Roll yield, popularized by the Goldman Sachs Commodity Index (GSCI), has become a source of debate within the commodity trading community. Even the definition of roll yield, a seemingly simple concept, has come into question by some who want to redefine it in unique ways. There are those who send alerts when roll yields go negative and those who make calls for traders to do their “contango homework.” Conventional wisdom holds that negative roll yield is an indicator of lower prices. Academics even claim that roll yield is a source of commodity market return.
This article will attempt to demonstrate, using GSCI (now the S&P GSCI) roll methodology, that roll yield, or more generally, futures curve shape, is not indicative of market returns. Conventionally defined, roll yield is just another measure of the complex character of commodity futures markets.
Additional questions remain as to the GSCI computation methodology and its implications for commodity asset class returns. Those are for another day.
What is roll yield? Simply put, roll yield is the price difference between delivery months in a roll. It is the shape of the futures price curve for a commodity futures contract (see “Contango vs. backwardation,” below).
Roll yield equals the difference in price between the new contract you are buying and the old contract being sold. For example, suppose on Aug. 31, 2012 you were to buy December corn at $7.99 ¾ and sell your existing September corn position at $8.02 ¾. What is your roll yield? It is simply the percentage difference between the two prices (new price/old price -1) or (799.75/802.75) -1 = -0.374%.
This is an example of negative roll yield. The 2012 curve is largely backwardated. The same trade this year has positive roll yield (364.75/359-1 = +1.6%) and this year’s curve is in contango. Over the last five years, corn was backwardated twice, in contango twice and largely mixed in 2010. In that time, corn rose two years and fell two years. Factors driving corn markets are many, varied and complex but, prima facie, curve shape does not look like one of them. Corn is not a special case.
The West Texas Intermediate crude oil futures price curves show a truly varied mix: 2010 clearly in contango, 2013 clearly backwardated and the rest are a mix (see “Crude facts,” below). Prices rose four years and fell one. These charts show the lack of effect of curve shape on long term prices.