A commodity index does not return what the spot price did
The Little Book of Commodity Investing
The idea
An investor who buys a commodity index does not own barrels in a tank. They own futures that must be rolled before delivery, selling the near contract and buying the next. When the next contract is dearer, contango, each roll loses money, and an index can fall while the spot price rises. When the next is cheaper, backwardation, the roll adds to returns. Stephenson's book covers ground thinly treated elsewhere, which is what earns it a place, and the point generalises to any instrument held through a roll.
Returns on a rolled futures position include the roll, so the shape of the curve matters as much as where spot goes.
When it works
Any question on commodity exposure, futures-based products or the difference between spot and investable returns.
When it may fail
The roll is one component, alongside collateral yield and spot movement, and curve shapes change. The point is to account for it, not to assume it always dominates.
How to use it
Asked whether to buy a commodity index, draw the futures curve first and say which way the roll pays. If the curve is in contango, the spot view has to overcome the roll cost before the position makes money.
Where it came from
Book The Little Book of Commodity Investing · John Stephenson
What the source says. Contango, backwardation and why a commodity index does not return what the spot price did, thinly covered elsewhere.
Connected ideas
Says something similar
Physical traders make money on logistics and access, not on a price viewIn physical commodities the money is in moving, financing and accessing the cargo; the price direction is usually hedged.
Concepts
Put it to work on L3VLUP
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