Winter 2020

This article provides a brief update on the many events and initiatives that have taken place this year, including (a) the appointment of additional Industry Advisory Council members; (b) the selection of the JPMCC’s new Program Manager; (c) the Center’s global outreach efforts; (d) our expanded academic class offerings; (e) the JPMCC’s professional education efforts; (f) the upcoming collaboration with Erasmus University Rotterdam; and (g) our plans for next year’s international commodities symposium.

In this brief report, Dr. Jian Yang, the JPMCC’s Research Director, provides updates on the JPMCC’s research activities through the fall of 2020. In particular, Dr. Yang discusses (a) his cowritten study which advances research on the price discovery function of commodity futures markets; (b) the Center’s forthcoming featured articles in China Futures Magazine; and (c) the JPMCC’s international commodities symposium and other research activities.

The article discusses the uneven impact of the COVID-19 pandemic across the commodity market sectors. The author concludes that COVID-19’s impact on energy markets is likely to leave a permanent scar while the impact on other commodity markets will likely be transitory. In particular, the pandemic is likely to induce some longer term impacts on commodity markets, including lower oil consumption, changes in the cost of transport, unwinding of supply chains, and, in the longer term, substitution among commodities due to changes in consumer preferences.

This paper investigates the impact of enormous capital inflows into commodity futures markets in China. Mimicking the positions of both passive long and systematic long-short speculators, the study finds increased speculation does not give rise to higher volatilities and co-movements, nor distorts the market’s association with economic fundamentals. Moreover, long-short speculators who trade on commodity fundamental information contribute positively to price discovery by reducing the broad market volatility and cross-correlation with stocks. Overall, intensified speculation did not have an adverse impact on the broad Chinese commodity futures market.

A number of empirical studies, mainly from academic researchers, have been crucial in the debate on the economic role of futures trading. This article briefly summarizes the literature covering these influential studies with a focus on agricultural futures contracts, financial futures contracts, and the transparency of data.

Base metals prices have fully unwound the +20% lockdown-driven 1Q20 sell-off as metals-intensive Chinese stimulus measures have driven a sharp V-shaped recovery in demand. We expect Chinese metals demand to remain strong until China’s credit cycle peaks somewhere in 3Q21 but recent signs of overheating in the property sector, a major driver of end-use metals consumption in the country, have raised some red flags. Past performance shows that a reluctance to stimulate the housing market in China can weigh heavy on base metals prices, even if other sectors like infrastructure and manufacturing remain supported. While property investment remains strong for now, too much of a good thing can have future consequences and the evolution of property policy in the coming months bears watching given the potential drag it could add to the base metals sector.

Systematic commodity risk-premia strategies have been popular among asset allocators and extensively studied by researchers. It is not as widely known, though, that the disproportionally large share of returns in such diversified commodity portfolios is attributed to energy futures. We show that even simple signals supported by the economics of oil storage and transportation arbitrage generate superior returns when applied to oil futures alone. The challenge is to be mindful of structural regime shifts that are prevalent in oil markets.

The oil market went through a tumultuous period in early 2020. The price of the West Texas Intermediate Blend hit a peak of over $60 per barrel and then plunged for the first time in history to a negative price for both the front-month futures contract and spot price at Cushing on 4/20/2020. This paper focuses on the apparent stability of the market during this time period and the financial engineering challenges that options and futures traders addressed to ensure the markets remained orderly and operating. The authors provide evidence that the market functioned normally in the face of a negative futures price and the listing of negative strike options. The paper specifically focuses on the difficulties in pricing and hedging of options under the traditional Black option model. The authors then explore two alternative model formulations and comment on their applicability.

Forecasts play a vital role in decision-making in the energy sector. Forecasting in the energy sector is a challenging task due to the large number of highly uncertain variables that is typically needed to forecast. On top of this, the energy transition is introducing new uncertainties which elevate the importance of accurate forecasting while making the task more difficult. The paper examines the key forecasting challenges against this backdrop from the perspective of an industry practitioner and introduces a systematic five-step approach to understanding, evaluating, and improving forecasts. Simplified use cases are presented which demonstrate that the five-step approach can generate commercial insights and improvements in forecast performance.

The authors note that data may be the New Oil, but oil is only valuable after it has been refined. The same holds true for data. This article looks at how “Nowcasting” techniques are being used to refine geospatial data in order to provide real-time supply-and-demand information to the oil market.

Efficient institutional investment portfolios are exposed to commodity derivatives. Nevertheless, the current lack of coherent industry guidance on the Environmental, Social and Governance (ESG) impact of commodity futures may lead some investors to consider even excluding these assets. In this article the author systematically studies the question, “Can a responsible investor invest in commodity futures?” The article lays out a taxonomy of perceived issues and then proceeds to discuss these issues in light of available guidelines and the relevant academic research. Lastly, the author offers two actions that responsible investors exposed to commodity futures should consider.

By trading, modeling, and hedging commodities, the authors learned that commodities are materially impacted by calendar events and seasonality that may not be fully priced into the commodity futures markets until these events approach the maturity of a commodity’s futures contract. The authors discuss how the seasoned commodity expert in a specific sector or commodity must consider these events as catalysts for short and intermediate commodity price moves, which allow for an increased probability of mean reversion in certain time periods and an increased probability of counter-seasonal price trends in other periods. In addition, based on the authors’ historical research, these observations should be useful in improving upon the design of a systematic futures trading system based on mean reversion.

In this brief article, the authors argue that oil-indexation contracts have lost their relevance as oil and gas prices continue to decouple. In addition, the impact of the COVID-19 pandemic has provided further evidence of how this pricing framework has become ever more obsolete and an impediment to market competition and efficiency.

In this issue of the GCARD, we have the pleasure of interviewing Mark Keenan. Mr. Keenan is Head of Research and Strategy at Engelhart Commodity Trading Partners (ECTP) and an Editorial Advisory Board Member of the Global Commodities Applied Research Digest. He has over 20 years of experience in commodity quantitative analysis, research and strategy across all the major energy, metal, agriculture and soft commodities markets. He is also the author of two books: Positioning Analysis in Commodities Markets – Bridging Fundamental and Technical Analysis and most recently, Advanced Positioning, Flow and Sentiment Analysis in Commodity Markets.

The pandemic of 2020 had a major influence on almost every facet of life as the COVID-19 virus wound its way around the world. Commodity markets were impacted as well, yet not in any unifying pattern. Every commodity was influenced differently. In this research, the author looks back at how four selected commodities performed – oil, copper, soybeans, and gold – in 2020, and tries to detangle the influence of the virus from everything else that was happening. It is a conflicted picture, which illustrates the many feedback loops and dynamic aspects of complex systems.