Is the convenience yield a good indicator of a commodity's supply risk?

Abstract

a b s t r a c tA strong increase in the demand for some commodities over the last decade will have a major impact on their future supply situation. Of increasing importance, therefore, is an assessment of a commodity's criticality, and especially its supply risk, by appropriate indicators. The literature has proposed numerous indicators of the supply risk. Here, we use the convenience yield of commodity futures as a supply risk indicator to address some of the major shortcomings of existing indicators, especially regarding their predictive power. This paper aims to test the applicability of the convenience yield as an indicator of a commodity's future supply risk. Therefore, we calculate historical convenience yields for 3-, 15-, and 27-month futures contracts for five major industrial metals (aluminum, copper, lead, nickel, and zinc) during the period 1999 to 2011. We compare the convenience yields at the beginning of the contract period to known indicators at maturity to find that the convenience yield has generally predictive power for the static stock lifetime (i.e., inventory volume/turnover) and future spot prices. Furthermore, we find that, with some restrictions, the convenience yield is an applicable indicator of a commodity's supply risk.

Spot and Futures Markets Linkages: Does Contango Differ from Backwardation?

“…Instead of assuming arbitrary values for the convenience yield, the (average) ones yielded by Heaney ()'s methodology for the full sample are used. In turn storage cost annualized rates are computed on the basis of LME warehousing rents, by following Stepanek, Walter, and Rathgeber ()'s procedure.…”

“…The existence of feedback‐effects between spot and futures prices has been extensively studied in the extant literature, as documented by the survey article by Chow, McAleer, and Sequeira (). More recent contributions in the area are Brooks, Rew, and Ritson (), Pindyck (), Heaney (, , ), Watkins and McAleer (), Tilton, Humphreys, and Radetzki (), Stepanek, Walter, and Rathgeber (), and Gulley and Tilton (), among others…”

“…This approach was previously used by Heaney (). In a related article, Stepanek, Walter, and Rathgeber () solved for the convenience yield from the equation relating the futures and spot prices in the cost‐of‐carry model, and found that the convenience yield had predictive power with respect to inventory/turnover and future spot prices.…”

Futures markets and fundamentals of base metals

“…A previous research has mainly focused on the use of the convenience yield as an indicator of supply shortage (e. g., Stepanek et al, 2013;Omura, Todorova, Li, & Chung, 2015), but it has neglected supply and demand interactions. Future research questions include studying metal price determination on the basis of fundamental factors, such as consumption, secondary (scrap) and mine production.…”

“…To our knowledge, this is the first study to link explicitly metal demand and supply to futures markets dynamics. A previous study in this line of research is Stepanek, Walter, and Rathgeber (2013), who focused on supply risk and concluded that the convenience yield had predictive power with respect to inventory/turnover and future spot prices. 4 This article is organized as follows.…”