Commodity index investment and food prices: does the “Masters Hypothesis” explain recent price spikes?

The “Masters Hypothesis” is the claim that unprecedented buying pressure in recent years from commodity index investors created massive bubbles in food and energy prices. The purpose of this article is to review the evidence from recent studies that investigate the empirical relationship between index investment and price movements in agricultural futures markets. One line of research uses time‐series regression tests, such as Granger causality tests, to investigate the relationship between price movements and index positions. This research provides little evidence in support of the Masters Hypothesis in agricultural futures markets. A second line of research uses cross‐sectional regression tests and studies in this area provide very limited evidence in favor of the Masters Hypothesis for agricultural futures markets. A third line of research investigates whether there is a significant relationship between commodity index trading and the difference, or spread, between futures prices of different contract maturities on the same date. These studies report a range of results depending on the type of test. However, the bulk of the evidence indicates either no relationship or a negative relationship, which is once again inconsistent with the Masters Hypothesis. Overall, this growing body of literature fails to find compelling evidence that buying pressure from commodity index investment in recent years caused a massive bubble in agricultural futures prices. The Masters Hypothesis is simply not a valid characterization of reality.     

A speculative bubble in commodity futures prices? Cross‐sectional evidence

Recent accusations against speculators in general and long-only commodity index funds in particular include: increasing market volatility, distorting historical price relationships, and fueling a rapid increase and decrease in the level of commodity prices. Some researchers have argued that these market participants—through their impact on market prices—may have inadvertently prevented the efficient distribution of food aid to deserving groups. Certainly, this result—if substantiated—would counter the classical argument that speculators make prices more efficient and thus improve the economic efficiency of the food marketing system. Given the very important policy implications, it is crucial to develop a more thorough understanding of long-only index funds and their potential market impact. Here, we review the criticisms (and rebuttals) levied against (and for) commodity index funds in recent U.S. Congressional testimonies. Then, additional empirical evidence is added regarding cross-sectional market returns and the relative levels of long-only index fund participation in 12 commodity futures markets. The empirical results provide scant evidence that long-only index funds impact returns across commodity futures markets.     

The Role of Index Trading in Price Formation in the Grains and Oilseeds Markets

We use both Granger‐causality and instrumental variables (IV) methods to examine the impact of index fund positions on price returns for the main US grains and oilseed futures markets. Our analysis supports earlier conclusions that Granger‐causal impacts are generally not discernible. However, market microstructure theory suggests trading impacts should be instantaneous. IV‐based tests for contemporaneous causality provide stronger evidence of price impact. We find even stronger evidence that changes in index positions can help predict future changes in aggregate commodity price indices. This result suggests that changes in index investment are in part driven by information which predicts commodity price changes over the coming months.     

How Reliable Are Hog Futures as Forecasts?

The Chicago Mercantile Exchange hog futures contract was revamped in 1997 and it is one of the largest futures markets for a nonstorable commodity. The literature is divided on whether or not futures prices for nonstorables provide reliable forecasts of cash prices. We find that from 1998 to 2004, the hog futures market was an unbiased predictor of cash prices.     

Commodity futures markets: a survey

This review article describes the main contributions in the literature on commodity futures markets. It is argued that modern studies have focused primarily on technical questions, with insufficient economic content. More research needs to be directed towards understanding fundamental economic issues such as why so few farmers hedge, the impacts of government farm programs on commodity futures, and the market impacts of commodity pools. The literature has failed to explain the prevalence of inverted markets in grains and oilseeds, and there is unexplainable price volatility in markets such as hogs and orange juice.     

New Evidence on the Impact of Index Funds in U.S. Grain Futures Markets

Commodity index trader position data are examined for the years prior to the 2007–08 commodity price increase. New data from 2004 to 2005 show that a large increase in commodity index positions occurred in select grain futures markets. However, the increased index participation took place well in advance of the 2007–08 boom in prices. Granger causality tests fail to find any causal link between commodity index activity and grain futures prices. Furthermore, there is little evidence of an index‐induced price bubble using long‐horizon regressions. Nous avons analysé les données sur les positions des opérateurs de marché au cours des années qui ont précédé la hausse des prix des denrées en 2007–08. Selon de nouvelles données pour la période 2004–05, une hausse substantielle des positions liées à l’indice des denrées est survenue sur des marchés de grain à terme sélectionnés. Toutefois, cette hausse des positions est survenue bien avant la montrée en flèche des cours en 2007–08. Le test de causalité de Granger n’a pas permis d’établir l’existence d’un lien de causalité entre l’activité liée à l’indice des denrées et les cours à terme des grains. De plus, les régressions pour processus à mémoire longue ne permettent pas de conclure à l’existence d’une bulle des prix induite par l’indice.     

Measuring the functional efficiency of agricultural futures markets

This article presents a method for measuring the functional efficiency of agricultural futures markets in terms of social welfare using a standard futures market structural model. Employing the concept of social surplus, it can be shown that, when futures prices are used to estimate future spot prices, the errors in prediction produce to some degree resource misallocation, which in turn results in welfare losses. Therefore, the social welfare associated with the presence of futures markets can be measured using a Social Loss index. The indicator was calculated for the period 1975–2015 and for several subperiods, which allow us to analyse functional efficiency before and after the 2007–2008 spikes in the prices of agricultural commodities. Futures contracts for 12 products are evaluated. The products are grouped in three different categories: ‘soft products’, ‘livestock’ and ‘grains and oilseeds’. The results indicate that livestock contracts tended to be more efficient than the rest of the contracts during the whole period, but in 2008–2015 their efficiency decreased vis‐á‐vis the rest of the products. Nevertheless, 2008–2015 proved to be the most efficient subperiod, confirming the remarkable development of agricultural futures markets over time.     

Futures markets and price stabilisation: An analysis of soybeans markets in North America

The objective of this paper was to determine whether the futures markets have a stabilising or destabilising impact on soybean's spot prices in North America. Directed acyclic graphs (DAGs) are used to test for causality between futures prices, spot prices and ending stocks, followed by time series econometric analysis. The DAGs point to the two-way causal link between futures and spot prices and a lack of a causal link between inventory/stocks and spot price volatility. Time series results, including cointegration, vector error correction, impulse response and variance decomposition analysis, indicate a large impact from futures markets on the level and volatility of soybean spot prices in both the short and long run. These results have potentially important implications, as the impact of commodity price volatility is typically asymmetric across different actors. Farmers, for example, unlike speculators, utilise price risk management (PRM) instruments such as futures markets to mitigate price risks and appear to suffer from intensified volatility precisely because of their use of these instruments. Therefore, additional policies to cope with commodity price volatility, such as direct price controls or mitigation of consequences, can have critical stabilising functions supporting farmers' welfare and regional (rural) development.     

How financial investment distorts food prices: evidence from U.S. grain markets

Convergence between commodity futures prices and the underlying physical assets at each contract's expiration date is a pivotal condition for the market's functioning. Between 2005 and 2010, convergence failed for several U.S. grain markets. This article presents a price pressure‐augmented commodity storage model that links the scale of nonconvergence to financial investment channeled through indices, which are traded in commodity futures markets. The model is empirically tested, using Markov regime‐switching regression analysis. Regression results strongly support the model's predicted link between index investment and the extent of nonconvergence for three grains traded at the Chicago Board of Trade: wheat, corn, and soybeans.     

What Does Granger Causality Prove? A Critical Examination of the Interpretation of Granger Causality Results on Price Effects of Index Trading in Agricultural Commodity Markets

The influence of index trading on price levels, returns, spreads or volatility in agricultural commodity markets is frequently investigated with bivariate Granger Causality (GC) tests. A joint review of existing empirical studies reveals scant and inconsistent evidence of GC from index activity to prices. Some findings of reverse GC from prices to index activity are reported. The literature offers three different interpretations of GC test results: (i) as prima facie causal evidence; (ii) as a test for informational efficiency of the markets; or (iii) as a test for the ability of one variable to improve the forecast of another variable. A critical examination of these interpretations against an extended theoretical background reveals that none allows direct inferences about the existence or absence of an influence from index trading activity on the price mechanism in the market. This severely limits the usefulness of a stand‐alone application of GC tests.     

How much of commodity price behavior can a rational expectations storage model explain?

A rational expectations competitive storage model was applied to the U.S. corn market, to assess the aptness of this framework in explaining monthly price behavior in an actual commodity market. Relative to previous models, extensive realism was added to the model, in terms of how production activities and storage costs are specified. By modeling convenience yield, “backwardation” in prices between crop years did not depend on the unrealistic assumption of zero ending stocks. Our model generated cash prices that were distributed with positive skewness and kurtosis, and mean and variance that increased over the storage season, comparable to the persistence and the occasional spikes observed in commodity prices. Futures prices were generated as conditional expectations of cash prices at contract maturity, and the variances of futures prices exhibited realistic time–to‐maturity and seasonal patterns. Model realizations of cash and futures prices over many “years” were used to demonstrate the wide variety of price behaviors that could be observed in an efficient market with a similar market structure, implying that economic and policy implications drawn from short, historical samples of prices could be misleading.     

The interaction of speculators and index investors in agricultural derivatives markets

Through the analysis of the weekly Commodity Futures Trading Commission reports on 12 US traded agricultural commodities, we revisit the heated debate on the impact of index flows on commodities prices. After introducing a novel stock‐to‐use proxy that may be used to represent inventory variations at the intra‐month level, we show that speculators, contrary to index investors, are sensitive to commodity‐specific fundamental information. Their endogeneity to commodities markets hinders the estimation of their market impact. Regarding the market impact of index flows, the endogeneity problem is alleviated in two ways: first, we restrict the scope to agricultural commodities, for which index flows are more exogenous to market prices; second, we introduce two novel instrumental variables that are computed from index flows outside the market under analysis. We find that index investment flows are offset by commercial players, not speculators. The serial correlation of index flows may explain the tendency of speculators to synchronize with index investors. There is strong evidence of an index flows' impact in those commodities markets where speculative and index positions are the most correlated. The market impact of index flows is located in periods of liquidity stress, as is the correlation between speculative and index positions. Overall, our results demonstrate an impact of index investors on some agricultural prices and suggest that the synchronicity between speculative and index positions is an important determinant of this impact.     

FUTURES PRICES AS FORECASTS OF COMMODITY SPOT PRICES: LIVE CATTLE AND WOOL*

In this paper the foundations on which the predictive interpretation of futures prices rests are discussed, and possible reasons for the differential predictive performance of futures prices as between different commodity markets examined. The predictive performances of futures, and spot prices themselves, are tested empirically, using Australian data for wool (a continuous inventory commodity) and finished live beef cattle (virtually a non-storable commodity), by means of instrumental variables estimation.     

Do wheat futures returns exhibit long‐range dependence?

The efficient market hypothesis, where asset prices follow a random walk and incorporate all relevant information, is often invoked in financial economics. There is some evidence however to suggest that some asset prices do not follow random walks but display long‐range dependence. Such systematic behavior of past returns is of interest to traders. This article examines long‐range dependence in wheat futures prices using rescaled range analysis and the Hurst exponent. Since this estimate is biased when long‐range dependence is absent and its distribution is unknown, a Monte Carlo simulation approach is proposed. Results show that wheat futures prices show no evidence of long‐range dependence and there are no profitable trading rules.     

Revisiting the determinants of futures contracts success: the role of market participants

The Chicago Mercantile Exchange introduced a futures contract for distillers’ dried grains (DDGs) in early 2010, but the market became inactive only four months after its inception. While many new futures contracts do not develop into high‐volume traders, interest from DDG cash market participants indicated that this contract could be successful. Prompted by the unexpected lack of trading activity in this new futures market, we empirically revisit the question of what factors contribute to a futures contract's success and extend the literature by investigating the roles of market participants and the significance of supporting futures markets. Estimation results indicate that the market participant type—hedger or speculator—affects futures contract trade volume. More importantly, we find that the viability of new futures contracts for commodities that are jointly produced with other commodities is impacted by hedgers’ trade volume of the related futures contract. These results provide important additions into the portfolio of indicators used by commodity exchanges to more cost‐effectively evaluate new futures contract products.     

Out‐of‐sample testing price discovery in commodity markets: the case of soybeans

Price discovery, a central function of futures markets, has been usually tested in‐sample by studying the common stochastic trend between spot and futures prices. Instead, to evaluate futures as anticipatory prices, we develop a forecast approach to out‐of‐sample test price discovery in a multivariate framework. We apply it to the soybeans market. Results indicate futures prices as the best available “predictors” of future spot prices, although this finding holds only on average and for certain periods, other models show forecasting gains.     

Price discovery in a private cash forward market for lumber

Cash forward contracting is a common, and often preferred, means of managing commodity price risk in many industries. Despite this, little is known about the performance of cash forward markets, in particular the role they play in price discovery. The US lumber market provides a unique case for examining this issue. The Bloch Lumber Company maintains an active cash forward market for many lumber products, and publishes benchmark forward prices on their website and disseminates these prices to data vendors. Focusing on 2×4 random lengths lumber and 7/16 oriented strand board, this research examines the lead–lag relationships between the 3-month forward prices published by Bloch Lumber, representative spot prices, and lumber futures prices at the Chicago Mercantile Exchange. Results suggest that at least for 2×4 random lengths lumber, the forward prices published by Block Lumber lead both the spot price and futures price, suggesting that this private cash forward market provides some level of price discovery in the lumber markets.     

Post–Uruguay Round price linkages between developed and developing countries: the case of rice and wheat markets

The Uruguay Round Agreement on agriculture attempted to lower distortions in global agricultural markets. However, the significant fall in commodity prices in the late 1990s may have reduced the incentives for both developed and developing countries to better integrate into world markets. This study analyzes price linkages and adjustment between developed and developing countries during the post–Uruguay Round period. Prices of two key commodities, long‐grain rice and medium‐hard wheat, are assembled for major exporters and producers. Results of multivariate cointegration analysis suggest partial market integration between developed and developing countries in the post–Uruguay Round period. Developed countries are found to be price leaders in these two markets, and in most cases, changes in their prices have relatively large impacts on those of the developing countries. Developing countries (e.g., Vietnam and Argentina) have faced considerable price adjustment due to changes in the developed countries' prices.     

全球农产品价格波动中金融化因素探析

近年来金融化因素在农产品市场中不断深化并形成新的特点，大量流向农产品市场的资金通过衍生市场进行非传统投机，尤其是将指数基金作为主要手段。供求状况难以反映农产品价格波动，而期货价格与指数基金的投机大大推动了农产品价格波动。我国应针对农产品金融化特性做出相应的政策调整。     

Agricultural Financial Risks Resulting from Extreme Events

Decision‐makers in the agricultural sector operate in a volatile and risky environment. The statistical assessment of agricultural commodity prices is necessary to deduce the stylised facts of agricultural markets and guide the action of market participants. This article examines the kurtosis values of 60 agricultural commodities and presents evidence that the distributions of their returns are fat‐tailed. We use power‐law distributions to model the tail returns and the possible time‐varying extreme event risks in commodity markets. Our results suggest that the usefulness of the value at risk and expected shortfall as risk management tools is questionable.