Structural Properties of Commodity Futures Term Structures and Their Implications for Basic Trading Strategies

Abstract

This paper examines the informational content of commodity futures term structures over time. Time series of commodity prices and returns are analyzed by means of static and rolling principal component analysis. We use weekly data from January 1998 to July 2009 of 23 commodity underlyings from Energy, Metals, Agriculture and Livestock. We find high stability of the principal components and their explanatory power over time. The first component identified as a level factor is paramount for the interpretation of term structure dynamics for most underlyings. This result suggests that an investor can exploit the information contained within the term structure and revealed by principal component analysis. We formulate three distinctive investment strategies based on term structure information which optimize roll yields. By creating portfolios according to a principal component ranking we significantly outperform a long-only benchmark.

Keywords: Futures term structure, Roll yield, Convenience yield, Contango, Backwardation, Commodity trading strategy, Principal component analysis

JEL Classification: G11, G13, G12