Commodity Investing by Pension Funds: Does it Disturb Markets?

Transcription

1 Commodity Investing by Pension Funds: Does it Disturb Markets? Jaap W. B. Bos (Maastricht University, ECCE) ROTMAN ICPM OCTOBER 2013 DISCUSSION FORUM

2 Outline What is the discussion? What is the evidence? What should the discussion be about? What does this imply for research? What does this imply for policy making? What does this imply for investment strategies?

3 Session Objective: Most of the debate regarding commodity futures index investing has centered on the question of whether this type of investment has contributed to rising commodity prices. I will argue that most of the stalemate arises from how this question has been asked. Instead, I will propose to answer when this type of investment contributes to rising commodity prices, and suggest some possible answers to this question, as well as suggest ways in which institutional investors can responsibly invest in commodities.

4 What is the discussion? The story: Investors invest in commodity futures, in particular in futures indices; In ten years, this has completely changed commodity futures markets; But has it contributed to rising spot prices?

5 What is the discussion? Contra: Every trader is atomistic (strong, but not for all) There is no spillover from futures to spot market (weaker) Volatility may have increased, but not the level of the spot price. (weak) Pro: Institutional investors are big players on these markets; (weak, but not for all) Commodities are storable, and inventory models can explain the relationship between future and spot market (stronger) Future market developments can prevent spot prices from dropping (strong)

6 What is the evidence? Impact on volatility of spot price probably exists Du, X., Yu C.L. and Hayes, D.J. (2011). "Speculation and volatility spillover in the crude oil and agricultural commodity markets: A Bayesian analysis." Energy Economics 33(3): Yes 31. Irwin, S.H. and Sanders, D.R. (2010). "The impact of index and swap funds on commodity futures markets: preliminary results" Food, Agriculture and Fisheries Working Paper No. 27, OECD, Paris. No Impact on level of spot price less clear Hong, H. and Yogo, H. (2009). "Digging Into Commodities." Working Paper, Princeton University. Yes Irwin, S.H. and Sanders, D.R. (2010). "The impact of index and swap funds on commodity futures markets: preliminary results" Food, Agriculture and Fisheries Working Paper No. 27, OECD, Paris. No Most of the research on oil Big share of the index, lots of political factors, input in production other commodities Not the most important for the poorest

7 What should the discussion be about? Instead of asking whether there is an effect, let s talk about when there is an effect, and acknowledge that the answer may be: 1. Never 2. Always 3. Sometimes Then we can start talking about the conditions required for there to be an effect (if any), and we can also see if we can avoid any negative effects while preserving positive effects. Finally, we can focus on different commodities, not just on oil...

8 Price A simple example without futures markets Time

9 Price A simple example with futures markets High futures price Inventories increase Supply does not increase High futures price Inventories increase Supply does not increase No (!) high futures price Inventories do not increase Supply increases Another bubble? Time

10 What happened? In this example, the volatility of prices increased: difference between minimum and maximum price went from 5 cents to 15 cents, and increased by 200%! Did the average price also increase? Average price increased by only 2.44% in this example (from to 1.05). Why the difference? Because we look at the entire period which may be a relevant horizon for investors, but perhaps is not for consumers.

11 What have we learned? If speculation has an effect, it may show up when the harvest is good. The effect of speculation is spiky (the grey shaded parts in the graph). Speculation pushes up prices, but not forever. The effect is most likely to occur when futures prices are not related to demand and supply (in the spot market). The effect is expected to be stronger when you can more easily store the commodity.

12 What does this imply for research? Use of mean-variance strategies is potentially very tricky Studying individual commodities may also miss the point Exact formulation of null hypothesis really matters for outcomes Studying only the financial (or real) side of the story is wrong Production data and accurate price information are very important

13 What does this imply for policy making? What does - in my opinion - not solve matters: Forbidding non-commercials (= 'speculators') from buying/selling commodity futures; Forbidding commodity futures indices; Assuming away any ties from futures to spot markets; Thinking that futures markets are purely 'financial'markets; Vertical integration of the supply chain. What is worth considering: Excluding oil (or energy in general) from commodity futures indices; Increasing the extent to which farmers hedge price risks via markets (and not via wholesale); Regulating spot markets in a better way; Investigate who is making how much when a product changes price.

14 What does this imply for investment strategies? In alternative asset classes, there is a bigger risk of being 'non-atomistic' : as an investor, you have impact, also on the price of the asset you invest in. Invest in productive resources (take a debt or (rather) equity position), long-term; Excluding oil (or energy in general) from commodity futures indices?; Taking long-only (rolled over) positions is not necessarily a way adding liquidity to a market.

15 For more information: "A Bitter Brew? Futures Speculation and Commodity Prices", jointly with Maarten van der Molen (available at and