Blaming Retail Investors for Commodity Prices

“Commodity index rolls have little futures price impact, and inflows and outflows from commodity index investment do not cause futures prices to change”

I haven’t come out strongly on either side of this issue because my job presents me with a dilemma.

On the one hand, I believe that individual investors have played at least some role in the bubbling up of commodity prices over the last few years.  On the other hand, to paint these investors as “evil speculators” is absurd…why shouldn’t we encourage the democratization of commodity exposure for retail investors if they’re going to have their lives affected by the price swings in these markets anyway?

With the advent of commodity-based index funds and ETFs, the daunting roadblock of learning to trade futures contracts has been circumvented, allowing even a neophyte to be invested in gold, oil, silver, gas and corn.  This is only one reason for higher prices and volatility, the others are well-known: Prop trading by Goldman Sachs and Morgan Stanley in the pits, insatiable appetites in China and other emerging economies, the declining US dollar and geopolitical fears in the age of the War on Terror.

I hate to see costs driven up for American drivers, restaurant owners etc. because of massive index fund or ETF inflows.  That said, I have clients that run trucking companies all over the country whose only salvation during much of the oil peak of 2007-2008 was that they could make money on that energy spike by buying ETFs, a hedge against the prices that were killing their businesses.

According to a new study, researchers have concluded that commodity funds have very little if any impact on commodity prices.  I find this hard to believe, but here’s what they’ve come up with…

From Financial Advisor Magazine:

The study finds that commodity index investment, the practice by funds that buy baskets of commodities as a way to synthetically diversify an investment portfolio, is not speculation and that intervention by the Commodity Futures Trading Commission, urged by Congress, would harm more than help commodity futures markets.

“Commodity index rolls have little futures price impact, and inflows and outflows from commodity index investment do not cause futures prices to change,” said Whaley.

Stoll said there’s no doubt prices of a variety of commodities rose steeply in the 2007 to 2008 period, but he and Whaley believe there is considerable doubt that index investors caused the rise.

The study was commissioned by Gresham Investment Management.  I’m a bit skeptical of their findings if only for the fact that Gresham is an investment advisor with a focus on guess what?  Yup, commodities.  Their corporate tagline is “We Know Commodities” so I’m not shocked to read in their study that commodity mutual funds don’t influence prices in a meaningful way.

To say that the SPDR Gold Shares ETF (GLD) has “little to no impact” on gold prices is like denying that water’s wet.  This one fund alone has over $37 billion in assets dedicated exclusively to bullion.  We’re talking Bull in a China Shop with this thing.  It is said to hold more gold than all but 7 government central banks and it’s now larger in terms of assets under management than other well-known ETFs, like the QQQQ Nasdaq shares (aka The Q’s) and the DIA Dow 30 (the Diamonds).

We can’t say that the food and crop-related funds even come close in terms of impact because of their smaller relative size within their respective market, but what happens if and when they do start driving supermarket prices?  And how about if the oil and gas ETFs should outgrow their current quaint proportions?  Gold is not a cost of living or of doing business for the majority of Americans but food and energy are a different story.

The last thing I’m advocating for here is restriction on commodity-driven investing for the masses.  It would be nice for the fund industry to be less disingenuous about their impact, but I won’t be holding my breath for that either.

I expect this issue to become of major concern to the White House, Congress and the regulatory complex should food and gas prices resume their skyward march that was only briefly interupted by the credit crunch.

Sources:

Indexers Not to Blame (Financial Advisor)

Gold GLD ETF Impace on the Gold Market (MarketOracle.UK)

Dollar Bears Buy ETFs for Safety (WSJ)

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