markets are speculators taking long positions and harvesting risk premiums. …