# How to calculate correlation between commodities with forward prices?

I'm trying to understand which is the correct way to calculate the correlation between 2 commodities with forward prices.

My idea would be first bootstrap forward prices to have only spot prices for each commodity and then to calculate the correlation on these bootstrapped prices.

What do you guys think about this idea? would it be too simplistic? Am I forgetting something or this could be a good approach to calculate this correlation? I'm curios to hear your thoughts on this

Drawing on “Time Series Momentum” (Moskowitz, Ooi and Pedersen, 2012), using return series from commodities futures is a perfectly valid way to compute the correlation between the contracts. The danger in this, however, is that you may be picking up effects driven by the peculiarities of the futures markets and not the underlying commodities. To address this, the authors analyze weekly position data from the Commodity Futures Trading Commission (CFTC) to study the trading activity of "speculators and hedgers".

From the paper:

We construct a return series for each instrument as follows. Each day, we compute the daily excess return of the most liquid futures contract (typically the nearest or next nearest-to-delivery contract), and then compound the daily returns to a cumulative return index from which we can compute returns at any horizon. For the equity indexes, our return series are almost perfectly correlated with the corresponding returns of the underlying cash indexes in excess of the Treasury bill rate.

As a robustness test, we also use the ‘‘far’’ futures contract (the next maturity after the most liquid one). For the commodity futures, time series momentum profits are in fact slightly stronger for the far contract, and, for the financial futures, time series momentum returns hardly change if we use far futures.

Additionally, AQR publishes the aggregate commodities return data from the paper here if that's any help.

Depends on the purpose, but I think it would be problematic to infer commodity spots from forward prices. The relationship between the spots and forwards, and the spot price themselves could exhibit very idiosyncratic behaviour, so depends on the commodities as well.

• Thanks for your reply Magic, of course Supply and Demand factors always play a role in commodities pricing. I would like to find a way to calculate a correlation measures between different commodities, do you have any suggestion for it? Aug 29, 2018 at 9:03
• The forward or futures prices with the shortest avaliable maturity would, in my humble opinion, give a reasonable estimate of correlation, assuming you are unable to get the spot rates (which would be ideal). Nov 26, 2018 at 17:40