COMMODITYINDICES
TABLE 2: PANEL REGRESSION ON PRICE RETURNS & VOLATILITY
suggestive). However, the line between
USING RELATIVE MEASURES OF INFLOW
an irrational bubble and an overshoot-
ingbyrationalbutill-informedmarkets
Model Coeff. t-statistic p-value
is thin. Even for the NASDAQ in the
Returns 0.22 2.92 0.00
1990s, which many accept as a classic
Volatility 0.54 2.10 0.04
example of a bubble, economists have
Source: CFTC, S&P GSCI, DJ-AIG, Bloomberg, Lehman Brothers estimates
found it difficult to prove conclusively
(Note: Bold and underlined represents statistical significance at the 1% level of confidence,
bold at the 5% level of confidence, and italics at the 10% level of confidence.)
that speculators drove prices upward
fullycognisantthatthepricewasunre-
what peculiar in that they allow investors to express a long-term flectiveoffundamentalvalue.
viewoncommoditiesthroughshort-termrollinginstruments.Wefeel The whole debate is unfortunately
that there is room for further financial innovation in the vehicles clouded by both the short history and
availabletoinvestors.Theriseofso-calledsecond-generationindices doubtsabouttheaccuracyofavailable
withinjectionsintothebackendoftheforwardcurveisapromising data on index investment in commodi-
development. ties. It is also possible that the weekly
The massive inflow of index investment has also raised difficult frequencyistoolowtocapturethesig-
questionsaboutwhetheranyoftherecentriseinenergyandother nificant intra-day or intra-week effects
pricescanbeattributedtothisinflow.Thishasbecomeaverypolit- on returns from index investment. New
icallychargeddebate.SeveraltestimoniesinCongressionalhearings data-gatheringandtransparencyinitia-
havearguedforacausallinkbetweenfinancialspeculatorsandhigh tives by the CFTC would provide a
energyprices.OnJune26
th
,2008,theUSHouseofRepresentatives wealthofadditionaldatatohelpframe
passed bills to curb so-called excessive speculation in energy mar- thedebate.
kets. As of this writing, the bill has been blocked in the Senate. The The spectacular growth of financial
legislationeffortisbackedbyanangrypublicgroaningunderrecord markets for commodities presents
high food and energy prices and seeking an easy scapegoat. exciting new opportunities for hedging
Regulatorshavealsomovedtoclosethe‘Londonloophole’,extend- bycommercialenterprisesandportfolio
ingCFTCpositionlimitstoWTIandBrentcrudecontractsontheUK- allocations by financial investors. The
basedICEexchange. global economy and its consumers will
... commodities markets, like all financial
reap the accumulating benefits from
improved risk management and more
markets, are not theoretical ideals liquidandefficientmarkets.
but imperfect human constructs
However, commodities markets, like
allfinancialmarkets,arenottheoretical
On the other side of the debate, many observers have opposed ideals but imperfect human constructs.
these initiatives, arguing that there is no evidence, either empirical Distortions can arise as markets adapt
or theoretical, that speculative activity affects prices. A common to the inflow from indices and other
argument states that the purely ‘financial’ nature of index invest- participants. The complexity of the
ment implies that they cannot affect a price that is determined by issue warrants intelligent and judicious
physicalmarkets. regulatory consideration. As markets
Our analysis suggests that reality is considerably more complex continue to mature from an influx of
and does not align with either extreme of the debate. We feel that speculative activity and commercial
whilepricesultimatelyreflectlong-termsupplyanddemandfunda- hedging,thesedistortionsshouldeven-
mentals, imperfections due to temporary liquidity constraints and tuallydiminish.
asymmetricinformationinmarketsallowfinancialactivitytopoten- But in the interim, devoting more
tiallydriveshort-rundeviationsinprices. thought and resources to improving
Theempiricalevidencereturnsamixedbag.Estimatesoftheprice transparencyandunderstandingofthis
impact vary depending on whether one uses absolute or relative important and rapidly growing aspect
measures of index investment. Furthermore, the positive effect is of commodity markets is an excellent
concentrated in the smaller agricultural commodity markets, not in firststep
•
oil markets, which have received so much limelight. The US CFTC
madeaprescientfirststepbydecidingtofirsttrackindexpositions DanielAhnisSeniorEnergyEconomist
inthelessliquidagriculturalmarkets.
withLehmanBrothers.
For volatility, the picture is a little more consistent. For both
T: +12125260706
absoluteandrelativemeasures,indexinvestmentdoesseemtopre-
E:
daniel.ahn@lehman.com
dicthighervolatility,asexpectedgivenourdiscussiononnoisetrad-
This is a condensed version of a longer report
ing. However, the magnitudes of the effect are small and will likely
published as a Lehman Brothers Commodities
Special Report.
shrinkfurtherifeffortsaremadetoimprovetransparency.
Pleasecontacttheauthorforcopies.
Ofcourse,itiseasierinhindsighttocallapricetrajectoryaspecu-
www.lehman.com
lative bubble (and the recent dramatic fall in commodity prices is
COMMODITIES NOW SEPTEMBER 2008 49
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