Tuesday, November 30, 2010

"The financialisation of commodities"

We are adamantly opposed to any regulatory framework that ennobles consumables as an "asset class".
If the betting crowd wants a toy to play with, they can run gold up to their heart's content.
And don't get me started on Goldman and their long-only index "investors".
Speculators taking the other side of a commercial hedger perform a societal good, the so-called investors are akin to hoarders, a crime that many societies have deemed worthy of the death penalty.
From VoxEU:
In recent years, hundreds of billions of dollars of investment has flowed into commodities markets. This column describes why and how commodities markets have grown so rapidly and discusses some policy implications.

 Crude oil, copper, cotton, soybeans, and live cattle – a seemingly unrelated set of commodities – went through a synchronised boom and bust cycle between 2006 and 2008 (see Figure 1).
Figure 1. Commodity prices

This cycle has stimulated heated debate in policy circles about whether speculation caused unwarranted increases in the cost of energy and food and induced excessive price volatility. There are two opposing views.
  • One view puts the boom-and-bust cycle down to a simple matter of supply and demand.
According to Krugman (2008), Hamilton (2009), Kilian (2009), and others, the rapid growth of emerging economies such as China propelled the quick increase in world demand and caused commodity prices to soar before the summer of 2008. Prices later fell sharply as the world recession caused demand to fade.
  • The second view points to the large flow of investment into commodity indices.
According to a CFTC staff report (2008) and Masters (2008), the total value of various commodity index-related instruments purchased by institutional investors has increased from an estimated $15 billion in 2003 to at least $200 billion in mid-2008. A recent report by the US Senate Permanent Subcommittee on Investigations (2009) argues that the dramatic index investment flow had distorted prices of some commodities such as wheat.

The growth of commodities

To thoroughly assess the role of financial investors in commodities markets, it is important to recognise the economic transition of commodities markets precipitated by the rapid growth of commodity index investment. We examine this process in a recent working paper (Tang and Xiong 2010). There is ample evidence suggesting that commodities markets were partially segmented from outside markets prior to early 2000s. Bessembinder (1992) and de Roon et al. (2000) show that commodity prices provided risk premium for idiosyncratic commodity price risk; Gorton and Rouwenhorst (2006) find that commodities had little price co-movements with stocks; and Erb and Harvey (2006) show that commodities in different sectors had little price correlation with each other. By arguing that commodities offer a diversification benefit to portfolios of stocks and bonds, Goldman Sachs and other indexers managed to promote commodity futures as a new asset class for institutional investors in the early 2000s following the collapse of the equity market. As a result, billions of dollars of investment has gradually flowed into commodities markets....MUCH MORE
HT: FT Alphaville