The document discusses the increase in uncertainty in commodity markets due to both fundamental changes and heightened financial investment, leading to potential herd behavior among traders. It highlights the significant rise in financial investment in commodities relative to global GDP and stresses the price impact of financial investors. Recommendations include enhancing market transparency, implementing tighter regulations, and evaluating the effectiveness of market interventions.

1. Financial Markets and Food Price Volatility:
Mapping Key Actors and Urgent Actions
IDS, Brighton, 6 February 2012
Food price volatility – assessing
potential market impacts
Jörg Mayer
Division on Globalisation and Development Strategies
UNCTAD

2. Main point
• Uncertainty in commodity markets has
strongly increased and this increase
has changed the functioning of
commodity exchanges

3. Uncertainty has always been a key characteristic
of commodity trading, but it has increased for
both fundamental and financial reasons

4. Greater uncertainty tends to cause rational
herding, especially information-based herding

5. Strong increase in financial investment
OTC-activity/global GDP ratio strongly increased in 2004–08, and
AUM/global GDP ratio doubled in 2005–07 and rose 2.5-fold in 2008–11
Financial investment in commodities and global GDP, 1998–2011, per cent
25 0.7
0.6
20
0.5
15 0.4
10 0.3
0.2
5
0.1
0 0.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Notional value of outstanding OTC equity-linked derivatives as a share of global GDP (left axis)
Notional value of outstanding OTC commodity derivatives as a share of global GDP (left axis)
Commodity assets under management as a share of global GDP (right axis)
Source: UNCTAD secretariat calculations based on BIS, Barclays Capital and UNCTADstat database.

6. The price impact of index traders
Regression analysis shows that index-based investors
amplified 2008-price spike
Actual and counterfactual WTI crude oil prices ($/bl) Actual and counterfactual wheat prices (c/bshl)
150
1 400
125 1 200
100 1 000
800
75
600
50
400
25 Actual 200 Actual
Counterfactual Counterfactual
0 0
janv- mai- sept- janv- mai- sept- janv- mai- sept- janv- janv- mai- sept- janv- mai- sept- janv- mai- sept- janv-
2006 2006 2006 2007 2007 2007 2008 2008 2008 2009 2006 2006 2006 2007 2007 2007 2008 2008 2008 2009
Source: C Gilbert (2010), Speculative influences on commodity futures prices 2006–2008, UNCTAD Discussion Paper No 197.

7. Composition of financial investment has changed
Index-based positions may have impacted prices until 2008 but since spring
2009 high correlation between prices and money manager positions
Wheat (Chicago Board of Trade)
250 1200
200
Net long positions: number of futures and options
1000
150
100
800
contracts ('000)
50
Cents/bushel
0 600
-50
400
-100
-150
200
-200
-250 0
13/06/2006 02/01/2007 01/01/2008 06/01/2009 05/01/2010 04/01/2011 27/12/2011
Price (right scale) PMPU (left scale) Money managers (left scale) CIT traders (left scale)

8. The additional price impact of money managers
There has been a double shift-change in correlation
between commodities and other asset markets
Correlation between DJ-UBSCI non-energy Correlation between GSCI excess return index
excess return and S&P 500 indices (1992–2012) and dollar exchange-rate index (1987-2012)
0.6 0.3
0.5 0.2
0.1
0.4
0.0
0.3
-0.1
0.2
-0.2
0.1
-0.3
0
-0.4
-0.1
-0.5
-0.2 -0.6
-0.3 -0.7
02/01/1992 02/01/1996 02/01/2000 02/01/2004 02/01/2008 02/01/2012 02/01/1987 02/01/1991 02/01/1995 02/01/1999 02/01/2003 02/01/2007 02/01/2011

9. Reasons behind second step increase in
correlation across financial markets
• Conventional story – quantitative easing
flooded financial markets with liquidity and
caused generalized ‘risk-on’ position taking
• Financial innovation – widespread adoption
of electronic trading in 2006 was followed
by strong increase in:
– trading on commodity exchanges
– the correlation between returns on equity
indexes and on commodity futures contracts

10. Summary of main points
• Uncertainty has increased because of (i) shifts in
fundamentals and (ii) presence of financial investors
• The size of financial investment in commodities has
strongly increased in nominal terms, as well as relative to
global GDP and physical commodity production
• Resulting greater uncertainty risks causing herd behaviour
• Several pieces of empirical evidence point to financial
investors’ price impact
• Three-pronged policy recommendations:
– Greater transparency across physical, futures and OTC markets
– Tighter regulation (debate on: clearing for standardized OTC-
contracts, speculative position limits, provisions regarding HFT)
– Big question is desirability and effectiveness of occasional direct
intervention by market authorities

11. Thank you !
joerg.mayer@unctad.org
Trade and Development Report 2011, ch. V
“Financialized commodity markets:
recent developments and policy issues”
http://www.unctad.org/en/docs/tdr2011ch5_en.pdf