Do Futures Premiums Predict Commodity Producer Returns?

We derive stock returns for firms producing nonrenewable commodities by employing the investment-based asset pricing approach. By identifying the appropriate time-varying discount rate the investment-based approach allows an alternative test of the Hotelling Valuation Principle. The empirical results support the principle and enable predicting returns from sorting firms into quintiles by expected return, producing a 19 percent realized difference between top and bottom quintile. The return differences cannot be explained by standard systematic risk factors, suggesting that at least one important risk factor is missing from standard models. The approach permits cost-of-capital estimation that circumvents identifying systematic risk factors.