30.2 ECONOMICS OF COMMODITY FUTURES MARKETS
This section briefly discusses two prominent theories that have been put forward to explain the relationships among futures prices, current spot prices, and expected future spot prices. Understanding these relationships is essential in explaining the potential sources of returns to CTAs and, in particular, trend-following strategies.
30.2.1 Theory of Storage and Convenience Yield
The theory of storage, as initially developed by Kaldor (1939), attempts to explain the relationship between futures prices and current spot prices. The theory emphasizes the importance of holding inventory and the potential benefits derived from the ownership of physical commodities as opposed to having a claim to commodities through forward and futures contracts.1 Ownership of commodities has economic value because it allows owners to absorb demand and supply shocks. Owners can meet an unexpected rise in demand and can avoid production disruptions resulting from supply shocks. The benefit of this ownership is often referred to as convenience yield, which is analogous to the equity dividends received by owners of equity shares and not by owners of futures contracts or other derivatives instruments.
Because commodity markets are volatile, both producers and consumers seek ways to hedge their risks. Derivative markets, such as futures and options, for commodities represent one venue through which producers and consumers of commodities can hedge their risks. Alternatively, ...