Futures basis, inventory and commodity price volatility: An empirical analysis

We employ a large dataset of physical inventory data on 21 different commodities for the period 1993-2011 to empirically analyze the behavior of commodity prices and their volatility as predicted by the theory of storage. We examine two main issues. First, we analyze the relationship between inventory and the shape of the forward curve. Low (high) inventory is associated with forward curves in backwardation (contango), as the theory of storage predicts. Second, we show that price volatility is a decreasing function of inventory for the majority of commodities in our sample. This effect is more pronounced in backwardated markets. Our findings are robust with respect to alternative inventory measures and over the recent commodity price boom.

► We analyze the empirical link of inventory to commodity prices and their volatility. ► We employ physical inventory data on 21 commodities. ► Two major implications of the theory of storage are empirically tested. ► Low inventory is associated with forward curves in backwardation, as the theory of storage predicts. ► Price volatility is a decreasing function of inventory for the majority of commodities considered.