If somebody would be so kind as to explain this to me like I’m a child. I dislike this topic and will forever more. The topic is commodity investing.
Would it be fair to say (and hopefully the extent of what we need to know for exam purposes):
Convenience yield and inventory levels are inversely correlated.
Convenience yield and forward prices are inversely correlated. If so, why is this the case? My feeble mind is thinking that a decrease in inventories (point 1) would lead to an increase in price.
In backwardation there is positive roll yield. Vice versa for contango.
It seems in commodity investing down is up and up is down.
2.) Yes. F ~ S0(1+R) + Storage - Conv. … So F is directly related to R and Storage, and inversely related to Conv. (Note the formula I wrote is an approximate and the real one is i think F = S0e(r+s-c)t ) . I usually figure these things out by looking at the formula. But basically the convince premium (benefit for holding the commodity) s higher then the cost to store, then the forward price will have to drop because its better to hold onto it then to buy the forward (which has no holding benefit)
3.) Depends if you are long or short. If you are long on a backwardation, you are buying the lower forward and selling the more expensive spot, so that would be positive roll yield.
Ok thanks - points 1 and 3 make sense and are reasonable. Still can’t wrap my head around 2 without thinking of that formula, which I will absolutely do if I ever see this devilish topic again.
Convenience yield seems like an arbitrary number in the first place. And if a rise in this yield relates to lower inventories then I naturally assume lower inventories = higher price. Basic supply/demand. Anyhow, I’ll forget my ill-founded logic and focus on deriving an answer from the formula.