Take a hypothetical commodity index fund. Over one year, the spot price change adds 1.5%, roll yield subtracts 7.5%, and collateral earns 4%. The fund loses 2% even though spot prices rose. Fees did not cause the loss. Roll yield did, and you need to understand where that drag comes from to answer these questions correctly instead of guessing.
You can get commodity exposure without touching a futures contract. Four main routes:
- Physical ownership: buy gold bars, store crude oil, hold silver coins. You bear storage and insurance costs, but you get direct spot price exposure with no roll yield drag.
- Commodity producer equities: buy shares in mining companies, oil producers, or agricultural firms. The problem: stock prices track company-specific risks (management, leverage, hedging policies) as well as the underlying commodity.
- Physically backed ETFs: funds that hold the actual commodity in vaults. Gold ETFs like GLD work this way.
- Commodity-linked notes and swaps: structured products tied to commodity prices. Some reference spot prices, others reference futures indices.
Common mistakes
- Confusing contango with normal contango. Contango means futures exceed current spot; it describes the curve shape. Normal contango means futures exceed the expected future spot; it describes the risk premium. A market can be in contango and normal backwardation simultaneously.
- Assuming contango means spot prices will fall. Contango describes the term structure of futures prices at a point in time. It says nothing about where spot prices are headed. Oil can be in contango while spot prices are rising steadily.
- Forgetting the collateral yield. Adding spot and roll alone omits collateral. Both valid decompositions include it: spot + roll + collateral, or excess return + collateral. On a fully collateralized position, collateral yield can be substantial. An answer of 2% (spot contribution 5% plus roll -3%) ignores the 4% collateral yield.
Bottom line
- Total return = spot return + roll yield + collateral yield (equivalently, excess return + collateral yield): spot-price changes primarily drive unhedged futures returns, while roll and collateral explain why futures returns differ from spot (a fully collateralized position can...
- Contango = futures price > spot (upward-sloping curve); backwardation = spot > futures (downward-sloping). These describe curve shape, distinct from normal contango/backwardation, which describe the risk premium versus expected future spot.
- Roll yield is the holding-period effect of basis convergence: with stable carry it is negative in contango and positive in backwardation; switching contracts creates no immediate gain or loss, and curve shape is not a price forecast.
- The cost-of-carry model, F = S0 x exp[(r + c - y)T], links spot, futures, risk-free rate, storage costs, and convenience yield and sets a maximum forward price; inelastic supply (annual crops) raises convenience yield while perfectly elastic supply pushes...
Exam shortcut
When you see a question about commodity returns, immediately decompose into the three components: spot, roll, collateral. Check that the calculation includes collateral. As a cross-check, total return also equals excess return (the futures price change) plus collateral yield. For contango vs. normal backwardation, ask two questions: "Is futures above current spot?" (contango/backwardation) and "Is futures above expected future spot?" (normal contango/normal backwardation). These are independent assessments. For Hotelling vs.
The full lesson (about 10,133 words, 68 min read) adds 3 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- natural resources
- land
- timber
- farmland
- contagion indices
- timber farmland returns
- commodities no futures
- commodity producers
- mlps
- term structure
- rolling contracts
- backwardation contango
- commodity diversification
- expected returns
- commodity indices
- commodity returns
- infra overview
- characteristics infrastructure
- primary risks infrastructure
- infrastructure sectors assets
- infrastructure investment styles
- project finance infrastructure
- infrastructure capital structures
- infrastructure risk-return analysis
- economic sensitivities infrastructure
- infrastructure across geographies
- infrastructure investment underwriting
- re categories
- cre advantages
- re styles
- re office
- re industrial retail
- re multifamily
- cre debt
- cre equity leases
- mortgage underwriting
- commercial mortgages
- cre financing
- cre vehicles
- liquid cre
- re development
- cre valuation
- income approach
- public re vehicles
- reit returns
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