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