LONG-SHORT COMMODITY INVESTING Strategies To mimic the trading behaviour of long-short market participants, we implement a battery of long-short strategies that
hedge fund managers are known to follow – where these strategies are based on momentum and term structure signals. We also replicate their trading behaviour by looking at the positions they took. In total we have four single-sort strategies and four double-sort strategies that are based on performance, roll-returns, the positions of hedgers or/and the positions of speculators. These rule-based strategies aim at systematically taking long positions in the commodities whose prices are expected to appreciate and short positions in the commodities whose prices are expected to depreciate. The single- and double-sort strategies implemented differ with regards to one characteristic only: the sorting criterion
used for asset allocation. In all other respects, the strategies use the same following three principles. First, the ranking period (R) over which the sorting criterion is averaged and the holding period (H) over which the long-short portfolios are held are always set to either four, thirteen, twenty-six or fifty-two weeks. On this basis, we end up with sixteen long, sixteen short and sixteen long-short portfolios for each strategy, where these sixteen portfolios come from the permutation of the four ranking and four holding periods. To ease presentation, we discuss the average performance across these sixteen combinations. Second, the constituents of the long and short portfolios are equally-weighted. This is to avoid concentration in any commodity and preserve diversification. Third, the long-short strategies are implemented on the 75% of the cross section that has the highest average open interest at the time of portfolio formation. This is to ease taking and liquidating positions and this limits transaction costs.
Due to space constraints, we detail only the single sort strategies here: Momentum: go long the 20% of commodity futures with the best mean returns (within the aforementioned 75% of the cross section) over the previous R weeks (winners) and short the 20% of commodity futures with the worst mean returns over the previous R weeks (losers). Hold the positions over the next H weeks, then form new sets of long, short, and long- short momentum portfolios. Term Structure: go long the 20% of commodity futures with the highest average roll-returns over the previous R weeks and short the 20% of commodity futures with the lowest average roll-returns over the previous R weeks, where roll-returns are measured as the difference in the logarithm of the prices of the nearest and second nearest contracts. Hold the positions over the next H weeks, then form a new set of long, short, and long-short term structure portfolios. Hedgers: go long the 20% backwardated contracts for which hedgers were net short (i.e. had low average hedging pressure) over the previous R weeks and short the 20% contangoed contracts for which hedgers were net long (namely had high average hedging pressure) over the previous R weeks. Hold the positions over the next H weeks, then form a new set of backwardated, contangoed and long-short portfolios. The hope is that the long-short risk premium thus modeled mimics the returns that speculators have earned over the period for taking the price risk hedgers were willing to get rid of. Speculators: go long the 20% backwardated contracts for which speculators were net long (i.e. had high average hedging pressure) over the previous R weeks and short the 20% contangoed contracts for which speculators were net short (i.e. had low average hedging pressure) over the previous R weeks. Hold the positions over the next H weeks, then form a new set of backwardated, contangoed and long-short portfolios.
performance and shorting the (remaining) 20% with the lowest past performance over a chosen observation period. Likewise, out of the 75% of contracts that are the most liquid, the term structure portfolio buys the 20% with the highest roll returns (i.e., the most downward-sloping term structure) and sells the 20% with the lowest roll-returns (or the most upward-sloping term structure). Finally, the hedging pressure strategies use as signals for asset allocation the positions of commercial traders and non- commercial traders, as reported by the CFTC. To be more specific, the strategies take long
positions in liquid backwardated commodities (for which commercial traders were net short and/or non-commercial traders were net long) and short positions in liquid contangoed commodities (for which commercial traders were net long and/ or non-commercial traders were net short). The either single- or double-sort strategies we end up with thus aim at systematically taking long positions in the 15% of commodities whose prices are expected to appreciate and short positions in the 15% of commodities whose prices are expected to depreciate.
Comparing Performance Having mimicked the returns that long-short commodity speculators earned over the period 1992-2011, we then move on to comparing the performance and risk characteristics of these long-short commodity portfolios with those of long-
... the strategies take long positions in liquid backwardated commodities ... and short positions in liquid contangoed commodities
only index positions using both an equally-weighted portfolio of the aforementioned twenty- seven commodity futures and the Standard and Poor’s Goldman Sachs Commodity Index (S&P-GSCI) as benchmarks.
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