The role of fundamentals and financialisation in recent commodity price developments : an empirical analysis for wheat, coffee, cotton, and oil

In the context of recent commodity price hikes, the financialisation of commodity derivative markets, reflected in the increased presence of financial investors and new financial products such as commodity index and exchange traded funds has been controversially discussed. Many studies focus on the effect of passive index investors on rising commodity prices, but hardly look at the effect of the diverse group of money managers where an important share engages in technical and trend following trading strategies and thus has the potential to push prices up and down. This is problematic given the increased importance of money managers and more generally of active trading strategies in recent years. We analyze for the commodities coffee, cotton, soft red winter and hard red winter wheat and WTI and Brent crude oil the effect of both types of financial investors within a Vector Autoregressive (VAR) model framework, conducting Granger (non-)causality tests and impulse response analyses for the period June 2006 to October 2012. We complement the bivariate model approach, which looks at the lead-lag relationship between financial investors' positions and commodity returns, with a multivariate approach. We thus assess financial investors' positions in addition to a range of fundamental and macroeconomic variables which may influence commodity prices. In both models, index investors' net long positions are not found to have a significant effect on commodity returns in recent years. In the multivariate model money managers' net long positions have a statistically significant and large effect on returns for all commodities; in the bivariate model they only have an effect for coffee. In the bivariate model, we also find that commodity returns drive money managers' positions, which may indicate the presence of trend following trading strategies. Overall, our results support the hypothesis of financialisation of commodity derivative markets.