Commodity Markets and Commodity Mutual Funds

Fundamental economic factors — market demand and supply conditions — provide the most consistent explanation for recent trends in commodity prices. The rise and fall of commodity prices on a monthly basis since 2004 has been strongly linked to the value of the U.S. dollar and the world business cycle — in particular, to the strength or weakness in emerging market economies such as China, Brazil, India, and Russia. Despite concerns raised by some policymakers that increased commodity index investment (the financialization of commodities) has driven commodity price movements, numerous academic studies have concluded that index-based investing has not moved prices or exacerbated volatility in commodity markets in recent years. An examination of ICI data on weekly and monthly net flows into commodity mutual funds reveals that these flows have little or no effect on the overall growth rate of commodity prices. In particular, weekly flows into commodity mutual funds do not lead to future commodity price changes. These results are consistent with academic papers that find little or no impact of commodity index investors on commodity prices in individual markets. Three key factors illustrate why flows into commodity mutual funds cannot explain commodity price movements since 2004. First, commodity mutual funds experienced net outflows on average from January 2006 to June 2008 while commodity prices rose. Second, flows into commodity mutual funds are spread across a wide range of markets and thus do not concentrate investment in a particular commodity. Finally, the $47.7 billion in commodity mutual funds as of December 2011 is miniscule relative to the size of global commodity markets