Digging into Commodities ∗

We investigate the determinants of aggregate commodity returns and establish the following findings. (1) Common predictors of bond and stock returns, such as the short rate and the yield spread, also predict commodity returns. A high yield spread predicts low commodity returns, consistent with commodities being a hedge for market fluctuations. (2) Even controlling for these common predictors, a low aggregate basis (the ratio of futures to spot price averaged across commodities) predicts high returns on being long commodity futures, consistent with the theory of backwardation. A low aggregate basis also predicts low spot-price growth, consistent with the theory of storage. The component of aggregate basis that is orthogonal to these common predictors does not predict bond or stock returns, suggesting that aggregate basis is a predictor that is local to the commodity market. (3) Aggregate basis explains as much of the variation in expected commodity returns as the common predictors. (4) Recent evidence suggests that aggregate basis has become a more important determinant of commodity returns relative to the common predictors. JEL classification: G12; G13; E31; E37