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The Impact of Speculative Trading in Commodity Markets – a Review of the Evidence September 2011

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The Impact of Speculative Trading in Commodity Markets – a Review of the Evidence September 2011 The impact of speculative trading in commodity markets – a review of the evidence September 2011 FTI UK HOLDINGS LIMITED 322 HIGH HOLBORN, LONDON WC1V 7PB Table of Contents Important notice ................................................................................................................. 3 Glossary ...................................................................................................................... 4 Executive Summary ........................................................................................................... 6 1 Introduction .................................................................................................. 9 Introduction to assignment ............................................................................. 9 Summary of paper ......................................................................................... 9 Content of this report ..................................................................................... 9 2 Background and context ........................................................................... 11 Introduction .................................................................................................. 11 What is speculation? .................................................................................... 12 Current debate ............................................................................................. 15 The search for explanations ......................................................................... 18 3 Why do we have speculation in commodity markets? ............................. 21 Introduction .................................................................................................. 21 Why speculation might be a market good ..................................................... 25 Why speculation might be a market ill .......................................................... 26 Some complexities ....................................................................................... 27 4 Overview .................................................................................................... 30 Equilibrium and/or long run price .................................................................. 30 Cause and effect problems .......................................................................... 31 Data issues .................................................................................................. 32 Time periods ................................................................................................ 32 Different products ........................................................................................ 33 5 Summary of findings ................................................................................. 34 6 Some issues that arise from the analysis ................................................. 41 Problems of getting to a definitive answer .................................................... 41 Issues surrounding policies to reduce speculation ........................................ 42 Proposed policies ........................................................................................ 43 Appendix 1 Sources of information .............................................................................. 45 Appendix 2 Detailed summaries of literature reviewed ............................................... 47 1 Price Formation in Financialised Commodity Markets: the Role of Information ........................................................................ 47 2 Index Investment and Financialization of Commodities ........................ 49 3 Placing the 2006/08 Commodity Price Boom into Perspective ............. 50 4 The Role of Inventories and Speculative Trading in the Global Market for Crude Oil ....................................................................................... 52 The impact of speculative trading in commodity markets – a review of the evidence | 1 5 Speculative Influences On Commodity Futures Prices 2006-2008 ....... 53 6 Commodity Prices and Price volatility: Old Answers to New Questions 54 7 The Adequacy of Speculation in Agricultural Futures Markets: Too Much of a Good Thing?................................................................ 56 8 Oil Market Dynamics through the lens of the 2002-2009 Price Cycle ... 57 9 The Impact of Index and Swap Funds on Commodity Futures Markets 59 10 Does Speculation Affect Spot Price Levels? The Case of Metals with and without Future Markets ................................................................. 60 11 Is Speculation Destabilizing? .............................................................. 61 12 Understanding Crude Oil Prices .......................................................... 62 13 The rise and fall in oil prices: analysis of fundamental and financial drivers ................................................................................................ 64 14 World Economic Outlook: Financial stress, Downturns, and Recoveries ................................................................................... 65 15 High prices on agricultural commodity markets: situation and prospects ..................................................................................... 66 16 Interim Report on Crude Oil ................................................................ 67 17 Do Birds of a Feather Flock Together? ................................................ 68 18 Facts and Fantasises about Commodity Futures ................................. 70 19 Onions revisited .................................................................................. 71 20 Speculation on Hedging Markets ......................................................... 71 The impact of speculative trading in commodity markets – a review of the evidence | 2 Important notice This report has been prepared by FTI UK Holdings Limited (“FTI”) for the Futures and Options Association under the terms of the engagement letter sent to Simon Andrews of the Futures and Options Association and dated 13 June 2011 (the “Contract”). This report has been prepared solely for the benefit of the Futures and Options Association and constitutes a literature review of the impact of speculation in commodity markets and no other party is entitled to rely on it for any purpose whatsoever. FTI accepts no liability or duty of care to any person (except to The Futures and Options Association under the relevant terms of the Contract) for the content of the report. Accordingly, FTI disclaims all responsibility for the consequences of any person (other than The Futures and Options Association on the above basis) acting or refraining to act in reliance on the report or for any decisions made or not made which are based upon such report. The report contains information obtained or derived from a variety of sources. FTI has not sought to establish the reliability of those sources or verified the information so provided. Accordingly no representation or warranty of any kind (whether express or implied) is given by FTI to any person (except to The Futures and Options Association under the relevant terms of the Engagement) as to the accuracy or completeness of the report. The report is based on information available to FTI at the time of writing of the report and does not take into account any new information which becomes known to us after the date of the report. We accept no responsibility for updating the report or informing any recipient of the report of any such new information. All copyright and other proprietary rights in the report remain the property of FTI and all rights are reserved. UK Copyright Notice © 2011 FTI UK Holdings Limited. All rights reserved. The impact of speculative trading in commodity markets – a review of the evidence | 3 Glossary Item Description Co-movement Correlated or similar movement of two entities Commodity Futures Trading Commission; independent agency of CFTC the United States government that regulates futures and options markets Efficient Market Hypothesis; this hypothesis claims that prices of EMH traded assets reflect all publicly available information FOA Futures and Options Association Standardised contract between two parties to exchange a specified asset of standardised quantity and quality for a price Futures contract agreed today with delivery occurring at a specified date in the future Futures market Financial exchange where futures contracts are traded Statistical test for determining whether one time series is useful in forecasting another i.e. to determine whether trader positions are Granger-Causality useful in forecasting commodity prices. It is important to note that Granger-Causality does not imply true causality An investment position designed to offset potential losses that may be incurred by a companion investment; for example, a Hedge futures contract can offset the potential loss associated with a drop in the price of wheat for a wheat farmer Collective investment scheme that aims to replicate the movements of a specific financial market; for example, the Index fund S&PGSCI is an index fund that aims to replicate the movements of commodities markets Asset’s ability to be bought or sold without causing a significant Liquidity movement in the price and with minimum loss of value In commodity derivatives, a position where the holder obtains a future right to buy a commodity at a price determined in advance, Long position thereby profiting if the spot value of the commodity
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