by Jodie Gunzberg, Managing Director, S&P Dow Jones Indices
Energy is back in a bear market now led by oil’s slide mainly due to rising output from Libya and Nigeria, two OPEC members exempt from cutting supply. The S&P GSCI Energy Total Return is on pace for its worst quarter since the fourth quarter of 2015 losing -13.4% quarter-to-date (through June 19, 2017.) This is driven by the Brent crude and (WTI) crude oil in the index that are also having their worst total returns since Q4 2015, losing 13.7% and 13.9%, respectively. In turn the S&P GSCI Total Return is also suffering with a loss of -8.3% in the quarter thus far, on pace to be its worst quarter since Q4 2015. However, ex-energy, commodities are doing fine.
Though energy’s impact on the broad commodity index is weighing the S&P GSCI Total Return down 12.9% year-to-date, investors are highly interested as commodities have rebounded more than 13% off their bottom on Jan. 20, 2016. Also, ex-energy commodities are up slightly this year with some like wheat (+8.6%,) cattle(+15%,) aluminum (+10.3%) and gold (+7.7%) up substantially. Now many investors fear political risk, weakness in the financial sector and uncertainty about global economic growth, so turn to gold as a safe haven. Others seem to like trading around the volatility in oil despite the drop, and the rest of the demand is mainly from the chance to enter the asset class at attractive levels for the longer-term benefits of inflation protection and diversification.
With the renewed interest in commodities as an asset class has also come more concern about contango, a term-structure condition where futures contracts with nearby expiration dates are cheaper than contracts with later-dated expiration dates. The result of contango is a roll return loss from selling the cheaper, expiring contracts to buy more expensive later-dated ones. (There is also an opposite condition called backwardation that is profitable to investors.) Contango happens when there are high storage costs from excess inventories, which has been the case as commodities have been substantially oversupplied.
Since commodities have been in contango since Aug. 2015 as measured by the roll yield (excess return – spot return of the S&P GSCI,) many investor think commodities are always in contango. However, this is certainly not the case, so below are some charts to demonstrate exactly how much time commodities spend in each condition of backwardation and contango. The black lines represent months in backwardation and the white lines represent months in contango. Overall, the commodities have spent about 60% of months in contango and 40% in backwardation. On average the roll return gain from backwardation is 1.1% in a month and the roll loss from contango is -0.9% from contango in a month, yielding a weighted average of about -0.1% in a month over time.
Unleaded gasoline spends 57% of months in backwardation, the most time of all the commodities. On the other hand, aluminum spends just 10% of its months in backwardation, the least of all the commodities. On average in a month, the roll return gain from unleaded gasoline is 20 basis points and the loss from aluminum is about 50 basis points. Note the difference in the pattern of the two term structure charts.