Commodities Roll Yield in 2009

Let's start with the obvious: 2008 was a difficult year for commodity investors. In fact, it was the worst year ever, with the S&P GSCI falling 42.35%.

The horrible thing was that it all felt so good right up through summer. The S&P GSCI was up 41.42% at midyear, trading at all-time highs, before plunging 62% in six consecutive wrenching months of declines.

There was almost nowhere to hide. Just two of the 24 commodities in the index delivered positive returns: cocoa and gold. By contrast, seven commodities fell more than 50%, led by lead, which tumbled 61.40%. And outside cocoa and gold, no other commodity did better than a -20% return. All these figures reflect excess returns, which combines spot returns with roll yield and reflects the experience of investors in this market.

Importantly, however, excess returns overstate how bad things were from a spot price perspective. From a spot perspective, four commodities had positive returns in 2008: cocoa (30.96%), sugar (9.15), gold (5.53%) and lean hogs (5.18%). An additional five commodities had returns of less than -20%: live cattle (-10.55%), corn (-10.65), feeder cattle (-12.54%), coffee (-17.73%) and soybeans (-19.29%).

The following figure shows how the spot returns differed from the excess returns.

The difference between these two figures owes itself to the fact that all 24 commodities had negative roll yields for 2008, which contributed between 1.4% (nickel) and 38.3% (lean hogs) of negative return to the commodities market.

The table below shows the spot, roll and excess returns for each of the commodities in 2008, sorted by the roll yield.

Commodity	Roll Return	Spot Return	Excess Return
Nickel	-1.4%	-55.5%	-56.9%
Heating Oil	-1.6%	-45.6%	-47.2%
Silver	-2.3%	-24.3%	-26.6%
Zinc	-2.4%	-49.4%	-51.8%
Crude Oil	-2.6%	-53.5%	-56.1%
Soybeans	-3.1%	-19.3%	-22.3%
Gold	-3.2%	5.5%	2.4%
Unleaded Gasoline	-3.9%	-57.4%	-61.3%
Aluminum	-4.9%	-36.1%	-41.0%
Cocoa	-5.8%	31.0%	25.1%
Brent Crude	-6.0%	-47.9%	-53.9%
Kansas Wheat	-7.1%	-31.0%	-38.1%
Wheat	-8.5%	-31.0%	-39.4%
Feeder Cattle	-8.7%	-12.5%	-21.3%
Coffee	-9.5%	-17.7%	-27.3%
Natural Gas	-11.9%	-24.9%	-36.7%
Corn	-12.4%	-10.6%	-23.1%
Cotton	-15.7%	-27.9%	-43.6%
Live Cattle	-16.8%	-10.5%	-27.3%
Sugar	-30.3%	9.1%	-21.1%
Lean Hogs	-38.3%	5.2%	-33.1%

The reason we write so much about contango is that it has an enormous impact on returns. For instance, a lot of investors (such as Jim Rogers) spent 2008 talking about the bullish outlook for sugar. Impressively enough, they were right: Sugar rose 9.1% in 2008 on a spot basis, despite global market conditions. But an investor in sugar lost 21.1% last year, because a vicious contango seriously impacted returns.

A similar story was true of most Agricultural commodities. Although the markets were down in 2008 on a spot basis, they were not down as much as investors experienced – because the roll yield was nasty.

The Outlook For 2009

As we enter 2009, the focus on contango has become even more important, because the roll yield in many commodities is brutal right now. The table below examines the annualized roll yield for the 24 S&P GSCI commodities. Data is as of January 9, 2009, and comes from each relevant exchange.

The data is calculated in the simplest manner possible: Next month's contract value (or next quarter for some commodities) is subtracted from this month's contract value, and expressed as a percentage of the current value of the contract. This figure is then annualized.

Importantly, this simplistic equation does not attempt to capture what investors will actually experience throughout the year. Contango levels change significantly on a day-by-day and month-by-month basis, and the level that investors experience will depend both on those trends and on where the figures stand when the indexes make their transition from one fund to the next. Often, a commodity will be in contango because it anticipates upward movement in the commodity spot price.

Still, expressing these differences in a percentage format gives you a window onto the direction in which roll yield may impact prices in 2009. (Figures are ranked by the weight of each commodity in the S&P GSCI.)

	Weight	Implied Roll Yield
Crude Oil	30.8%	-153.2%
Brent Crude	12.5%	-90.4%
Unleaded Gasoline	3.6%	-50.4%
Heating Oil	5.1%	-6.1%
GasOil	5.1%	-5.9%
Natural Gas	7.8%	8.1%
Aluminum	2.6%	-12.5%
Copper	2.4%	0.0%
Lead	0.4%	0.0%
Nickel	0.7%	3.5%
Zinc	0.6%	-6.7%
Gold	3.4%	3.5%
Silver	0.3%	-1.4%
Wheat	5.3%	-19.3%
Kansas Wheat	1.2%	-10.9%
Corn	5.0%	-15.9%
Soybeans	3.3%	0.0%
Cotton	1.1%	-5.4%
Sugar	1.9%	-47.9%
Coffee	0.9%	-22.2%
Cocoa	0.4%	4.1%
Feeder Cattle	0.6%	15.9%
Live Cattle	3.3%	-53.1%

The place to look is at the top of the table, at the highest-weighted commodities in the index. The levels of contango are simply punishing in many of those commodities, with historic headwinds in the Oil and Gasoline markets.

It's worth noting that a number of commodities have positive roll yields right now: feeder cattle, natural gas, nickel, cocoa, etc. By and large, however, these have small weights in the index.

No one is suggesting that oil's annual contango is really going to cost investors 153%. But the annualized figures dramatize the fact that contango is vicious in today's market. Even if spot prices rise, investors in an S&P GSCI index fund (or other commodity index funds) could well experience negative returns. As we learned in 2008, roll yield matters.

Comments

[ikkyu:]

Excellent presentation on a critical topic. Thanks.
Best wishes from Osaka,
john

Jan 12 09:16 AM