Tuesday, 5 June 2012

How to Invest in Commodities (Part II)


Historical Perspective

 

I've included a table showing the trades for the last 20 years. The trades assume we only enter trades when the expected return is over 4% and the trades are closed when the expected future returns fall below 4%. If you remember from the previous post that expected returns are:

((Target Price / Entry Price)^ (1/10))-1

So when the price is equal to the target price the expected future returns will equal zero. If you use 4% as your minimum annual return (below this there will be many opportunities elsewhere to invest) then the maximum entry price will be about 68% of the target price. It depends on your preferences of course, you might want to be less strict if you were wanting more commodities exposure to diversify your portfolio.

The chart below illustrates this on a coffee trade:


Point A is your entry point as the price breaks it's 100 day high. B is the target used in our expected returns calculation. C is the exit point based on a price of 68% of the purple target line. At this level the future expected return is less than 4% so we close the trade and look for better opportunities elsewhere.
In practice you probably wouldn't enter a trade without an expected return above 5.5% or 6% and certainly at least a few percentage points above where you would exit to prevent quick in-out trades. Essentially there needs to be enough of a return to make it worth the effort. 

The table below gives all the trades for the last 20 years with an expected return above 4% on entry:


Commodity Expected Entry Price Exit Price Return Days Annualised
Coffee 6.0% 27/02/1991 103 05/05/1994 102 -1.0% 1148 -0.3%
Silver 7.2% 03/06/1991 4.3 18/05/1993 4.6 7.0% 705 3.6%
Cocoa 6.7% 05/09/1991 1246 17/11/1993 1331 6.8% 792 3.1%
Coffee 6.3% 06/09/1991 100 05/05/1994 102 2.0% 959 0.8%
Silver 5.9% 13/01/1992 4.3 18/05/1993 4.6 7.0% 485 5.2%
Cocoa 6.6% 27/07/1992 1164 17/11/1993 1331 14.3% 470 11.0%
Coffee 9.7% 16/10/1992 72 05/05/1994 102 41.7% 559 25.5%
Silver 5.6% 01/04/1993 4 18/05/1993 4.6 15.0% 47
Coffee 8.8% 30/06/1993 77 05/05/1994 102 32.5% 305
Cocoa 6.9% 01/07/1993 1059 17/11/1993 1331 25.7% 136
Copper 4.5% 23/04/1999 95 09/07/1999 99 4.2% 76
Sugar 8.2% 24/08/1999 5.3 17/07/2000 7.8 47.2% 323
Soybeans 5.0% 30/08/1999 383 31/03/2000 424 10.7% 210
Cotton 7.6% 07/01/2000 26 17/08/2000 35 34.6% 220
Sugar 9.0% 13/04/2000 5.1 17/07/2000 7.8 52.9% 94
Soybeans 4.8% 18/12/2000 391 16/07/2002 413 5.6% 568 3.6%
Cocoa 6.1% 09/01/2001 922 17/01/2001 1129 22.5% 8
Soybean Oil 5.3% 26/02/2001 19 13/07/2001 21 10.5% 137
Soybeans 5.9% 29/06/2001 351 16/07/2002 413 17.7% 377 17.1%
Copper 4.2% 27/11/2001 95 18/03/2002 97 2.1% 111
Coffee 11.8% 04/03/2002 60 01/12/2004 105 75.0% 987 23.0%
Soybeans 6.3% 04/03/2002 333 16/07/2002 413 24.0% 132
Cotton 18.8% 20/03/2002 10 12/09/2003 33 230.0% 532 126.9%
Cotton 18.0% 17/06/2002 11 12/09/2003 33 200.0% 445 146.2%
Sugar 8.6% 16/08/2002 4.9 28/01/2003 7.2 46.9% 162
Coffee 9.5% 06/09/2002 65 01/12/2004 105 61.5% 805 24.3%
Sugar 6.0% 10/03/2004 5.4 28/06/2004 6.3 16.7% 108
Coffee 5.2% 15/11/2004 93 01/12/2004 105 12.9% 16
Cotton 8.1% 17/02/2005 20 14/10/2005 27 35.0% 237
Copper 5.0% 31/03/2009 214 17/04/2009 238 11.2% 17
Cotton 5.2% 20/04/2009 23 01/05/2009 25 8.7% 11









Average




34.9% 361 25.9%


As you can see there weren't that many trades. 31 in the last 20 years. Admittedly the returns have been very good with the average trade lasting about 1 year and returning over 25% per year on average. The only losing trade was a long term trade in Coffee that failed to gain any momentum. After three years it was closed out at a small loss as the long term moving average turned down and cut it off.

As you would expect the higher the expected return on entry the higher the realised return would be:
 






Next time we will look at the current commodities markets and see what opportunities there are at present.

See also: Part 1, Part 3





















































































































































































































































































































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