Commodity Market Capital Flow and Asset Return Predictability

Abstract:     
We establish several new findings on the relation between capital flow in commodity markets and asset returns. Capital flowing into commodity markets, as measured by high open-interest growth, predicts high commodity returns and low bond returns. Open-interest growth is a more powerful and robust predictor of commodity returns than other known predictors such as the short rate, the yield spread, the basis, and hedging pressure. It is positively correlated with commodity returns but has information for future returns beyond that contained in past commodity prices. Open-interest growth also predicts changes in inflation and inflation expectations. These findings suggest that open-interest growth contains information about future inflation that gets priced into commodity and bond markets with delay. Our findings are consistent with recent theories of gradual information diffusion and have implications for macroeconomic forecasting models.

Keywords: Bond price; Commodity price; Inflation; Time-varying expected returns; Trading

JEL Classifications: G12, G13, E31, E37

Working Paper Series