Economic Significance of Non-Hedger Investment in Commodity Markets

35 Pages Posted: 15 Mar 2012

See all articles by Les Coleman

Les Coleman

University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Jonathan Dark

University of Melbourne; Financial Research Network (FIRN)

Date Written: March 14, 2012

Abstract

Popular contention is that trading in futures markets by investors without a physical position (that is, non-hedgers) has lifted commodity prices. This contradicts the standard finance assumption that futures markets shadow the physical market by providing liquidity for hedgers, and at most accelerate inevitable price change. This divergence of opinion is unresolved.

We test for the possibility of a link between futures market trading and physical prices by examining monthly data in 22 commodity futures markets as they grew after the 1980s. We introduce a new variable termed scaled open interest (OI) which is open interest in a commodity’s futures market divided by its global physical production. This is analogous to the hedge ratio and so deviations from its trend point to trading activity by non-hedgers.

We find a cointegrating relationship in larger markets between scaled open interest and real spot price, where it is usually the price that adjusts to deviations from long run equilibrium. We use cross sections of the dataset to examine this cointegrating relationship, and suggest factors that could contribute to our findings. The most satisfactory explanation is that tax-incentivized savings have thrown up a wall of money that leads investors to seek a long exposure to commodities, which lifts their price irrespective of fundamentals.

Keywords: commodity prices, market efficiency, index investors, speculative activity, futures markets

JEL Classification: Q32, G12

Suggested Citation

Coleman, Les and Dark, Jonathan, Economic Significance of Non-Hedger Investment in Commodity Markets (March 14, 2012). Available at SSRN: https://ssrn.com/abstract=2021919 or http://dx.doi.org/10.2139/ssrn.2021919

Les Coleman (Contact Author)

University of Melbourne - Department of Finance ( email )

Faculty of Business & Economics
Parkville, Victoria 3010 3010
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Jonathan Dark

University of Melbourne ( email )

185 Pelham Street
Carlton, Victoria 3053
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Register to save articles to
your library

Register

Paper statistics

Downloads
137
Abstract Views
820
rank
213,928
PlumX Metrics