Research from Yale on Commodities

Many would consider the practice of placing assets in a commodity fund to be speculation rather than investing. That perception was amplified by a recent Bloomberg article, which reported the dismal performance of many managed-futures funds and commodity-trading advisors (CTAs). Contrary to that image, Geert Rouwenhorst, a Yale University professor, claims he has found a way to construct a commodity-based fund that earns a significant premium over inflation.

Indeed, Rouwenhorst says his research supports a return “somewhere in the 7% range.”

Rouwenhorst spoke at the 2013 Schwab Impact conference held in Washington, D.C. In addition to his position at Yale, he is also a partner at SummerHaven Investment Management, a Connecticut-based commodities-futures manager.

Rouwenhorst’s approach rests on two findings, which he claimed are supported by extensive historical data: “Non-renewable” commodities perform better than renewable ones, and scarcer commodities –those that trade in backwardation – perform better than more plentiful ones.

Rouwenhorst did not provide a copy of the slides from his presentation, because he said it was still in the process of publication.

I’ll review Rouwenhorst’s research and the basis for the return projections for his fund. I’ll also present my counterargument and why I remain un-persuaded that his approach is anything other than the latest incarnation of commodity speculation.

Two centuries of commodity returns

Rouwenhorst’s research has sought to answer three questions: How well do commodities keep up with inflation in the long run? How well do commodities track inflation from year to year? How does one think about the expected return for commodities?

With regard to the first question, Rouwenhorst looked at studies showing that commodities have not keep pace with inflation since the Civil War. This would seemingly make them undesirable as investments, but Rouwenhorst argued that these results will not be repeated in the future, at least with respect to agricultural commodities, since we have become much more efficient at growing crops.

Rouwenhorst was not satisfied with the data in those studies, so he collected his own and constructed an index of more than 100 commodities going back to approximately 1800. He adjusted for the mix of commodities over time, since items like plaster of Paris were once more commonly used than they are today.