Sources of Return from Commodity Investments
An investor can invest in commodities by taking a collateralized long position in commodities derivatives such as futures, forwards, and swaps. There are three primary sources of return:
1. Collateral Yield: Long derivative positions require margin, which acts as collateral. Collateral yield is the return earned on this margin money. It's generally equivalent to T-bill returns.
2. Roll/Convenience Yield: The roll/convenience yield is the return earned from rolling the derivative contract forward. If the market is in contango, the convenience yield will be negative, and the market is in backwardation, it will be positive. This is because, in backwardation, the long investor can buy the commodity from a hedger at a price lower than the spot price.
3. Spot Price Return: As the name suggest, this is the return from the fluctuation in spot prices. This again can be positive or negative.