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Commodity Futures

These entries address investing and trading in commodities and commodity futures as an alternative asset class to equities.

Factor Crowding in Commodity Futures

Can investors detect when commodity futures momentum, value and carry (basis) strategies are crowded and therefore likely to generate relatively weak returns? In the March 2021 version of their paper entitled “Crowding and Factor Returns”, Wenjin Kang, Geert Rouwenhorst and Ke Tang examine how crowding by commodity futures traders affects expected returns for momentum, value and basis strategies. They define commodity-level crowding based on excess speculative pressure, measured for each commodity as the deviation of non-commercial trader net position (long minus short) from its 3-year average, scaled by open interest. They calculate crowding for a long-short strategy portfolio as the average of commodity-level crowding metrics of long positions minus the average of commodity-level crowding metrics for short positions, divided by two. They specify strategy portfolios as follows:

  • Momentum – each week long (short) the equally weighted 13 commodities with the highest (lowest) past 1-year returns as of the prior week.
  • Value – each week long (short) the equally weighted 13 commodities with the highest (lowest) ratios of last-week nearest futures price to nearest futures price three years ago.
  • Basis – each week long (short) the equally weighted 13 commodities with the highest (lowest) basis, measured as percentage price difference between nearest and next maturity contracts as of the prior week.

For each strategy, they measure effects of crowding by measuring returns separately when strategy crowding is above or below its rolling 3-year average. Using weekly (Tuesday close) investor position data published by the Commodity Futures Trading Commission (CFTC) for 26 commodities traded on North American exchanges during January 1993 through December 2019, they find that:

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Best Safe Haven ETF?

A subscriber asked which exchange-traded fund (ETF) asset class proxies make the best safe havens for the U.S. stock market as proxied by the S&P 500 Index. To investigate, we test 14 ETFs as potential safe havens:

Utilities Select Sector SPDR (XLU)
iShares 20+ Year Treasury Bond (TLT)
iShares 7-10 Year Treasury Bond (IEF)
iShares 1-3 Year Treasury Bond (SHY)
iShares iBoxx $ Investment Grade Corporate Bond (LQD)
iShares Core US Aggregate Bond (AGG)
iShares TIPS Bond (TIP)
Vanguard REIT ETF (VNQ)
SPDR Gold Shares (GLD)
PowerShares DB Commodity Tracking (DBC)
United States Oil (USO)
iShares Silver Trust (SLV)
PowerShares DB G10 Currency Harvest (DBV)
SPDR Bloomberg Barclays 1-3 Month T-Bill (BIL)

We consider three ways of testing these ETFs as safe havens for the U.S. stock market based on daily or monthly returns:

  1. Contemporaneous return correlation with the S&P 500 Index during all market conditions at daily and monthly frequencies.
  2. Performance during S&P 500 Index bear markets as defined by the index being below its 10-month simple moving average (SMA10) at the end of the prior month.
  3. Performance during S&P 500 Index bear markets as defined by the index being -20%, -15% or -10% below its most recent peak at the end of the prior month.

Using daily and monthly dividend-adjusted closing prices for the 14 ETFs since respective inceptions, and contemporaneous daily and monthly levels of the S&P 500 Index since 10 months before the earliest ETF inception, all through late April 2021, we find that: Keep Reading

Do Copper Prices Lead the Broad Equity Market?

Is copper price a reliable leading indicator of economic activity and therefore of future corporate earnings and equity prices? To investigate, we employ the monthly price index for copper base scrap (not seasonally adjusted) from the U.S. Bureau of Labor Statistics, which spans multiple economic expansions and contractions. Using monthly levels of the copper scrap price index and the S&P 500 Index during January 1957 through November 2020 (nearly 64 years), we find that: Keep Reading

Crude Oil Seasonality

Does crude oil (an important part of commodity indexes) exhibit an exploitable price seasonality? To check, we examine three monthly series:

  1. Spot prices for West Texas Intermediate (WTI) Cushing, Oklahoma crude oil since the beginning of 1986 (34+ years).
  2. Nearest expiration futures prices for crude oil since April 1983 (37+ years).
  3. Prices for United States Oil (USO), an exchange-traded implementation of short-term crude oil futures since April 2006 (14+ years).

We focus on average monthly returns by calendar month and variabilities of same. Using monthly prices from respective inceptions of these series through October 2020, we find that: Keep Reading

Smart Money Indicator Verification Update

“Verification Tests of the Smart Money Indicator” performs tests of ideas and setup features described in “Smart Money Indicator for Stocks vs. Bonds”. The Smart Money Indicator (SMI) is a complicated variable that exploits differences in futures and options positions in the S&P 500 Index, U.S. Treasury bonds and 10-year U.S. Treasury notes between institutional investors (smart money) and retail investors (dumb money) as published in Commodity Futures Trading Commission Commitments of Traders (COT) reports. Since findings for some variations in that test are attractive, we add two further robustness tests:

Using COT report data, dividend-adjusted SPDR S&P 500 (SPY) as a proxy for a stock market total return index, 3-month Treasury bill (T-bill) yield as return on cash (Cash) and dividend-adjusted iShares 20+ Year Treasury Bond (TLT) as a proxy for government bonds during 6/16/06 through 4/3/20, we find that:

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Verification Tests of the Smart Money Indicator

A subscriber requested verification of findings in “Smart Money Indicator for Stocks vs. Bonds”, where the Smart Money Indicator (SMI) is a complicated variable that exploits differences in futures and options positions in the S&P 500 Index, U.S. Treasury bonds and 10-year U.S. Treasury notes between institutional investors (smart money) and retail investors (dumb money). To verify, we simplify somewhat the approach for calculating and testing SMI, as follows:

  • Use a “modern” sample of weekly Traders in Financial Futures; Futures-and-Options Combined Reports from CFTC, starting in mid-June 2006 and extending into early February 2020.
  • For each asset, take Asset Manager/Institutional positions as the smart money and Non-reporting positions as the dumb money.
  • For each asset, calculate weekly net positions of smart money and dumb money as longs minus shorts. 
  • For each asset, use a 52-week lookback interval to calculate weekly z-scores of smart and dumb money net positions (how unusual current net positions are). This interval should dampen any seasonality.
  • For each asset, calculate weekly relative sentiment as the difference between smart money and dumb money z-scores.
  • For each asset, use a 13-week lookback interval to calculate recent maximum/minimum relative sentiments between smart money and dumb money for all three inputs. The original study reports that short intervals work better than long ones, and 13 weeks is a quarterly earnings interval.
  • Use a 13-week lookback interval to calculate final SMI as described in “Smart Money Indicator for Stocks vs. Bonds”.

We perform three kinds of tests to verify original study findings, using dividend-adjusted SPDR S&P 500 (SPY) as a proxy for a stock market total return index, 3-month Treasury bill (T-bill) yield as return on cash (Cash) and dividend-adjusted iShares 20+ Year Treasury Bond (TLT) as a proxy for government bonds. We calculate asset returns based on Friday closes (or Monday closes when Friday is a holiday) because source report releases are normally the Friday after the Tuesday report date, just before the stock market close. 

  1. Calculate full sample correlations between weekly final SMI and both SPY and TLT total returns for lags of 0 to 13 weeks.
  2. Calculate over the full sample average weekly SPY and TLT total returns by ranked tenth (decile) of SMI for each of the next three weeks after SMI ranking.
  3. Test a market timing strategy that is in SPY (cash or TLT) when SMI is positive (zero or negative), with 0.1% (0.2%) switching frictions when the alternative asset is cash (TLT). We try execution at the same Friday close as report release date and for lags of one week (as in the original study) and two weeks. We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics. Buying and holding SPY is the benchmark.

Using inputs as specified above for 6/16/06 through 2/7/20, we find that: Keep Reading

Exploiting Liquidity Needs of Futures-based ETFs

Has growth in futures-based exchange-traded funds (ETF) predictably affected pricing of underlying assets? In his November 2019 paper entitled “Passive Funds Actively Affect Prices: Evidence from the Largest ETF Markets”, Karamfil Todorov investigates impacts of ETF trading on pricing of futures on equity volatility (VIX) and commodities, the two asset classes most dominated by ETFs. He decomposes sources of these impacts into three rebalancing needs: (1) rolling of futures contracts as they expire; (2) inflow/outflow of investor funds; and, (3) maintenance of constant daily leverage. By modeling the fundamental value of VIX futures contracts using S&P 500 Index and VIX option prices, he quantifies non-fundamental ETF rebalancing impacts on VIX futures prices. Finally, he tests a strategy to exploit the need for daily leverage rebalancing by trading against it. Specifically, he approximates daily liquidity provision by each intraday reforming portfolios that short a pair of long and short futures-based ETFs on the same underlying asset (volatility, natural gas, gold or silver). In other words, he shorts at the open and covers at the close each day. Using daily data for selected ETFs and their underlying futures for VIX, U.S. natural gas, silver, gold and oil as available during January 2000 through December 2018, he finds that: Keep Reading

Exploiting VIX Futures Roll Return with ETNs

“Identifying VXX/SVXY Tendencies” finds that S&P 500 implied volatility index (VIX) futures roll return, as measured by the percentage difference in settlement price between the nearest and next nearest VIX futures, may be a useful predictor of iPath S&P 500 VIX Short-Term Futures ETN (VXX) and ProShares Short VIX Short-Term Futures ETF (SVXY) returns. VXX and SVXY target 1X daily performance for VXX and -0.5X for SVXY relative to the S&P 500 VIX Short-Term Futures Index. Is there a way to exploit this predictive power? To investigate, we compare performances of:

  1. SVXY B&H – buying and holding SVXY.
  2. SVXY-Cash – holding SVXY (cash) when prior-day roll return is negative (zero or positive).
  3. SVXY-VXX – holding SVXY (VXX) when prior-day roll return is negative (zero or positive).

We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance statistics. Using daily split-adjusted closing prices for SVXY and VXX and daily settlement prices for VIX futures from SVXY inception (October 2011) through December 2019, we find that:

Keep Reading

Identifying VXX/SVXY Tendencies

Are there reliable predictors supporting strategies for timing exchange-traded notes (ETN) constructed from near-term S&P 500 Volatility Index (VIX) futures, such as iPath S&P 500 VIX Short-Term Futures ETN (VXX) and ProShares Short VIX Short-Term Futures ETF (SVXY), available since 1/30/09 and 10/4/11, respectively. The managers of these securities buy and sell VIX futures daily to maintain a constant maturity of one month, continually rolling partial positions from nearest to next nearest contracts. VXX and SVXY target 1X and -0.5X daily performance relative to the S&P 500 VIX Short-Term Futures Index, respectively. We consider five potential predictors for these ETNs:

  1. Level of VIX, in case a high (low) level indicates a future decrease (increase) in VIX that might affect VXX and SVXY.
  2. Change in VIX (VIX “return”), in case there is some predictable reversion or momentum for VIX that might affect VXX and SVXY.
  3. Implied volatility of VIX (VVIX), in case uncertainty in the expected level of VIX might affect VXX and SVXY.
  4. Term structure of VIX futures (roll return) underlying VXX and SVXY, as measured by the percentage difference in settlement price between the nearest and next nearest VIX futures, indicating a price headwind or tailwind for a fund manager continually rolling from one to the other. VIX roll return is usually negative (contango), but occasionally positive (backwardation).
  5. Volatility Risk Premium (VRP), estimated as the difference between VIX and the annualized standard deviation of daily S&P 500 Index returns over the past 21 trading days (multiplying by the square root of 250 to annualize), in case this difference between expectations and recent experience indicates the direction of future change in VIX. VRP is usually positive, but occasionally negative.

We measure predictive power of each in two ways: (1) correlations between daily VXX and SVXY returns over the next 21 trading days to daily predictor values; and, (2) average next-day SVXY returns by ranked tenth (decile) of daily predictor values. Using daily levels of VIX and VVIX, settlement prices for VIX futures contracts, level of the S&P 500 Index and split-adjusted prices for VXX and SVXY from inceptions of the ETNs through December 2019, we find that: Keep Reading

Commodity Futures Risk Premium Over the Long Run

What are long run returns for commodity futures? In their September 2019 paper entitled “The Commodity Futures Risk Premium: 1871-2018”, Geetesh Bhardwaj, Rajkumar Janardanan and Geert Rouwenhorst estimate the historical risk premium of commodity futures from a long and broad sample free of survivorship bias covering 230 contract series traded since 1871 mostly in the U.S. and the UK. They calculate the premium as average excess return for rolling front-month contracts in three ways: (1) simple equal weighting of all monthly observations; (2) equal-weighted separately calculated premiums for each contract series; and, (3) average excess return for an equal‐weighted index series. They explore the link between survival of a contract series and its risk premium. They also estimate returns to basis or momentum factor strategies that are each month long (short) the equal-weighted half of available commodities with the higher (lower) futures basis or prior-year spot return. Using monthly prices for 230 commodity futures traded on 28 exchanges during 1871 through 2018, they find that: Keep Reading

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