This paper explores the impact of investor flows and financial market conditions on returns in crude-oil futures markets. I begin with a review of the economic mechanisms by which informational frictions and the associated speculative activity may induce prices to drift away from fundamental" values and show increased volatility. This is followed by a discussion of the interplay between imperfect information about real economic activity, including supply, demand, and inventory accumulation, and speculative activity. Finally, I present new evidence that there was an economically and statistically significant effect of investor flows on futures prices, after controlling for returns in US and emerging-economy stock markets, a measure of the balance-sheet flexibility of large financial institutions, open interest, the futures/spot basis, and lagged returns on oil futures. The intermediate-term growth rates of index positions and managed-money spread positions had the largest impacts on futures prices.

Investor Flows and the 2008 Boom/Bust in Oil Prices

Recent volatility of prices of major grains has generated a wide array of analyses and policy prescriptions that reveal the inability of economists to approach a consensus on the nature of the phenomenon and its implications for policy. This review of market events and their economic interpretations finds that recent price spikes are not as unusual as many discussions imply. Further, the balance between consumption, available supply, and stocks seems to be as relevant for our understanding of these markets as it was decades ago. Though there is much to be learned about commodity markets, the tools at hand are capable of explaining the main forces at work, and of giving good guidance to policymakers confronted with a bewildering variety of expensive policy prescriptions.

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The Economics of Grain Price Volatility

This paper explores the impact of investor flows and financial market conditions on returns in crude oil futures markets. I argue that informational frictions and the associated speculative activity may induce prices to drift away from “fundamental” values, and may result in price booms and busts. Particular attention is given to the interplay between imperfect information about real economic activity, including supply, demand, and inventory accumulation, and speculative activity in oil markets. Furthermore, I present new evidence that there were economically and statistically significant effects of investor flows on futures prices, after controlling for returns in the United States and emerging-economy stock markets, a measure of the balance sheet flexibility of large financial institutions, open interest, the futures/spot basis, and lagged returns on oil futures. The largest impacts on futures prices were from intermediate-term growth rates of index positions and managed-money spread positions. Moreover, my findings suggest that these effects were through risk or informational channels distinct from changes in convenience yield. Finally, the evidence suggests that hedge fund trading in spread positions in futures impacted the shape of term structure of oil futures prices.

This paper was accepted by Wei Xiong, finance.

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In the long view, recent grain price volatility is not anomalous. Wheat, rice, and maize are highly substitutable in the global market for calories, and when aggregate stocks decline to minimal feasible levels, prices become highly sensitive to small shocks, consistent with storage models. In this decade, stocks have declined due to high income growth and biofuels mandates. Recently, shocks including the Australian drought and biofuels demand boosts due to the oil price spike were exacerbated by a sequence of trade restrictions by key exporters beginning in the thin global rice market in the fall of 2007, which turned market anxiety into panic. To protect vulnerable consumers, countries intervened in storage markets and, if they were exporters, to limit trade access. Recognizing these realities, vulnerable countries are building strategic reserves. The associated expense and negative incentive effects can be controlled if reserves have quantitative targets related to the consumption needs of the most vulnerable, with distribution to the latter only in severe emergencies. More-ambitious plans manipulate world prices via buffer stocks or naked short speculation to keep prices consistent with fundamentals. Past interventions of either kind have been expensive, ineffective, and generally short-lived. Further, there is no significant evidence that prices do not reflect fundamentals, including export market access.

/pdf/international-grain-reserves-and-other-instruments-to-5ff8oxofq8.pdf

International Grain Reserves and Other Instruments to Address Volatility in Grain Markets

Periodically, the global economy experiences great commodity booms and busts, characterized by a broad and sharp comovement of commodity prices. There have been two such episodes since the Korean War. The first event peaked in 1974 and the second in 2008, 34 years apart. Both created major economic and political shocks, including fallen governments and human suffering due to high food prices. Each occurrence raised serious concerns over food and energy security and led to more government intervention in the commodity markets. Although there is no simple explanation for what causes such complex events, they do share similar characteristics. We find at the core of these cycles a set of contemporaneous supply and demand surprises that coincided with low inventories and that were magnified by macroeconomic shocks and policy responses. In the next few decades, the world faces the prospect of continued increases in the demand for commodities and greater uncertainty about supply. However, because market particip...

Commodity Booms and Busts

http://wpage.unina.it/cafiero/storage/cafiero_et_al_2009.pdf

The empirical relevance of the competitive storage model

The nature of commodity price behavior remains in substantial dispute. Previous empirical tests of the standard storage model have concluded that storage arbitrage cannot explain the high serial correlation of prices. We introduce a Maximum Likelihood estimator that, unlike available approaches, makes full use of the predictions of the model about the most striking feature of commodity prices, the skewness revealed in their asymmetric dynamics, displaying occasional spikes. Our results for sugar establish the empirical relevance of storage in determining its price behavior. The dynamics of commodity prices can be quite different from those of the shocks that drive them.

Subject headings: Commodity Price Dynamics, Storage, Speculation, Sugar, Maximum Likelihood Estimation, Non-linear Dynamic Models.

/pdf/can-storage-arbitrage-explain-commodity-price-dynamics-16zpcpqal6.pdf

Juan R. A. Bobenrieth H

Papers

The empirical relevance of the competitive storage model

Can Storage Arbitrage Explain Commodity Price Dynamics