Emily Vogl, Frank Vogl
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IIF G-20 Report Stresses Strong Links Between Commodity Prices and Fundamentals, Rather Than Speculation
IIF Submission to the G20: Financial Investment in Commodity Markets: Potential Impact on Commodity Prices & Volatility
Washington D.C., September 12, 2011 — The IIF Commodities Task Force involving senior executives from leading financial services firms sent a report to the Group of 20 today stressing that there is little convincing evidence linking financial investment with trends in commodity prices and volatility. While there have been periods of correlation (sometimes attributed to “herding” behavior), in recent years, including among previously uncorrelated markets, researchers have not documented a clear causal link between financial investment and commodity prices.
The new report notes, however, that a strong link between commodity prices and fundamental supply and demand factors is indisputable. Higher commodity prices and volatility should be seen in the context of a steady increase in demand (mainly from emerging markets) and periodic supply constraints.
The report is being issued following calls by the French G-20 leadership, for more transparency and tighter regulation—including position limits on commodity derivatives trading. The IIF noted there is, however, an evident divergence of views within the G-20 on the need for strengthened regulation. In the U.S., regulatory developments include a proposal for position limits by the Commodity Futures Trading Commission (CFTC), under the expanded authority of the Dodd-Frank Act.
The Institute of International Finance is the leading global association of financial services firms with more than 440 member institutions. It notes in the new report that financial investment is an integral part of commodity trading. Commercial market participants who need to hedge their exposures (e.g., heavy users of commodities such as airlines or food manufacturers) will tend to hold net short positions; on the other side of the transaction, financial investors such as commodity index traders generally take long-only positions as a hedge against inflation and for portfolio diversification. Both sides thus benefit—financial investment provides essential market liquidity and counterbalancing positions. The ability to hedge against inflation and invest in commodities as part of a diversified portfolio reflects the social utility of financial investment in commodities, and is of particular value for long-term investment vehicles, such as retirement plans.
The report adds that speculation does not take place in the absence of fundamentals: it facilitates the processing of new information in spot and futures commodity markets in response to developments in fundamental supply and demand-related factors. Without speculation, the price signals to suppliers—and hence the supply response—would be dampened. While proposals to enhance the transparency of data provision to regulators on commodity prices and trading activity are broadly welcomed by private-sector market participants, the imposition of additional regulations such as position limits on trading activity could impair market liquidity and efficiency.
The report underscored that proposals by policymakers to directly address fundamental supply/demand imbalances that have contributed to price volatility—e.g., measures to unblock supply constraints or remove restrictions on the supply or export of key commodities—would be welcome. Investment in productive capacity could help minimize market distortions, contributing greatly to reducing commodity price volatility.
Emily Vogl, Frank Vogl