Study Sheds Light on Commodity Investments, Questions Volatility, Price Spikes

(October 25, 2011) — A new study — titled “Long-Short Commodity Investing: Implications for Portfolio Risk and Market Regulation” — by the EDHEC-Risk Institute has shed light on the future of commodity investments.

A number of policy-makers have blamed the decade-long rise in commodity prices and recent market volatility on the growing influence of financial investors and called for new regulation restricting their participation in commodity markets, writes the author, Jolle Miffre, EDHEC-Risk Institute Professor, with market data and support from CME Group. In addition, market financialisation has also led investors to worry about higher integration between commodity and traditional financial markets weakening the portfolio benefits of commodity investment, EDHEC noted.

The study aimed to provide clarity on whether greater use of commodities as investment tools has resulted in such investments consequently losing their traditional strength of non-correlation with financial investments.

“Aside from offering better performance, lower volatility and lower correlation with stocks than the S&P-GSCI, the long-short strategies based on speculators and hedgers positions stand out for also having decreasing conditional correlations with the S&P500 index in periods of high volatility in equity markets: unlike long-only commodity portfolios, these long-short commodity portfolios thus serve as partial hedge against extreme equity risk,” the paper stated. “They are also better diversifiers than long-only commodity portfolios in periods of extreme risk in fixed income markets. The paper also contributes to the recent debate on the financialization of commodity futures markets by showing that long-short speculators had no impact on the volatility of commodity markets or on their correlation with traditional assets.”

Earlier this year, aiCIO reported that as pension funds are questioning their investments in commodities and their impact on fueling food inflation, others in the industry say that viewpoint is limited in scope. One concern among institutional investors is that billions of dollars in new investment from pensions and hedge funds may contribute to high volatility. “The last thing they want to do is to be on the other side of a trade to a starving person in Africa,” a source in the fund management industry told Reuters, noting a heightened concern among investors about rising grain and fuel prices fueling a rise in poverty in developing countries.

However, some warn that fears over commodity investment and spiraling food prices are largely unwarranted, based on incomplete information. “Yes, pensions are beginning to question their investment in the sector, thinking it may be unethical to invest in commodities. But the fact that their investment is directly pushing up prices — namely making food commodities scarce and impacting less developed countries — is largely political and press-driven,” Shelley Goldberg, director of global resources and commodities strategy at Roubini Global Economics (RGE), told aiCIO in June when asked about the social effects of investments in commodities and the possible contribution to increased poverty.

Jeremy Grantham, chief investment strategist of fund manager GMO Capital Management, has also contributed heavily to the debate on the future of commodities, writing in a March newsletter that since growth of natural resources is severely limited as population and demand soar, the age of cheap commodities prices is over. “The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value,” Grantham wrote in GMO’s quarterly newsletter. “We all need to adjust our behavior to this new environment. It would help if we did it quickly.”