Commodity Markets and Commodity Mutual Funds

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Commodity Markets andCommodity Mutual Funds

Chris Plantier

Investment Company Institute

October 15, 2012


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Why Commodity Investment Doesnt

Explain Commodity Price Increases

I. Commodity Investment Globally and theFinancialization of Commodities

II. Spurious Relationship btw Assets and PricesIII. Economic Fundamentals Strong Global

Growth and Weak U.S. Dollar

IV. An Empirical Horse RaceV. Why Commodity Mutual Funds Cant Explain

Higher Commodity Prices

2


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Commodity Investment Globally

According to BarCap, worldwide assets undermanagement in commodity investment products

(ETPs, commodity swaps, and medium-termnotes) stood at $426 billion in November 2011,compared to $156 billion in November 2008

Most of the increase ($170 billion) represents net

inflows from investors spread across a number ofcommodity markets; the remainder$100billionreflects the recovery in commodity pricessince late 2008

3


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Global Commodity Markets are Massive

With Over $10 Trillion Monthly Turnover

Barcap estimates global commodity futures andoptions markets at $11.8 trillion in October 2011

However, size varies by commodity with futuresand options markets of gold, zinc, crude oil, andcopper all exceeding $1 trillion

4


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Global Commodity Market Size

5

Billions of dollars

Note: Spot (physical) market value is calculated using supply and average price for 2010 for each individual commodity.

Source: Barclays Capital

CommodityTotal sales in spot

market$ Billions, annual

Trading volume in futures andoptions markets

$ Billions, monthly

Futures and optionsmarket open interest

$ Billions

West Texas Intermediateand Brent crude oil

2,500 2,800 279

Live cattle CME 1,500 76 21

Heating oil and gasoil 800 982 74

Unleaded gasoline 705 318 33

Gold 182 2,067 145

Silver 21 369 30

Zinc 27 1,910 13

Copper 144 1,228 58Aluminium 89 484 47

Corn 104 291 64

Wheat CBOT 165 61 17

Soybean 120 375 55

Totals 6,357 10,964 835.0


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Impact of Financialization of

Commodities on Commodity Prices

Any price impact from index funds likely stemsfrom two sourcesnew flows and the

rebalancing of positions over time In theory, fund flows could impact prices as

some critics argue, empirical question though

Rebalancing generally stabilizes prices P fund (or swap dealer) sells position and P fund (or swap dealer) buys position

However, monthly roll may impact prices at

certain times of the month 6


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Financialization of Commodities,

a.k.a. the Massive Passive ArgumentSometimes referred to as massive passives, commodity indexfunds have created a massive, ongoing demand for futures contractsunconnected to normal supply and demand for the underlying

commodities... the more index funds and their swap dealers push tobuy long future contracts and outnumber the speculators seeking tobuy shorts, the more their buying pressure, by the very nature ofsupply and demand, will drive up the price of the long contracts. Theresulting higher futures prices then translate all too often into higherprices for the underlying commodities, in part because so many of

the contracts for the underlying commodities use futures prices asthe commodity selling prices. Senator Levins Opening StatementNov 2011

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0

50

100

150

200

250

300

350

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1997 1999 2001 2003 2005 2007 2009 2011

Gold (left scale), price per ounce

Corn (right scale), price per metric ton

WTI (right scale), crude oil price per barrel

Commodity Prices Rose Over the Last

Fifteen YearsMonthly, 1997-2011*

Price per unit (dollars) Price per unit (dollars)

*Data to December 2011

Source: World Bank


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Assets and Number of Commodity

Mutual Funds (CMFs)

9

Monthly, 2004-2011*

*Data through December 2011

Source: Investment Company Institute

0

5

10

15

20

25

30

$0

$10

$20

$30

$40

$50

$60

2004 2005 2006 2007 2008 2009 2010 2011

Assets (billions) Number of funds

Assets (left scale)

Number of funds(right scale)


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Commodity Mutual Fund (CMF) Assetsand Commodity Price Indexes

10

Monthly, 2006-2011*

*Data through December 2011Note: Prices indexed to 100 in January 2006

Sources: Investment Company Institute and Bloomberg

50

75

100

125

150

175

200

$0

$10

$20

$30

$40

$50

$60

2006 2007 2008 2009 2010 2011

Assets (billions) Index level

Commodity mutual fund assets (left scale)

Dow Jones-UBS CommodityIndex (right scale)

S&P GSCI (right scale)


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Emerging Market Industrial Production

Growth and Commodity Price Growth

11

Monthly, 2005-2011*

*Data to October 2011.Note: The correlation between the two growth rates is 0.82.

Sources: Netherlands Bureau for Economic Policy Analysis and Bloomberg

-60%

-50%

-40%-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

-10%

-5%

0%

5%

10%

15%

20%

2005 2006 2007 2008 2009 2010 2011

Percentage year over year Percentage year over year

Emerging market industrial production growth

(left scale)

Dow Jones-UBS Commodity Index

(right scale)


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Commodity Prices & U.S. Dollar Value

12

*Data to October 2011.Note: The correlation between the two series is -0.87.

Sources: Bloomberg, Federal Reserve

Monthly, 2004-2011*

65

70

75

80

85

90

95200

300

400

500

600

700

800

900

2004 2005 2006 2007 2008 2009 2010 2011

Commodity price index Trade-weighted Index (inverted scale)

S&P GSCI (left scale)

Broad trade-weighted exchange value of U.S. dollar(right scale)


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Estimated Monthly/Weekly Regressions

Prices and contemporaneous CMF flows

(1) ln(Pt)= + *Ct/At-1,

Commodity prices, CMF flows, & fundamentals

(2) ln(Pt)= f(ln(Pt-1), Ct/At-1, ln(USDt),ln(EMt))

Lead/Lag relationship (VAR) on weekly data (3) ln(Pt)= f(ln(Pt-k), Ct-k/At-1-k),

(4) Ct/At-1 = f(ln(Pt-k), Ct-k/At-1-k),

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Monthly Results

14

Equation 1Fund Flows, CtEquation 2USD only Equation 2EM only Equation 2All Equation 2w/o Ct

Intercept -0.0062

(0.0093)

-0.0464

(0.5370)

-1.3131

(0.8889)

-1.8066**

(0.7105)

-1.1895*

(0.6807)

ln(Pt-1) -0.1819

(0.1198)

-0.0296

(0.1044)

-0.3140***

(0.0836)

-0.2944***

(0.0969)

Ct/At-1 0.2876**

(0.1385)

0.2609***

(0.0717)ln(USDt) -2.5333***

(0.5625)

-2.4282***

(0.4500)

-2.3703***

(0.5285)

ln(EMt) 2.4242***

(0.8163)

1.6917**

(0.6472)

1.8948***

(0.6327)

R-squared 0.0557 0.2985 0.1115 0.3955 0.3512

Adj. R-squared 0.0456 0.2832 0.0920 0.3683 0.3296D-W Statistic 1.738 1.946 2.106 2.012 1.995

Sample 2004M02 to

2011M12

2004M02 to

2011M12

2004M02 to

2011M11

2004M02 to

2011M11

2004M02 to

2011M11

*denotes statistical significance at the 10 percent level

** denotes statistical significance at the 5 percent level

*** denotes statistical significance at the 1 percent level


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ForecastsEconomic Fundamentals

versus Commodity Mutual Fund Flows

15

*Data and dynamic forecasts are from February 2004 to November 2011.Note: The correlation between the Dow Jones-UBS Commodity Index and the forecast based on economic fundamentals is0.80. It is -0.05 for the forecast based on flows.

Source: Bloomberg

Commodity price index level, monthly, 2004-2011*

100

150

200

250

300

350

400

450

500

2004 2005 2006 2007 2008 2009 2010 2011

Forecast based only oneconomic fundamentals

Dow Jones-UBS Commodity IndexForecast based only on

commodity fund flows


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Net New Cash Flow to CMFs and

Commodity Price Changes

16

Monthly, 2004-2011*

*Data as of December 2011

Sources: Investment Company Institute and Bloomberg (Dow Jones UBS Commodity Total Return Index)

-20%

0%

20%

40%

60%

80%

-$0.5

$0.0

$0.5

$1.0

$1.5

$2.0

2004 2005 2006 2007 2008 2009 2010 2011

Billions Monthly percent change

Monthly net new cash flow(left scale) Dow Jones-UBS Commodity Total

Return Index (right scale)


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Conclusion

Fundamentals, not funds, drive commodityprices, e.g., EM growth and USD matter

Flows to commodity mutual funds have little orno influence on commodity prices

This finding is consistent with academicresearch showing that financialization has not

driven commodity prices

Investing in commodity mutual funds providesimportant benefits for investors diversificationand natural hedge against inflation

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Why Commodity Mutual Funds CantExplain Higher Commodity Prices

First, commodity mutual funds experienced net outflowson average from January 2006 to June 2008 whilecommodity prices rose

Second, flows into commodity mutual funds are spreadacross a wide range of markets and thus do notconcentrate investment in a particular commodity (seeFigure 15 in paper)

Finally, the $47.7 billion in commodity mutual funds asof December 2011 is miniscule relative to the size ofglobal commodity markets

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Commodity Mutual Funds' ImpliedPosition in Commodity Markets

19

MarketImplied weight in individual

commodities1Percent

Implied dollar position incommodity, assets2

Billions

Share of index in market volumePercent

WTICrude 16.2% $7.7 0.5%Natural gas 10.4% 4.9 1.5%Gold 9.7% 4.6 0.2%Soybean 7.3% 3.5 0.9%Copper 7.1% 3.4 0.3%Corn 6.8% 3.2 1.1%Aluminium 4.9% 2.3 0.5%Wheat CBOT 4.5% 2.1 3.5%Heating oil 3.7% 1.8 0.5%

Unleaded gasoline 3.6% 1.7 0.5%Live cattle CME 3.3% 1.6 2.1%Sugar 3.2% 1.5 1.8%Silver 3.0% 1.4 0.4%Soybean oil 2.6% 1.3 N/AZinc 2.6% 1.3 0.1%Coffee 2.2% 1.1 1.3%

Nickel 2.1% 1.0 1.1%Lean hogs CME 1.9% 0.9 2.3%Cotton 1.9% 0.9 3.6%Brent crude 1.7% 0.8 0.1%Gasoil 0.7% 0.3 0.1%Wheat (KBOT) 0.1% 0.0 0.1%Lead 0.0% 0.0 0.0%

Feeder cattle CME 0.0% 0.0 0.2%Cocoa 0.0% 0.0 0.1%Tin 0.0% 0.0 0.0%Palladium 0.0% 0.0 0.0%


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Footnotes to Commodity Mutual Funds'Implied Position

Note: Based on December 2011 Assets of $47.7 billion

1 Implied weight is calculated from the weights in the Dow-Jones UBS and S&P GScommodity indexes. Each is weighted according to the assets of commodity mutualfunds tied to the underlying index. For example, over 90 percent of commoditymutual funds assets are linked to the Dow-Jones UBSCI and less than 10 percentto the S&P GSCI; each of which has a weight, respectively, of 29.9% and 14.7% onWTI oil. That implies that an average weight for commodity mutual funds of 16.2%as of December 2011.

2 Implied dollar position is the corresponding weight multiplied by total assets incommodity mutual funds as of December 2011 ($47.7 billion). For example,

commodity mutual funds have an implied weight of 16.2% of their $47.7 billion inassets invested in WTI crude oil, for an estimated dollar position of $7.7 billion.

Sources: Dow Jones-UBS, Barclays Capital

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Annex

Some literature on impact of commodity investment

Figures 8 through 12, and Figure 14 from paper

8-global size of flows, 9-rebalancing and oil, 10-examples and #s of commodity investment products,11-index weights in two broad commodity indexes, 12-CPI ex FE versus S&P500 and commodity index, and14-weekly CMF flows since early 2009

Weekly regression results

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Commodity index-linked new flows donot affect returns

Stoll and Whaley 2010find that neither commodityindexlinked flows nor monthly rolls cause futuresprice levels to change across a wide variety of

commodity markets Irwin and Sanders 2011bfind little evidence that

index-linked investment affects commodity marketreturns or volatility

Using internal CFTC data, Aulerich, Irwin, andGarcia 2010find negligible evidence that dailyindex-linked investment affects commodity returnsin 12 agricultural markets

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Rebalancing impact on commodityprice volatility

Irwin and Sanders 2010suggests that commodityindex investors may reduce commodity pricevolatility because the indexes fixed weights force

them to sell into markets with the greatest priceincreases and buy into markets with falling prices

Aulerich, Irwin, and Garcia 2010shows that indexinvestors can dampen volatility in some markets

Brunetti, Byksahin, and Harris 2011 examinedaily swap dealer positions (a proxy for indexinvestment) and find no evidence that thesepositions contribute systematically to price changes

or volatility in the crude oil, natural gas, and corn 23


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Monthly rolls of positions do not causefutures price levels to change

Mou 2010and Frenk and Turbeville 2011 examine theperiod when index investors typically exit futurespositions and roll into new positions. They find that the

spread between prices for nearby and next-nearbywidens during the roll, but no persistent levels effect

Stoll and Whaley 2010find that monthly rolls do notcause futures price levels to change across a wide

variety of commodity markets Kastner 2010shows that United States Natural Gas (a

commodity ETF) has no significant effect during the timethe monthly roll occurs

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8: Investment Flow into Global

Commodity Markets by Sector, 12MSum

25

Billions of dollars, monthly, 20092011*

*Data to November 2011.

Source: Barclays Capital

$0

$5

$10

$15

$20

$25

$30

$35

2009 2010 2011

Agriculture

Base metals

Precious metals

Energy


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9: Oil Price Versus Futures EquivalentPosition of Commodity Index Traders

26

Daily, December 2007 to December 2008

Sources: Federal Reserve, U.S. Commodity Futures Trading Commission

300

320

340

360

380

400

420

0

20

40

60

80

100

120

140

160

12/3/2007 3/3/2008 6/3/2008 9/3/2008 12/3/2008

Price per barrel Number of contracts (thousands)

Futures equivalent(right scale)

Oil Price(left scale)


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10: Number of Commodity Exchange-Traded Products and Mutual Funds

27

1 Commodity mutual funds are mutual funds whose primary investment objective is to give investors broad exposure to commodities by benchmarking tocommodity indexes that are diversified across a wide array of commodities.2 Managed futures strategy mutual funds are those that seek to give investors exposure to commodities, interest rates, and exchange rates through derivativessuch as futures and swaps. To date, these funds have not been predominately invested in commodities, so are included in this table purely for completeness.Note: Number in parentheses denotes number of broad-based commodity ETFs or ETNs.Source: Morningstar

Commodity ETFs Commodity ETNs Commodity mutual funds1Managed futures strategy

mutual funds2

December 1, 2004 1 (0) 0 (0) 2 0

December 1, 2006 6 (2) 3 (2) 7 0

December 1, 2008 18 (3) 42 (6) 12 2

December 1, 2010 28 (4) 43 (7) 2313

September 30, 2011 34 (4) 61 (8) 30 20


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11: Commodity Index Weights, 2011

28

Note: Weights on tin andpalladium are zero in bothindexes.Sources: Dow Jones-UBS, Barclays Capital

Commodity S&P GSCI

Dow Jones-UBS

Commodity Index

WTIcrude 29.9% 14.7%

Brent crude 16.8% 0.0%

Gasoil 7.2% 0.0%

Heating oil 5.3% 3.6%

Corn 5.1% 7.0%

Unleaded gasoline 4.9% 3.5%

Copper 3.6% 7.5%

Wheat CBOT 3.4% 4.6%

Gold 3.4% 10.5%Natural gas 2.8% 11.2%

Soybean 2.7% 7.9%

Live cattle CME 2.5% 3.4%

Aluminium 2.4% 5.2%

Sugar 2.4% 3.3%

Lean hogs CME 1.4% 2.0%

Cotton 1.3% 2.0%

Coffee 1.1% 2.4%

Wheat (KBOT) 0.9% 0.0%Nickel 0.7% 2.3%

Silver 0.6% 3.3%

Zinc 0.6% 2.9%

Lead 0.5% 0.0%

Feeder cattle CME 0.4% 0.0%

Cocoa 0.3% 0.0%

Soybean oil 0.0% 2.9%

Tin 0.0% 0.0%

Palladium 0.0% 0.0%


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12: Commodity Index and S&P 500

index vs. CPI F&E Component

29

Dollars invested, monthly, 2002-2011*

*Data are as of December 2011Sources: Bloomberg, U.S. Bureau of Labor Statistics

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Dow Jones-UBS Commodity Total Return Index

S&P 500 index (total return )

Consumer Price Index, food and

energy component


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14: Net New Cash Flow to CMFs and

Weekly Price Changes

30

Weekly, 2009-2011*

*Data as of December 2011

Sources: Investment Company Institute and Bloomberg (Dow Jones UBS Commodity Total Return Index )

-10%

0%

10%

20%

30%

40%

-$0.5

$0.0

$0.5

$1.0

$1.5

$2.0

2009 2010 2011

Billions Weekly percent change

Weekly net new cash flow(left scale)

Dow Jones-UBS Commodity TotalReturn Index (right scale)


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Weekly Contemporaneous Results

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Equation 1 Equation 1 with S&P GSCI

, Intercept -0.00157

(0.00173)

-0.00217

(0.00243)

, Slope 0.2776**(0.1188)

0.3209**(0.1611)

R-squared 0.0195 0.0138

Adjusted R-squared 0.0171 0.0114

Durbin-Watson Statistic 2.002 1.996

Sample 1/12/2004 to 12/26/2011 1/12/2004 to 12/26/2011





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Weekly VAR Resultsln(Pt) Ct/At-1

Intercept -0.00008

(0.0016)

0.0012**

(0.0005)

Coef on ln(Pt-1) 0.0016

(0.0502)

0.0189

(0.0149)

ln(Pt-2) -0.0530

(0.0503)

-0.0121

(0.0149)

ln(Pt-3) 0.0334(0.0500)

-0.0018(0.0148)

Coef on Ct-1/At-2 -0.0200

(0.1656)

0.2474***

(0.0490)

Ct-2/At-3 0.3049*

(0.1606)

0.3106***

(0.0475)

Ct-3/At-4 -0.1482

(0.1516)

0.2172***

(0.0448)R-squared 0.0125 0.5515

Adjusted R-squared -0.0021 0.5448

Sample 2/02/2004 12/26/2011 2/02/2004 12/26/2011




Commodity Markets and Commodity Mutual Funds

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