Chemical Link Versus Industrial Link among Commodity Futures

Abstract

Gasoline (GA) and kerosene (KO) are extracted from crude oil (CO), such that the three fuel commodities share a chemical link. On the other hand, GA also shares an industrial link with natural rubber (NR) and palladium (PA) since these are complementary commodities which are heavily consumed by the automobile industry. We contrast the information content embedded in the two economic links. Focusing on TOCOM futures contracts written on the five commodities and centering on GA, we confirm that incremental information provided by either CO, KO or NR, PA over a buy-and-hold strategy and a naive forecast, are both statistically and economically significant. While the chemical link forecast is more profitable, a double-link forecast generated from a VECM with two cointegrating vectors (KO-GA and GA-NR prices) outperforms both single-link forecasts based on risk-adjusted profit net of transaction costs. This indicates the dissimilar nature of the two economic links and further incremental profits from incorporating both links to forecast GA futures return.

Keywords: return, volume, cross-market, VAR, VECM, commodity futures

JEL Classification: G14, G15