Financial flows in commodity

markets

Torbjörn Iwarson, tel 076-001 57 90, torbjorn.iwarson@seb.se

There is a difference between

1. Informed speculation

2. Cornering the market

3. Creating rents

2

Accusations against speculation are not new –

the Agrarian Movement, some quotes from ”The Chicago Board of Trade 1859-1905”, Jonathan Lurie, Univ of Illinois Press, 1979

”We are profoundly impressed with the conviction that the gigantic gambling

device known as short selling, in which one party agrees to sell what never

did and never will exist, and the other agrees to buy what he knows is never

to be delivered to him, has been a potent cause in producing the ruinous

agricultural depression from which the country has suffered”, from a print

1892

”By the combined action of certain persons… organised into… Boards of

Trade, the prices of all kinds of farm products are so manipulated and

depressed that they cannot be produced except at a loss to the farmer”, the

Hurricane Grange No. 359.

Butterworth Bill of 1890: a dealer pays $1000 pa for the privilege to trade in

futures and options, 5 cents / lb of cotton, 20 cents / bu of grain bought or

sold.

Hatch Bill of 1892: $2000 pa + 20 cents / bu of grain. (passed the House

easily. Was sent back from Congress with amendments), failed to get 2/3

majority with a small margin in 1893. 3

Why did it not pass?

CBOT: Produce gambling ”bears about the same relation to legitimate

commerce and speculation… that the froth and foam of the Niagara do to the

almighty volume of water underneath. It is the bubbe and fuss and fury, the

froth and foam upon the surface that offends, not commerce itself”, DP April

29, 1890.

”How in the world a farmer can be benefited by the passage of such a

measure… is beyond us”, Northwestern Miller, January 22, 1892

Farmers were quite active speculators, Prairie Farmer wrote on Dec 27,

1884: ”What is wanted now, is for farmers to hold back all the grain they

possibly can, and hold on to it”.

The reason most cited for not interfering in the commodities markets was

that ”the ethical distinctions involved between legitimate and illigitimate

speculation are not easily reducible to exact legal definition”, Newman

Smyth, Forum 19, 1895.

4

Assets under management

5

0

50

100

150

200

250

300

350

400

450

Index AUM

Total Commodity AUM

ETP AUM

Source: SEB, Barclays

USD bn

AUM for the largest ETPs

6

0

20

40

60

80

100

120

140

160

180

jan

-10

mar

-10

maj

-10

jul-

10

sep

-10

no

v-1

0

jan

-11

mar

-11

maj

-11

jul-

11

sep

-11

no

v-1

1

jan

-12

Basemetals

Other Precious

Gold

Energy

Agri

Index

Source: SEB, Bloomberg

Flow Energy ETPs

7

-1500

-1000

-500

0

500

1000

1500

Energy ETPs and price change

8

y = -684.54x - 96.964R² = 0.0089

-1500

-1000

-500

0

500

1000

1500

-20% -15% -10% -5% 0% 5% 10% 15%

Flow

Powershares DB Agriculture, the largest Agri

ETP in the world, weekly data from 2007

9

y = 0.0002x + 0.0011R² = 0.0516

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

-400 -300 -200 -100 0 100 200 300 400

Price

y = 8E-05x + 0.0018R² = 0.011

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

-400 -300 -200 -100 0 100 200 300 400

Price-1

y = -1E-04x + 0.0035R² = 0.0159

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

-400 -300 -200 -100 0 100 200 300 400

Price+1

Granger causality goes from price change in

wheat to ETP flow. ETP flow statistically has

the opposite price causation!

10

Koeff St err t-kvot p-värde

Konstant 0.003483 0.003371 1.033036 0.30254

Flow -9.9E-05 4.81E-05 -2.05797 0.040582

Koeff St err t-kvot p-värde

Konstant 8.370262 4.281558 1.954957 0.051651

Price-1 133.7397 78.5073 1.703531 0.089654

Flow actually causes price to go down!

Price change causes flow

Weekly data from 2007

What about non-

commercials in CFTC data?

Share of open interest held by ”Swap dealers” in the

latest COT report

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

CB

T W

hea

t

CO

MEX

Co

pp

er

CM

E Le

an H

ogs

CM

E Li

ve C

attl

e

CB

T So

ybea

n

CB

T C

orn

ICE

Co

tto

n

KC

BT

Wh

eat

ICE

Co

ffee

CB

OT

Ro

ugh

Ric

e

ICE

Suga

r

NYM

EX H

O

CO

MEX

Silv

er

ICE

Ora

nge

juic

e

NYM

EX R

BO

B

ICE

Co

coa

CO

MEX

Go

ld

NYM

EX C

rud

e

Share held in CBT wheat

CBT Wheat

0%

5%

10%15%

20%

25%

30%

35%40%

45%

50%

2006-

12-01

2007-

03-01

2007-

06-01

2007-

09-01

2007-

12-01

2008-

03-01

2008-

06-01

2008-

09-01

2008-

12-01

2009-

03-01

2009-

06-01

2009-

09-01

2009-

12-01

2010-

03-01

2010-

06-01

2010-

09-01

2010-

12-01

2011-

03-01

2011-

06-01

2011-

09-01

2011-

12-01

Share held in crude oil

NYMEX crude

-10%

-5%

0%

5%

10%

15%

20%

2006-

12-01

2007-

03-01

2007-

06-01

2007-

09-01

2007-

12-01

2008-

03-01

2008-

06-01

2008-

09-01

2008-

12-01

2009-

03-01

2009-

06-01

2009-

09-01

2009-

12-01

2010-

03-01

2010-

06-01

2010-

09-01

2010-

12-01

2011-

03-01

2011-

06-01

2011-

09-01

2011-

12-01

Correlations between price change and

change in (# of) contracts held by non-

commercials (weekly data) for corn

15

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

Since 1994

Dito 2008-2009 (an unusual credit crunch as

common factor affecting all things)

16

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

2008-2009

Dito for corn since 2010

Price change causes change in speculative position

17

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

Since 2010

Is there some other common factor behind

commodity waves?

Share of global population with GDP per

capita between 2000 and 13000 dollars

19

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

The sum of GDP for countries in the growth

zone for GDP/capita as explanatory variable

20

R² = 0.7713

0

20

40

60

80

100

120

0 1E+13 2E+13

Oil

Linjär (Oil)

R² = 0.6661

0

100

200

300

400

500

600

700

800

900

1000

0 1E+13 2E+13

W

Linjär (W)

Crude oil (black) explained by the ”Emerging

market GDP indicator” and US CPI

21

-20

0

20

40

60

80

100

120

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

10 year rolling correlations between the

”emerging market” indicator and the volatility

of Chicago wheat prices

22

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1960 1970 1980 1990 2000 2010 2020Co

rre

lati

on

Conclusion

The importance of financial flows is greatly exaggerated.

The fundamental and powerful demand force caused by the modernisation

of half the world’s population does not get the attention it should.

If you want to read more on this, there is for example:

Scott H. Irwin and Dwight R. Sanders, “The Financialization of Commodity

Futures Markets or: How I Learned to Stop Worrying and Love the Index

Funds”, October 2010 (http://ssrn.com/abstract=1699793)