Subject 5. Commodities and other altenative investments

Commodities include agricultural products, energy products and metals. Returns are based on changes in price and do not include an income stream such as dividends, interests, or rent.

Most investors do not want to get involved in storing commodities such as cattle or crude oil. A common investment objective is to purchase indirectly those real assets that should provide a good hedge against inflation risk. Another investment objective is for portfolio diversification.

Commodity derivatives are financial instruments that derive their value from the value of the underlying commodities. They include commodity futures, forwards, options and swaps. There are also other means of achieving commodity exposure.

Commodity spot prices are determined by market supply and demand.

The price of a commodity futures contract is determined by the spot price, risk-free rate, storage costs and convenience yield.

  • Contango: when futures prices are higher than the spot price.
  • Backwardation: when futures prices are lower than the spot price.

Three sources of return for each commodity futures contract:

  • Roll yield.
  • Collateral yield.
  • Spot prices.

Other alternative investments include collectibles such as antiques and fine arts, fine wine, stamps and coins, jewelry and watches, etc. Collectibles usually:

  • Don't provide current income.
  • Are illiquid, and not easy to value fairly.
  • Incur storage costs.

There are a few price indices for different collectibles.

User Contributed Comments 4

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RamaG: Contango: when futures prices are higher than the spot price.
Backwardation: when futures prices are lower than the spot price.
Murtadha: Contango, when the forward curve is upward sloping and spot prices are lower than future prices due to minimal or lack of convenience yield, which represents cost of carry i.e. storage costs. This can be verified by the roll yield.
jagp: Contango: when futures price is higher that the EXPECTED future spot price. Same goes for normal backwardation
Mheaton37: @AnalystNotes - alternative*