Are commodity futures a good hedge against inflation?

ABSTRACT Because of the erosive effects of inflation on real asset returns, inflation hedging is an important issue for medium- and long-term investors such as pension funds, insurance companies and mutual funds. This study assesses the inflation-hedging properties of commodity futures across three dimensions: investment horizon, market 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. Commodity futures in the energy, industrial metals, and live cattle markets have the most favorable hedging properties. However, the hedging capacity exhibits substantial variation over time. It has been increasing since the early 1980s and reaches a historical high toward the end of the sample period. Furthermore, there is a trade-off between the reduction in real return portfolio variance realized by adding commodity futures indexes to the portfolio and the expected real portfolio return.