“Be Careful What You Ask For, You Might Just Get It”

Statement on 2012 Research Conference to Discuss Key Issues in Derivatives Markets

Commissioner Bart Chilton

November 30, 2012

There’s a song by Everclear “Be Careful What You Ask for.” Wall Street and their allies, many of whom make a pretty penny speculating and facilitating speculation in commodity markets, want the Commission to rebut their view that speculation affects commodity futures prices. There are indeed some studies out there that made findings consistent with this view. For example, Irwin and Sanders (OECD 2011) found that “Massive Passives” (commodity index funds) are not likely to have caused a commodity price bubble in the late 2000s. Many of these studies relied on the so-called Granger causality test and data from the weekly CFTC Commitment of Traders Report.

The problem is that the data and methodology used in these studies are not a great way to test whether Massive Passive or other speculative inflows of money affect commodity futures prices or price volatility. More recent studies make this point as well. Bos and van der Molen (Maastricht University 2012) found that the effect of speculation in coffee markets was “spiky” during the period they observed and that is why the reason why past studies failed to find a link between speculation and commodity prices. Similarly, Henderson, Pearson, and Wang (George Washington University and University of Illinois at Urbana-Champaign 2012) pointed out that reliance on CFTC Commitments of Traders data, which only has weekly data on commodity futures market positions, cannot measure the more immediate impact of speculation on commodity futures prices (by the way, the Commission needs to improve the Commitment of Traders report).

The problem gets worse for Wall Street: there is mounting evidence that speculation affects commodity prices. Brian Henderson is here to present the paper he wrote along with Pearson and Wang. This paper looked into the price impact of the issuance of commodity-linked notes (a security that generates payouts based on commodity prices) and the hedges of these issuances. Henderson, Pearson, and Wang found that commodity investor flows cause significant price changes in the underlying futures markets, and therefore provide direct evidence of the impact of financial investment (i.e. speculation) on commodity futures prices. Similarly, Bos and van der Molen’s model suggested speculation results in an average 20% price deviation from where prices in coffee markets would be but for speculation.

The studies I’ve mentioned are just two of dozens of papers that provide evidence that speculation does have an effect on commodity prices. A Goldman Sachs commodities research report from March 21, 2011 estimated that “each million barrels of net speculative length tends to add 8-10 cents to the price of a barrel of oil” independent of supply and demand fundamentals. Similarly, Juvenal and Ivan (St. Louis Fed. 2011) found “financial speculation significantly contributed to the oil price increase between 2004 and 2008.” Dozens of papers, including 16 that are academic peer-reviewed papers, find a link between commodity speculation and prices and can be found on the World Economy, Ecology, and Development website.¹

I think the next position limits proposal is going to delve deeper into the speculation studies. What the Commission finds might lead to somewhere Wall Street might not like. The Everclear song continues: “Just when you think that everything is gonna be alright, that's where it all goes bad.”

¹ World Economy, Ecology, and Development website at http://www2.weed-online.org/uploads/evidence_on_impact_of_commodity_speculation.pdf

Last Updated: November 30, 2012