Are Commodity Futures a Good Hedge Against Inflation?

Abstract

This study assesses the hedging properties of commodity futures across three dimensions: market, investment horizon and time. Measured over the full sample period (1970-2011), commodity futures show significant ability to hedge US inflation, especially for investment horizons of at least one year. Particularly commodity futures in the markets energy, industrial metals, and live cattle have favorable hedging properties. However, the hedging capacity exhibits substantial variation over time. It has been increasing since the early 1980s and reaches an historical high towards the end of the sample period. Although we establish significant hedging ability for commodity futures indices, we observe a trade-off between the reduction in real return portfolio variance realized by adding commodity futures indices to the portfolio and the expected real portfolio return.

Keywords: Inflation hedging, costs of hedging, commodity futures, investment horizon

JEL Classification: G11, G15, E44