Relative Basis and Expected Returns in Commodity Futures Markets

The commodity futures basis—the difference between the first and second futures prices—is known to forecast commodity futures returns, arguably through its relation with the convenience yield. We propose a refined measure of the basis, dubbed the relative basis, which is the difference between the traditional basis and a similarly defined longer-term basis. We argue that the relative basis is more informative about expected commodity futures returns than the basis, because it excludes components in the traditional basis that are closely related to storage costs and financing costs. In our empirical analyses, we show that a) the relative basis exhibits much more time variation than the traditional basis, and b) subsumes the traditional basis in forecasting commodity futures returns.