Long-term investment in commodity futures defies the obvious

Intelligent people can convince themselves to believe the silliest things.

Some make themselves believe that wearing masks does nothing to minimize COVID-19 transmission.

Others insist that wearing a bicycle helmet makes you more likely to get into an urban bike crash than not wearing one.

And multitudes of supposedly smart-money people convinced themselves that investing in passive, long-only commodity futures funds was a good way to make money on autopilot.

The third wrong-headed idea above was analyzed by agricultural economists Scott Irwin and Dwight Sanders in a 2012 study, which they and two other colleagues recently revisited in a February 2020 journal article.

Their conclusion: “The return to holding individual futures contracts over many years and decades is zero,” Irwin told me when I called him in early June.

“Taking a bundle or a portfolio of long positions in the commodity futures market is a loser’s game after costs.”

Forward futures prices don’t contain a risk premium paid to speculators from hedgers, such as farmers. Beyond a few days, there is no “roll return” to investment funds moving from a nearby to a further out futures contract.

There is no appreciation of the value of futures contracts in general, as there often is with equities or private ownership of businesses.

None of this should be surprising because most ag economists have believed this forever. However, for a brief period, every Wall Streeter and his purebred dog seemed to believe that holding long futures positions was generally going to make investors money.

This wasn’t because of a cyclical bull market in commodities, which was happening from the early 2000s to the mid-2010s, but because of a belief that the commodity values represented in futures contracts gained value as time went on.

Hundreds of billions of dollars poured into passive (which means they don’t trade in and out of positions opportunistically, but just buy and hold regardless of market conditions) commodity funds, despite only weak evidence that it was a good long-term strategy. There was much contrary evidence.

That new belief lasted until the commodity boom busted in 2014. Now the amount of investment money in long-only funds is a pittance compared to what it was, and the faith in holding commodities as a way to get wealthier is gone. Trading into and out of commodities can earn a smart or lucky person a lot of money. Just holding them forever doesn’t earn anything other than disappointment.

Irwin and his colleagues dissect why the holding-commodities-earn-a-return theory occurred and was believed by many smart people. They find answers in dodgy mathematics, skewed sample periods and odd thinking.

But to me, the theory and its adherents arose from a powerful desire from many to want to believe it was true. With stocks hammered in 2000-01, again in 2007-09, protracted wars not going well and many of the world’s economies swirling in the toilet, it was a powerful temptation to find something to invest in that would be dependable, safe and rewarding. For many, commodities became that something.

In retrospect, it’s a silly idea, but that’s how many investors allow themselves to think, before they lose their shirts.

Which brings me to masks and bicycle helmets. I have a number of intelligent friends who are dead-set against wearing face masks during the pandemic, insisting they aren’t an easy, reasonable and necessary element of minimizing COVID-19. I also have a number of bright friends who insist that wearing a bicycle helmet in city traffic is unnecessary and perhaps even likely to increase your chances of having a collision.

There’s lots of evidence that wearing masks and bicycle helmets is a smart thing to do, even a necessary one, for personal and social safety, but some people insist on believing otherwise.

It’s all part of what I call The Artful Defiance of Obvious Realities. It’s all part of being human.

It’s part of being smart and being able to think up bizarre ways to justify being silly.

But it’s not where the smart money goes. At least, not where the money that’s actually smart and isn’t just chasing silly ideas goes.

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