There are more than two ways to examine commodity price and income returns. These include the assessment of traded economy indexes and directly reviewing price and income returns. Interestingly, total return has a strong association with inflation but a weak link with price return. Commodity total returns are influenced by both price and income returns, a reality that has not altered despite commodities’ dismal performance over the years.
Over the years, it has been shown that total return has a high correlation with income return. Investment returns are strongly connected with roll returns, inflation, and collateral returns (Erb & Harvey, 2015). Although income roll returns, returns, and collateral returns have all shown a strong correlation with inflation over time, price returns have shown the opposite relationship. The correlation between commodity price returns and total returns is minimal, while the correlation involving commodity price returns and inflation is unfavorable. Even though it’s tough to anticipate the future, understanding the predicted rate of income growth might assist estimate the S&P GSCI’s total return. The S&P GSCI’s total returns do not linearly correlate with flawless price return projections.
Those who anticipate a robust correlation between the price return of a commodities futures portfolio and its overall return may find this outcome hard to believe. Historically, the price returns of the S&P GSCI index have been inversely connected to the income returns of the index, exemplifying what may be labeled the “Croesus dilemma” (Erb & Harvey, 2015). That appears to be related to the fact that price return disparities do not entirely cancel out income return differences. A common argument favoring commodity investments is that their overall returns protect against inflation. Total returns are positively associated with income returns, while S&P GSCI price returns are negatively linked with realized inflation.
In conclusion, price and income returns determine overall returns in stocks, commodities, and bonds. Despite this dissection, predicting future price and income returns is still tricky. Commodity investments are often advocated because their long-term returns hedge against inflation in the market. The findings may disappoint investors who have been persuaded to assume that an investment in commodities’ futures would provide a high return proportional to its price.
Reference
Erb, C. B., & Harvey, C. R. (2015). Conquering misperceptions about commodity futures investing. SSRN Electronic Journal, 72(4), 26-35. Web.