Backwardation in Futures Markets Correlates with Low Inventories and Abnormal Returns, says Research

March 21, 2011


Commodity futures risk premiums vary across commodities and over time depending on the level of physical inventories, as predicted by the Theory of Storage. Using a comprehensive dataset on 31 commodity futures and physical inventories between 1969 and 2006, we show that the convenience yield is a decreasing, non-linear relationship of inventories. Price measures, such as the futures basis ("backwardation"), prior futures returns, and prior spot returns reflect the state of inventories and are informative about commodity futures risk premiums. The excess returns to Spot and Futures Momentum and Backwardation strategies stem in part from the selection of commodities when inventories are low. Positions of futures markets participants are correlated with prices and inventory signals, but we reject the Keynesian "hedging pressure" hypothesis that these positions are an important determinant of risk premiums.

source : SSRC,

HistorySquared :

There is an ETF based on this professor’s research that uses a combination of backwardation, inventories, and momentum that historically produced roughly a 20% return in testing. The symbol is USCI.

Chart of USCI vs PowerShares Commodity Index Fund



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