Speculation By Commodity Index Funds: The Impact on Food and Energy Prices

Description

Commodity futures prices exploded in 2007-08 and concerns about a new type of participant in commodity futures markets began to emerge. Market participants, regulators, and civic organizations began raising concerns that inflows from new "commodity index" investments were driving the increases in commodity prices instead of economic fundamentals. The main argument was that unprecedented buying pressure from these speculative long-only futures traders created massive bubbles that resulted in prices substantially exceeding fundamental value. At the time, it was not uncommon to link concerns about speculation and high prices to world hunger, food crises, and civil unrest. Naturally, this outcry resulted in numerous regulatory proposals to restrict speculation in commodity futures markets through transaction taxes, speculative position limits, and even the bizarre idea of a "virtual reserve" whereby a public agency would take futures positions opposite speculators. At the core, these assertions raised major economic questions about the efficiency of price discovery in commodity futures markets. Moreover, these so-called remedies did not come without a potential cost. Burdensome regulations would increase compliance and risk sharing costs across the global food system -- lowering prices for producers and increasing costs to consumers. To guide this debate, a rigorous approach was needed to understand the dynamics between prices and commodity index activity. This book documents a curated selection of papers on the impact of index investment on commodity futures prices. The chronology of the papers roughly follows the timeline of our involvement in the world-wide debate about commodity speculation as it evolved after 2007. The 10 papers follow the evolving speculation debate with new author forwards highlighting the contribution and impact. Policy-makers, researchers, and market participants will find this not only as useful documentation of the debate; but, also a natural starting point when high commodity prices inevitably create the next speculation backlash. Cover Speculation by Commodity Index Funds Dedication Copyright Contents About the Authors 1 Intersections 2 Devil or Angel? The Role of Speculation in the Recent Commodity Price Boom (and Bust)1 New Author Foreword Abstract 2.1  Introduction 2.2  Conceptual Errors 2.3  Inconsistent Facts 2.4  Empirical Tests 2.5  Lessons from History 2.6  Conclusions Acknowledgments References 3 New Evidence on the Impact of Index Funds in US Grain Futures Markets1 New Author Foreword Abstract 3.1  Introduction 3.2  Review of Debate 3.2.1  The bubble story 3.2.2  Arguments against the bubble 3.3  Data 3.4  Tests for Price Impacts 3.5  Conclusions Acknowledgments References 4 The Impact of Index and Swap Funds in Commodity Futures Markets1 New Author Foreword Abstract 4.1  Introduction 4.2  It Was a Bubble 4.3  It Was Not a Bubble 4.4  Evidence to Date 4.5  New Evidence 4.6  Conclusions References 5 Testing the Masters Hypothesis in Commodity Futures Markets1 New Author Foreword Abstract 5.1  Introduction 5.2  Measures of Commodity Index Fund Investment 5.2.1  Commitments of Traders (COT) reports 5.2.2  Disaggregated Commitments of Traders (DCOT) report 5.2.3  Supplemental Commitments of Traders (SCOT) report 5.2.4  Index Investment Data (IID) report 5.3  Data and Descriptive Statistics 5.3.1  Comparison of IID, DCOT, and SCOT data 5.3.2  Comparison of mapping algorithm to IID 5.4  Cross-sectional Regression Tests 5.5  Time-series Tests 5.5.1  Granger causality tests 5.5.2  Long-horizon regression tests 5.6  Conclusions Acknowledgments References 6 Financialization and Structural Change in Commodity Futures Markets1 New Author Foreword Abstract 6.1  Introduction 6.2  Trends in Open Interest and Volume 6.3  Structural Changes 6.3.1  Electronic trading 6.3.2  Market access 6.3.3  Passive investment 6.4  Trends in Market Composition 6.5  Market Impacts 6.6  Summary and Conclusions Acknowledgments References 7 A Reappraisal of Investing in Commodity Futures Markets1 New Author Foreword Abstract 7.1  Introduction 7.2  Returns to Individual Commodity Futures Markets 7.3  Returns to Portfolios of Commodity Futures Markets 7.4  Recent Performance of Commodity Investments 7.5  Summary and Conclusions Acknowledgments References 8 The ‘Necessity’ of New Position Limits in Agricultural Futures Markets: the Verdict from Daily Firm-level Position Data1 New Author Foreword Abstract 8.1  Introduction 8.2  Position Data 8.3  Position Trends and Characteristics 8.4  Empirical Methods and Results 8.4.1  Correlation coefficients 8.4.2  Difference-in-means test 8.4.3  Granger causality tests 8.4.4  Long-horizon tests 8.5  Summary and Conclusions Acknowledgments References 9 Bubbles, Froth, and Facts: Another Look at the Masters Hypothesis in Commodity Futures Markets1 New Author Foreword Abstract 9.1  Introduction 9.2  Time-series Analysis 9.2.1  Time-series data 9.2.2  Rank order tests 9.2.3  Time-series correlations 9.2.4  Extreme moves 9.2.5  Consistency 9.3  Cross-sectional Analysis 9.3.1  Cross-sectional data 9.3.2  Cross-sectional regressions 9.4  Summary and Conclusions Acknowledgments References 10 Mapping Algorithms, Agricultural Futures, and the Relationship between Commodity Investment Flows and Crude Oil Futures Prices1 New Author Foreword Abstract 10.1  Introduction 10.2  Literature Review 10.3  Impact of Index Investment on Crude Oil Prices 10.3.1  Impact of index positions from the Masters algorithm 10.3.2  Impact of index positions from alternative sources 10.4  Mapping Algorithms 10.4.1  Replication of commodity indices 10.4.2  The Masters algorithm 10.4.3  Testing fixed-ratio relations 10.4.4  Decomposition of the mapping algorithm results 10.5  Summary and Conclusions Appendix A. Derivation of Equation (10.3) Case 1. Non-roll days Case 2. Non-January roll days Case 3. January roll days Appendix B. Supplementary data Acknowledgments References 11 Sunshine versus Predatory Trading Effects in Commodity Futures Markets: New Evidence from Index Rebalancing1 New Author Foreword Abstract 11.1  Introduction 11.2  S&P GSCI Construction and Rebalancing 11.2.1  The S&P GSCI 11.2.2  S&P GSCI rebalancing 11.2.3  Economic significance of the S&P GSCI rebalancing 11.3  Methods 11.4  Results 11.4.1  CARs following the announcement date 11.4.2  CARs around the rebalancing period Rebalancing versus roll effects 11.4.3  Regressions Baseline model Rebalancing effects over time Rebalancing effects along the futures curve Rebalancing and the Great Recession Rebalancing and large commodity markets Rebalancing and the Bloomberg Commodity Index 11.5  Conclusions Appendix A. Supplementary Data Appendix B. Mathematical Derivation of Eqn 11.5 Appendix C. Data Appendix Credit Author Statement References 12 The Order Flow Cost of Index Rolling in Commodity Futures Markets1 New Author Foreword Abstract 12.1  Introduction 12.2  The S&P GSCI Roll 12.3  Index Rolling and the Event Window 12.4  Growth of Order Flow Demand 12.5  Estimated Spread Impacts 12.6  Order Flow Cost Estimates 12.7  Conclusions Acknowledgments References 13 Lessons Learned 13.1  First Lesson: the Masters Hypothesis Is False 13.2  Second Lesson: There Is Plenty Left to Do 13.3  Third Lesson: Attacks on Speculation Will Not End Anytime Soon 13.4  Closing Thoughts References Index Back Cover