The Case for Long-Short Commodity Investing

Abstract

The article presents strong evidence in favor of long-short (as opposed to long-only) commodity investments. We show that long-short fully collateralized commodity portfolios based on momentum, term structure or hedging pressure present higher Sharperatios, lower volatility and lower correlation with the S&P 500 index than long-only commodity portfolios. Besides long-short hedging pressure portfolios serve as partial hedge against extreme equity risk as they present decreasing correlations with the S&P 500 index in periods of heightened equity volatility. This is good news to equity investors: it is precisely when the volatility of equity markets is high that the benefits of diversification are most appreciated. In contrast, the conditional correlation between the S&P 500 and long-only commodity indices substantially rises with the S&P 500 volatility, suggesting that the risk diversification of long-only commodity portfolios prevails less when needed most.