Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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Commodities weekly: The forward curve and impact on returns
Ole Hansen
Head of Commodity Strategy
Key points in this update:
- Commodities have so far yielded gains across all sectors this December, led by grains and energy.
- Despite several headwinds, the BCOMTR has delivered a year-to-date return of more than 5%.
- We explain why the slope of the futures curve results in notable differences between total return and futures price changes.
- Two major examples being the difference between a tight cocoa market and a loose US natural gas market
As the holiday season and new year approach, market activity has begun to slow, with traders and investors adjusting positions—often downward—in anticipation of the quiet period. This strategy helps protect profits and avoid fresh losses as liquidity wanes, a condition that can amplify volatility in response to unexpected events.
In commodities, December has so far yielded gains across all sectors, led by grains and energy. Overall, the Bloomberg Commodity Total Return Index (BCOMTR), which tracks a basket of 24 major commodity futures spanning energy, metals, and agriculture, is currently up around 1% on the month, heading for an annual gain of around 5.5% – a solid return considering multiple headwinds throughout the year. These include a stronger USD, which has risen 6% against a basket of major currencies; lower grain prices due to another bumper crop production year; and concerns over China’s slowdown, impacting demand for energy and industrial metals.
Notably, cocoa, the year’s top performer, isn’t part of the index, and if we exclude natural gas, which has dropped by a third, BCOMTR’s return would exceed 9%. The difference between total return and futures price change, which may differ quite considerably, depends on the futures curve structure—a topic we’ll explore further.
Adverse weather has driven strong gains in cocoa, coffee, and orange juice. These soft commodities rely heavily on production in limited regions, making them vulnerable to weather events, such as those seen in Vietnam, West Africa, and Brazil this year.
Gold, meanwhile, continues to build on a record-breaking rally this year and is currently on track for an unprecedented eight consecutive December gains. Enjoying the tailwind from surging gold prices together with higher industrial metal prices, we have seen silver perform very strongly as well. Just like gold, it is currently up by more than 30% on the year, and while gold continued to reach fresh record highs, silver ‘only’ managed a twelve-year high at USD 34.9 per ounce, well below the 2011 record at USD 50 per ounce.
As we take a closer look at the individual and overall returns across the commodities market, it is once again appropriate to talk about the impact the shape of the futures forward curve has on investor returns. As an example, why is the natural gas first-month futures showing a 38% gain on the year while the actual total return has slumped to a 34% loss?Backwardation and contango explained
Backwardation is a market condition in which the futures or forward price of a commodity is lower than the spot price. In other words, contracts for future delivery are priced lower than the current market price of the commodity. This scenario is often seen in markets where the commodity is in short supply or there is high demand for immediate delivery. Total return in commodities includes both the spot return (change in the price of the commodity itself) and the roll return (the gain or loss associated with rolling over futures contracts). In a backwardated market, the roll return is typically positive, which can enhance the total return for investors. This contrasts with contango, where the futures price is higher than the spot price, often resulting in a negative roll yield reducing the total return.
The tight market conditions seen this year, especially in coffee and cocoa, have driven futures prices for prompt delivery well above prices for delivery at a later date. Rolling a futures long from an expiring contract to the next will therefore trigger a positive roll yield—i.e., selling the expiring contract at a higher price than the next—and the steepness of the curve will determine the actual return. For this reason, the total return on an investment in cocoa so far this year has exceeded 300%, while the actual change in the futures price during this period has ‘only’ been 158%.
This positive impact has also benefited investors in crude oil and fuel markets. Both Brent and WTI trade lower than where we started the year. However, a prolonged period of backwardation, supported by OPEC+ production curbs, has resulted in positive returns in both, most notably WTI, which throughout the year has seen a slightly steeper backwardation than Brent, hence the current return in WTI of nearly 11% as opposed to the 2% loss compared with where prices trade now compared with the beginning of the year.
At the other end of the spectrum, we find natural gas, which is a notoriously difficult market to trade with a bullish long bias. This is simply because of the forward curve, which tends to trade in contango—not only due to the difference between low summer and high winter prices but also a general assumption of higher prices in the future. The result of this curve structure over the past year has been a 38% gain in the futures price being translated into a loss of around 34%.
Ultimately, whether a futures market is in backwardation or contango plays a crucial role in long-only investment outcomes. Over recent years, the BCOMTR has outperformed the underlying spot market, aided by several markets trading in backwardation, and we believe this tailwind will continue to support investments in commodities next year. Adding to this, a continued easing of monetary conditions lowering the funding cost of holding tangible assets, and we continue to see the commodities sector as an attractive diversifier relative to other, more traditional investment assets such as bonds and equities.
Recent commodity articles:
10 Dec 2024: Brazil's coffee crisis pushes Arabica to all-time high
9 Dec 2024: COT Report: Speculators bought crude and gold: euro shorts reach 4-year peak
6 Dec 2024: Commodities weekly: Copper rises on China optimism; OPEC delay signals crude weakness
3 Dec 2024: COT: Mixed week in commodities as dollar buying continued
29 Nov 2024: Commodities take a breather after action-packed November
28 Nov 2024: Coffee surges to a 47-year high
28 Nov 2024: Choppy gold market turns to Santa for December support
27 Nov 2024: Podcast: Will gold enjoy a Santa rally for the eight year in a row?
25 Nov 2024: COT Report: USD long jumps; Mixed week in commodities
22 Nov 2024: Commodity weekly: Strongest performance since April
19 Nov 2024: Gold and silver rise on Russia-US tensions
18 Nov 2024: COT: Limited dollar demand despite strength; Acclerated metals selling
11 Nov 2024: COT: Speculators bought energy and grains, sold gold ahead of elections
8 Nov 2024: Commodity weekly: Mixed response to Trump 2.0
6 Nov 2024: Podcast: US election and the market reactions, including commodities
6 Nov 2024: Trump and Republican victories spark commodity decline
4 Nov 2024: COT: Speculators flock to dollars, exit commodities ahead of US election
1 Nov 2024: Commodity weekly: Some weakness seen ahead of critical week
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