UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

GENEVA

TRADE AND DEVELOPMENT

REPORT, 2009

UNITED NATIONS

New York and Geneva, 2009

UNCTAD/TDR/2009

Chapter II

The Fi

of Com

The Financialization of Commodity Markets 53

The build-up and eruption of the current global 

financial crisis was paralleled by an unusually sharp 

increase and subsequent strong reversal in the prices 

of internationally traded primary commodities. Recent developments in commodity prices have been 

exceptional in many ways. The price boom between 

2002 and mid-2008 was the most pronounced in several decades – in magnitude, duration and breadth. It 

placed a heavy burden on many developing countries 

that rely on food and energy imports, and contributed 

to food crises in a number of countries in 2007–2008 

(TDR 2008, chap. II, section C). The price decline 

since mid-2008 stands out both for its sharpness and 

for the number of commodity groups affected. It was 

one of the main channels through which the dramatic 

slowdown of economic and financial activity in the 

major industrialized countries was transmitted to the 

developing world.

The strong and sustained increase in primary 

commodity prices between 2002 and mid-2008 was 

accompanied by the growing presence of financial 

investors on commodity futures exchanges. This 

financialization of commodity markets has caused 

concern that much of the recent commodity price 

developments – and especially the steep increase in 

2007–2008 and the subsequent strong reversal – was 

largely driven by financial investors’ use of commod

ities as an asset class.

Over the 78 months from early 2002 to mid2008 the IMF’s overall commodity price index rose 

steadily and nominal prices more than quadrupled. 

During the same period, UNCTAD’s non-fuel 

commodity index tripled in nominal terms and in

creased by about 50 per cent in real terms. After 

peaking in July 2008, oil prices plunged by about 

70 per cent within six months (which represents the 

largest percentage decline ever experienced over 

such a short period), while non-fuel prices fell by 

about 35 per cent from their peak in April 2008. 

Although considerable, this reversal corresponds 

to only about one seventh of the previous six-year 

increase, so that commodity prices have remained 

well above their levels of the first half of this decade. 

Although the timing differed from one commodity to 

another, both the surge in prices and their subsequent 

sharp correction occurred in all major commodity 

categories. 

Much of the recent commodity price developments have been attributed to changes in fundamental 

supply and demand relationships (see chapter I, 

section A.2). However, the extreme scale of the recent changes in primary commodity prices, and the 

fact that prices increased and subsequently declined 

across all major categories of commodities, suggests 

that, beyond the specific functioning of commodity 

markets, broader macroeconomic and financial factors 

Chapter II

The Financialization of Commodity M

A. Introducti
54 Trade and Development Report, 2009

that operate across a large number of markets need to 

be considered to fully understand recent commodity 

price developments. The depreciation of the dollar 

was clearly one general, albeit minor, cause of the 

surge in commodity prices. But a major new element 

in commodity trading over the past few years is the 

greater presence on commodity futures exchanges of 

financial investors that treat commodities as an asset 

class. The fact that these market participants do not 

trade on the basis of fundamental supply and demand 

relationships, and that they hold, on average, very 

large positions in commodity markets, implies that 

they can exert considerable influence on commodity 

price developments. 

This chapter aims at enhancing understanding of 

how the speculative activities of financial investors 

that are active in both financial and commodity markets can influence price movements to higher or lower 

levels than those dictated by market fundamentals. 

Section B shows how commodity futures trading has 

come to be increasingly influenced by the participation of financial investors that have no interest in the 

physical delivery of primary commodities. Section C 

discusses the determinants of financial investors’ investment decisions, while sections D and E address 

the effects of their growing involvement on price developments, and the higher costs to commercial users 

of hedging against commodity price risk. Section F 

suggests the need for broadening and strengthening 

supervision and regulation of commodity markets so 

as to improve the informational value of commodity 

price developments for producers and consumers, and 

section G concludes.

B. The growing interdependence of financial 

and commodity markets

Commodity futures markets play an important 

role in price discovery and in the transfer of price risk 

from market participants that have an interest in the 

physical commodities (i.e. producers and consumers) to other agents that, driven 

by speculative motives, are prepared to assume the price risk. 

Traditionally, speculation relating to commodities has been 

based on information about demand and supply developments. 

The behaviour of market partici

pants has been based on their 

perception of changes in these 

fundamental factors. However, 

in recent years an increasing 

number of financial investors 

have entered commodity futures markets. Motivated 

by portfolio diversification considerations that are 

largely unrelated to commodity market fundamentals, 

they regard commodities as an investment alternative 

to asset classes such as equities, bonds or real estate. 

They take positions in commodities as a group, based 

on their assessment of the risk-return properties of portfolios that contain a proportion of commodity futures 

relative to portfolios that contain 

only traditional asset classes. 

One way financial investors 

can gain exposure on commodity markets is through spot 

market activities (i.e. buying 

and accumulating physical commodities in inventories). This 

strategy has probably contributed to the price increases in 

the relatively small markets for 

precious metals such as gold and 

silver (Koh, 2007). However, it is more difficult to 

pursue this physical market strategy for other commodities, especially because of the greater storage 

costs they entail.

The behaviour of financial 

investors on commodity 

markets is motivated by considerations that are largely 

unrelated to commodity 

market fundamentals.
The Financialization of Commodity Markets 55

Another way investors gain exposure on commodity markets is by engaging in the markets for 

futures contracts or options. In futures contracts, the 

trader commits to buying or selling a commodity 

at a future date and at a pre-established price (the 

futures price). This contract may be traded later, so 

that the trader would not have to actually receive or 

deliver the commodity at the fixed time. Instead, the 

commitment would be transferred to other agents, 

who would then make a gain or loss depending on 

the changes in futures prices that may have occurred. 

When agents buy options, they gain the right (but 

not the obligation) to buy or sell a commodity at a 

future date and at a pre-established price, and they 

pay a premium to the agents who make the opposite 

commitment.

Trading volumes on commodity exchanges 

increased considerably during the recent period of 

substantial rises in commodity prices. The number 

of futures and options contracts outstanding on 

commodity exchanges worldwide rose more than 

threefold between 2002 and mid-2008 (chart 2.1A). 

During the same period, the notional value1

 of 

commodity-related contracts traded over the counter (OTC) (i.e. contracts traded bilaterally, and not 

listed on any exchange) increased more than 14-fold, 

to $13 trillion (chart 2.1B).2 However, financial 

investments in commodities fell sharply starting in 

mid-2008. Some observers have taken this parallel 

development of commodity prices and financial investments in commodities as prima facie evidence of 

the role of large-scale speculative activity in driving 

commodity prices first up and then down.

Most financial investors in commodities take 

positions related to a commodity index. Two common indexes are the Standard & Poor’s Goldman 

Sachs Commodity Index (S&P GSCI) and the 

Dow Jones-Union Bank of Switzerland Commodity Index (DJ-UBSCI) (previously called the Dow 

Jones-American International Group Commodity 

Index (DJ-AIGCI)).3 These indexes are composites 

of futures contracts on a broad range of commodities 

(including energy products, agricultural products and 

metals) traded on commodity exchanges.4 Several 

variables determine the returns on investments in 

commodity indexes (see box 2.1).

Financial investors engage in commodity futures markets for portfolio reasons. This is based on 

the belief that adding commodity futures contracts to 

Chart 2.1

Financial investment in commoditi

Source: BIS, Quarterly Review, June 2009. 

0 0

2

4

6

8

10

12

14

1993 1995 1997 1999 2001 2003 2005 2007 2009 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2008

(June)

5

10

15

20

25

30

35

40

45

50

A. Futures and options contracts

outstanding on commodity exchanges,

December 1993–March 2009

(Number of contracts, millions) 

B. Notional amount of outstanding

over-the-counter commodity derivatives,

December 1998–December 2008

(Trillions of dollars) 

Other commodities

Other precious metals

Gold
56 Trade and Development Report, 2009

Box 2.1

Financial investment in commodity indexes a

the relationship between futures and spot 

Financial investment in commodity indexes is undertaken as part of a passive investment strategy (i.e. 

there is no attempt to distinguish between the good and bad performance of individual commodities). 

Financial investors gain exposure in commodity indexes by entering into a bilateral financial agreement, 

usually a swap, with a bank. They purchase parts in a commodity index from the bank, which in turn 

hedges its exposure resulting from the swap agreement through commodities futures contracts on a 

commodity exchange. 

Financial investment in commodity indexes involves only “long” positions (i.e. pledges to buy 

commodities) and relates to forward positions (i.e. no physical ownership of commodities is involved at 

any time). Index funds buy forward positions often relating to futures contracts with a remaining maturity 

of about 75 working days (i.e. roughly three calendar months), which they sell as expiry approaches, 

at about 25 working days (or roughly one calendar month) prior to expiry of the contract, and use the 

proceeds from this sale to buy forward positions again. This means that investors that own, say, the 

November crude oil contract, will sell that contract and buy the December contract before delivery 

begins on the November contract. Then they will later “roll” from December into January, and so on. 

This process – known as “rolling” – is profitable when the prices of futures contracts are progressively 

lower in the distant delivery months (i.e. in a “backwardated” market) and negative when the prices of 

futures contracts with longer maturities are progressively higher (i.e. in a “contango” market).

Four variables determine the total return earned by financial investors in commodity indexes: spot 

return + roll yield + collateral return + recomposition yield, where the spot return reflects the spot price 

movements of the underlying commodities, the collateral return is the interest on the collaterala

 that the 

investors have to set aside as margin for investments in commodity futures positions, the recomposition 

yield arises from a periodic redefinition of the basket of commodities underlying a portfolio, and the roll 

yield is obtained from selling futures contracts that have an expiry date the month prior to the delivery 

month and using the proceeds to buy futures contracts with a longer maturity.

The roll yield is similar to the risk premium that speculators expect to earn by taking an opposite position 

to that of commodity producers that seek to hedge the price risk of their output. This risk premium 

corresponds to the difference between the current futures price and the expected future spot price at the 

time the position is taken. If the futures price is set below the expected future spot price, a purchaser of 

futures contracts (speculator) will generally earn the risk premium; by contrast, if the futures price is 

higher than the expected future spot price, a seller of futures contracts (hedger) will earn the premium. 

Assuming hedgers outnumber speculators, Keynes (1930) and Hicks (1939) – in their theory of “normal 

backwardation” – expected that, in general, the futures price would be lower than the expected future 

spot price, so that the risk premium would normally accrue to speculators.

The roll yield differs slightly from this kind of risk premium because index traders do not hold futures 

contracts until their expiry. When the price of futures contracts depreciates near the delivery date, the roll 

yield is negative. Roll returns were positive during much of the 1980s and 1990s, but since 2002 they have 

mostly been negative. However, given the large spot returns during the commodity price hikes between 

2002 and mid-2008, the total return was nonetheless positive during most of this period (see chart).

The above implies that the total return on investment in commodity indexes partly depends on the 

intertemporal relationship between futures and spot prices on commodity exchanges. This relationship 

is known from financial markets, but the difference is that commodity futures markets trade contracts on 

assets that incur storage and interest costs – often called “cost of carry”. This cost implies that in order to 
The Financialization of Commodity Markets 57

induce storage, futures prices and expected future spot prices must increase more than the cost of carry 

to compensate inventory holders for the costs associated with storage. However, the cost of storage must 

be weighed against the so-called “convenience yield” (i.e. the a priori unmeasurable utility of physically 

owning a particular commodity or the premium when the inventory is sold). Inventory holders have the 

option to sell commodities on the spot markets when market conditions tighten, or to dispose of a secure 

supply of the commodity, thus insuring themselves against the costs associated with supply disruption. 

The convenience yield tends to be higher when inventories are lower, as tighter market conditions confer 

greater benefits for the physical ownership of a commodity. It will increase sharply when inventories fall 

below the level of short-term consumption requirements. 

The above elements can be combined to determine the term structure of commodity prices. The difference 

between contemporaneous spot and futures prices – often called “basis” – depends on the relative size of 

the cost of carry and the convenience yield. The negative of the basis can be expressed as follows:

Ft,T - St

 = Intt + wt - ct

where Ft,T is the futures price at date t for delivery at time T, St is the spot price at time t, Intt is the 

interest cost, wt is the storage cost, and ct is the convenience yield. An upward sloping futures curve, a 

phenomenon known as “contango”, implies that inventory holders are rewarded for the cost of carrying 

inventories. A downward sloping futures curve, a phenomenon known as “backwardation”, indicates that 

the convenience yield exceeds the cost of carry.

It should be noted that the notion of backwardation, which relates to the comparison of contemporaneous 

spot and futures prices, differs from the concept of “normal backwardation” (mentioned above), which 

Spot and roll returns on commodity index investments, January 1980–M

(Per cent)

Source: UNCTAD secretariat calculations, based on Bloomberg. 

Note: The roll return is the discount or premium obtained by “rolling” positions in futures contracts forward as they approach delivery. 

The numbers shown in the figure approximate the roll return (calculated as the difference between excess and spot returns of 

the S&P GSCI) and are expressed as six-month moving averages. The excess return reflects the return on commodity futures 

price movements, while the spot return reflects changes in spot prices.

Box 2.1 (continued)

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

May 2009

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

S&P GSCI spot return

S&P GSCI total return

S&P GSCI roll return
58 Trade and Development Report, 2009

compares futures prices with expected future spot prices. From the latter perspective, the basis is 

determined by a risk premium, πt,T, which corresponds to the difference between futures prices and 

expected future spot prices, and the expected appreciation or depreciation of the future spot price, 

[Et(ST) - St]. It can be expressed as:

Ft,T - St = [Et(ST) - St] - πt,T 

The risk premium will be positive, thus attracting more speculators to the market, to the extent that hedgers 

have net short positions and offer a risk premium to speculators with net long positions, and to the extent 

that hedging demand exceeds the net long positions of speculators. Moreover, the risk premium – and 

thus the gap between spot and futures prices – can be expected to rise when low inventories heighten the 

risk of price volatility.b Changes in traders’ positions will usually indicate changes in expected future spot 

prices with attendant effects on the term structure of contemporaneous spot and futures prices.

A major purpose of futures contracts traded on commodity exchanges is to provide a way for hedgers 

to insure themselves against unfavourable movements in the future values of spot prices. To serve this 

purpose, speculators who take positions opposite to those of hedgers must collect information on the 

likely future movements of spot prices, so that the value of the futures contract is an unbiased estimate of 

the value of the spot price on the delivery date specified in the futures contract. Policymakers, especially 

central bankers, commonly base part of their decisions on this feature, as they use the price of commodity 

futures contracts as a proxy for the market’s expectations of future commodity spot prices (Svensson, 

2005; Greenspan, 2004).

By contrast, the value of futures contracts will not serve this price discovery purpose (i) if those taking 

speculative positions base their activities on information unrelated to the underlying supply and demand 

fundamentals on commodity markets, or (ii) if the size of their position is substantially larger than that of 

hedgers so that the weight of their position determines prices. Empirical evidence generally indicates that 

futures prices are less accurate forecasts than simple alternative models such as a random walk without 

drift (i.e. expecting no change from current spot prices). Indeed, Bernanke (2008) has highlighted the 

difficulty in arriving at a reasonable estimate of future commodity price movements based on signals 

emanating from commodity futures markets. He therefore emphasizes the importance of finding 

alternative approaches to forecasting commodity market movements. Thus, empirical evidence indicates 

that mechanisms that would prevent prices from moving away from levels determined by fundamental 

supply and demand factors – the efficient absorption of commodity-related information and sufficiently 

strong price elasticity of supply and demand – may be relatively weak on commodity markets.

a Collateral is a position set aside by traders to ensure that they are able to fulfil their contractual commitments. 

During the lifetime of a futures contract, the clearing house of the concerned commodity exchange issues margin 

calls to adjust the amount of collateral so as to reflect changes in the notional value of traders’ contractual 

commitments.

b Falling inventories signal the scarcity of the commodity for immediate delivery, which will cause spot prices 

to increase. Futures prices will also increase, but not by as much, because of expectations that inventories will 

be restored over time and spot prices will return to normal levels, and perhaps also because the risk premium 

rises. However, if inventories are slow to adjust, past demand and supply shocks will persist in current inventory 

levels. 

Box 2.1 (concluded)
The Financialization of Commodity Markets 59

their portfolio improves its overall risk-return characteristics: these contracts exhibit the same average return as investments in equities, but over the 

business cycle their return is negatively correlated 

with that on equities and bonds. Moreover, the returns on commodities are less volatile than those on 

equities or bonds, because the 

pairwise correlations between 

returns on futures contracts for 

various commodities (e.g. oil 

and copper, or oil and maize) 

traditionally have been relatively low (Gorton and Rouwenhorst, 2006).

Contrary to equities and 

bonds, commodity futures contracts also have good hedging 

properties against inflation (i.e. their return is posi

tively correlated with inflation). This is because 

commodity futures contracts represent a bet on 

commodity prices, such as those of energy and food 

products that have a strong weight in the goods baskets used for measuring current price levels. Also, 

futures prices reflect information about expected 

changes in commodity prices, so that they rise and 

fall in line with deviations from expected inflation. 

Furthermore, investing in commodity futures contracts tends to provide a hedge against changes in 

the exchange rate of the dollar. One reason for this 

may be the fact that most commodities are traded in dollars. 

Given that a depreciation of the 

dollar exchange rate reduces 

the purchasing power of commodity exports, exporters may 

attempt to increase commodity 

prices in dollar terms to compensate for any depreciationrelated shortfalls in earnings. 

Commodity exporters may also 

diversify their reserve holdings 

by changing dollars into euros in order to reduce the 

exchange-rate risk associated with foreign-exchange 

reserves. This could explain why, between 2006 and 

2008, the turning points in oil prices frequently mirrored those in the exchange rate of the dollar vis-à-vis 

the euro (Till, 2008: 33).

Financial investors invest 

in commodity markets 

with a view to broadening 

their portfolios in order to 

diversify risk. 

Establishing a link between speculation and 

commodity price developments often meets with 

scepticism. This scepticism is based partly on the 

argument that financial investors only participate in 

futures and related derivative markets, and that they 

will affect spot prices only if they take delivery and 

hold the physical commodities in inventories. In 

relation to oil prices, for example, Krugman (2008) 

argues that speculative activity that drives prices 

above fundamental equilibrium prices will cause 

market imbalances and excess supply, which eventually must result in inventory accumulation. However, 

no inventory accumulation was observed during the 

sharp increase in oil prices in 2007–2008, so that, 

according to this reasoning, speculation cannot have 

played a role in the oil price hike.

However, arbitrage forces may change spot 

prices following a change in futures prices, without 

a significant increase in actual transactions. Since the 

short-run price elasticity of commodity supply and 

demand is extremely low, only very sharp and lasting 

price changes can be expected to trigger significant 

supply and demand responses and related changes in 

inventories. Moreover, the financialization of commodity trading appears to have led to greater price 

C. Problems with the financialization 

of commodity futures trading
60 Trade and Development Report, 2009

volatility (see below), which is known to increase 

precautionary demand. This in turn implies that an 

increase in spot prices should not necessarily be 

associated with a decline in market demand and a 

resulting accumulation of inventories. Rather, the accumulation 

of inventories will occur only 

gradually and spot prices will 

overshoot during this process. 

This means that during periods of increased precautionary 

demand “there is no reason to 

expect a positive contemporaneous correlation between inventories and the precautionary 

demand component of the spot price” (Alquist and 

Kilian, 2007: 37).

Finally, as noted by the IMF (2008a: 89), “data 

on commodity inventories are poor and lack global 

coverage”. Inventory data suffer from at least three 

shortcomings: (i) the absence of a common database that would include comprehensive data for all 

commodities; (ii) conceptual questions relating to 

the definition of relevant inventories, given that, 

currently, data are available only for inventories 

held at delivery points (e.g. for industrial metals, in 

warehouses at the London Metal Exchange (LME), 

and for oil, in Cushing, Oklahoma), while there are 

no data for inventories that are held off exchange but 

could be made available economically at the delivery point at short notice; and (iii) information about 

inventories is often published with a time lag and subsequently revised (Gorton, Hayashi and Rouwenhorst 

(2007: 11). Overall, existing official inventory data 

are not reliable indicators in the debate on the relative 

impact of fundamentals and of financial investors on 

commodity prices.

More fundamental scepticism with regard to the link 

between speculation and commodity price developments is 

based on the “efficient market” hypothesis. According to 

this view, prices perfectly and 

instantaneously respond to all 

available information relevant 

to a freely operating market. 

Market participants continuously update their expectations from inflowing public and private information. This means that prices will move either when 

new information becomes publicly available (e.g. 

when harvest forecasts or changes in oil production 

are announced), or when private information is reflected in prices through transactions.

There are at least two reasons why the efficient market 

hypothesis may fail in relation 

to commodity markets, at least 

in the short run. First, changes 

in market positions may occur 

in response to factors other than 

information about market fundamentals. Second, individual 

market participants may take 

position changes that are so large relative to the size 

of the market that they move prices (the so-called 

“weight-of-money” effect). 

To examine how different sorts of information 

may influence market positions, it is useful to group 

market participants into three categories based on differences in their rationale for position taking: informed 

traders, uninformed traders and noise traders.

Informed traders rely on information about current market fundamentals and on forecasts of future 

market conditions. However, making an informed 

market assessment faces two difficulties: (i) mediumand longer-term commodity supply and demand 

conditions are subject to considerable uncertainty 

(for example because of unknown depletion rates 

of non-renewable resources and unknown effects 

of climate change on agricultural production); and 

(ii) inventory data, which provide valuable signals for 

short-term price expectations, suffer from significant 

measurement errors, as already mentioned, and data 

on current global commodity 

supply and demand conditions 

are published with large time 

lags and are frequently revised. 

Therefore, informed traders must 

formulate price expectations on 

the basis of partial and uncertain 

data. This may lead them to focus 

on a small number of available 

signals, with the attendant risk 

of herding and copying the 

behaviour of others. Alternatively, it may cause traders to consider past price 

movements themselves as a good guide to future 

developments.

Arbitrage forces may change 

spot prices following a 

change in futures prices, 

without a significant increase 

in actual transactions.

Official inventory data are 

not reliable indicators in 

the debate on the impact 

of financial investors on 

commodity prices.
The Financialization of Commodity Markets 61

Noise traders trade for broader strategic reasons, 

and make position changes irrespective of prevailing 

conditions on commodity markets. On commodity 

markets, index traders behave like noise traders: they 

change their total positions in commodities based on 

information relating to other asset markets but which 

has no relevance for commodity markets. In addition, 

they tend to change the composition of their positions 

in commodities in response to different price changes 

for different commodities with a view to maintaining a specific commodity’s predetermined weight in 

a commodity index. This makes it difficult for other 

traders to judge whether market prices are changing 

because of the position changes of the noise traders 

or as a response to new information about market 

fundamentals. 

Uninformed traders, who glean information on 

future price developments from current and past price 

movements, are particularly exposed to such situations. 

They follow what may be called “momentum strategies” – buying commodities that have experienced 

rising prices and selling those 

that have underperformed. Uninformed traders observe price 

movements but are unable to 

identify whether price changes 

were caused by informed or 

noise trading. Hence, they risk 

misinterpreting a noise trader’s 

position change as a genuine 

price signal and, by incorporating this signal into their trading 

strategy, perpetuate the “informational” value of this 

signal across the market. Given that uninformed traders often use similar trend identification techniques, 

they run the risk of collectively generating the trends 

that they then individually identify and follow. On 

commodity markets, money managers, such as pension funds, behave like momentum traders.

One effect of momentum trading that uses 

statistical analysis tools is that the resulting changes 

in positions can be anticipated by other market 

participants. Thus, it provides continued arbitrage 

possibilities. Speculators will try to benefit from such 

profit opportunities. Traders working for financial 

institutions will do this in order to meet their institutions’ short-term performance targets or reporting 

requirements, even if doing so implies going against 

signals from long-term fundamental supply and demand factors (de Long et al., 1990). This can lead 

to speculative bubbles. The same kind of snowball 

effect can be created by commodity trading by financial investors when they react to signals from other, 

non-commodity markets. This can occur if the price 

changes stemming from their position changes feed 

into momentum trading strategies. Momentum trading on commodity markets is not a new phenomenon. 

However, the trend towards greater financialization 

of commodity trading is likely to have increased the 

number and relative size of price changes that are 

unrelated to market fundamentals.

It is highly probable that these mechanisms, 

which lead to speculative bubbles, have been at work 

on commodity futures exchanges, given the correlation between the trading activities of index traders 

and those of momentum-trading money managers. 

Such a correlation during the period January 2005–

August 2008 has been documented for agricultural 

markets such as cotton, maize, soybeans and wheat. 

On the other hand, the market presence of these trader 

categories in natural gas and crude oil markets has 

displayed an inverse relationship 

(Informa Economics, 2009).5

This difference between 

agricultural and energy markets 

also occurs with respect to the 

correlation between price volatility and the market presence 

of these two trader categories. 

For all the examined agricultural 

products, except soybeans, the 

trading activity of both these trader categories was 

observed to be positively correlated with price volatility, while the presence of index traders in the gas 

and oil markets was seen to be inversely correlated 

with price volatility. Given that price volatility was 

significantly higher in the oil and gas markets than 

in the agricultural markets (Informa Economics, 

2009, Part 3: 5–12), and that these energy markets 

are generally much more liquid than agricultural 

markets, this finding suggests that on energy markets 

money managers could rely on a larger number of, 

and stronger, price signals, and were therefore less 

exposed to “wrong” signals coming from index traders. Hence, the impact of position taking by index 

traders on momentum trading has most likely been 

concentrated in agricultural markets. 

A second reason why the efficient market hypothesis may fail on commodity markets relates to 

Financialization of commodity 

trading appears to have 

increased price changes 

that are unrelated to market 

fundamentals.
62 Trade and Development Report, 2009

the fact that the number of counterparties (especially 

those with an interest in physical commodities) and 

the size of their positions are less than perfectly price 

elastic. Thus, large orders may face short-term liquidity constraints and cause significant price shifts. This 

implies the possibility of a temporary, or even persistent, “weight-of-money” effect, which is particularly 

high in commodity markets where the short-run price 

elasticity of both production and consumption is very 

low, and hence the physical adjustment mechanisms 

of markets are weak. As a result, in tight markets 

with minimum inventory levels, the relevance of 

expectations based on longer-term fundamental 

factors sharply declines, which makes it difficult to 

determine a market price solely on the basis of fundamentals. “This indeterminacy allows weight of the 

speculative money to determine the level of prices” 

(Gilbert, 2008a: 19). 

The weight-of-money effect relates primarily 

to index-based investment. One reason for their 

relatively large size relates to the fact that index traders take positions across many 

commodities in proportions that 

depend only on the weighting 

formula of the particular index, 

independent of the specific market conditions for the individual 

commodities contained in the 

index. Hence, large positions 

taken by index traders implies a 

significant risk that the weightof-money effect will exacerbate the price impact of 

trading in response to factors other than information 

about commodity market fundamentals.

The analytical distinction between informed, 

uninformed and noise traders (table 2.1) is difficult 

to apply in practice. The Commodity Futures Trading Commission (CFTC) – the institution mandated 

to regulate and oversee commodity futures trading 

in the United States – publishes trading positions in 

anonymous and summary form in its weekly Commitments of Traders (COT) reports. The CFTC classifies 

market participants as “commercial” if they are hedging an existing exposure, and as “non-commercial” 

if they are not.6

 However, it is widely perceived that, 

as a consequence of the growing diversity of futures 

market participants and the greater complexity of 

their activities, the COT data may fail to fully represent futures market activity (CFTC, 2006a). This 

is because those hedging, and therefore defined as 

commercial market participants, have normally 

been considered entities involved in the production, 

processing or merchandising of commodities. However, many market participants who report positions 

as hedges, and who therefore fall under the “commercial” category, are in fact commodity swap dealers, 

such as commodity index traders, who have no interest in the physical commodities. If their underlying 

positions were held directly as commodity futures 

contracts (rather than being intermediated through 

OTC swap agreements), they would be categorized 

as “non-commercial”.

Responding to these concerns, in 2007 the CFTC 

started to issue supplementary data on the positions 

of commodity index traders for 12 agricultural commodities (CFTC, 2006b).7

 The index trader positions 

include both pension funds, previously classified as 

non-commercial traders, and swap dealers, that had 

been classified as commercial traders. According to 

the CFTC (2009), commodity index traders generally replicate a commodity index, but may belong to 

either the commercial or noncommercial category. 

A primary concern often 

expressed with respect to the 

financialization of commodity 

trading relates to the magnitude 

of index trader activity, combined with the fact that such 

traders tend to take only long 

positions. Table 2.2 provides evidence of the relative 

share of both long and short positions held by different trader categories in those agricultural markets for 

which the CFTC has been publishing disaggregated 

data for January 2006 onwards.8

 The data clearly 

show that index funds are present almost exclusively 

in long positions,9

 and that they account for a large 

portion of the open interest in some food commodity 

markets.10 Indeed, over the period 2006–2008, the 

relative shares of index traders in total long positions 

in cotton, live cattle, feeder cattle, lean hogs and 

wheat were significantly larger than the positions 

of commercial traders in those commodities, while 

they were roughly of equal size for maize, soybeans 

and soybean oil.

While the number of index traders is relatively 

small, their average long position is very large (middle panel of table 2.2), sometimes more than 10 times 

the size of an average long position held by either 

The impact of index traders 

on momentum trading seems 

to have been concentrated in 

agricultural markets.
The Financialization of Commodity Markets 63

Table 2.1

Commodity futures trading behaviour: tradi

speculators, managed funds and index trad

Traditional speculators Managed funds Index traders

General market 

position

Active positions on both sides of 

the market; able to benefit in both 

rising and declining markets

Active, often large, positions on 

both sides of market; able to 

benefit in both rising and declining 

markets; relatively opaque 

positions

Passive, large and long-only 

positions in swap agreements with 

banks, which in turn hold futures 

contracts to offset their short 

positions; able to benefit only 

in rising or backwardated (spot 

price>forward price) markets; 

transparent positions

Position taking 

behaviour 

React to changes in commodity 

market fundamentals (supply, 

demand, inventories); mostly 

trade in one or two commodities 

of which they have intimate 

knowledge; leveraged positions

Some (e.g. hedge funds) conduct 

research on commodity-market 

fundamentals and thus react to 

changes in those fundamentals. 

Others (e.g. commodity trading 

advisers) mostly use statistical 

analyses (trend identification and 

extrapolation, automatic computerized trading), which extract information from price movements. 

They thereby risk misinterpreting 

noise trader position taking for 

genuine price information, engaging in herd behaviour and causing 

snowball effects; leveraged 

positions

Not interested in fundamentals 

of specific commodity markets 

but may have views on 

commodities as a whole; relative 

size of positions in individual 

commodities determined by 

an index weighting formula; 

idiosyncratic position taking such 

as rolling at predetermined dates; 

position changes are relatively 

easy to predict; fully collateralized 

positions

Impact on liquidity Improve liquidity Active, large positions can 

improve liquidity and make 

hedging easier for large 

commercial users. In periods of 

rapid and sharp price changes, 

large positions are a “liquidity 

sponge”, making it difficult for 

hedgers with commercial interests 

to place orders

Passive, large positions act as a 

“liquidity sponge”

Reaction to sharp 

price changes

May be taken by surprise if 

price changes are unrelated to 

fundamentals; can be forced out 

of the market if they lack liquidity 

to meet margin calls triggered by 

sharp price increases

Taking and closing positions are 

often automatically triggered 

by computer programs; risk of 

causing a snowball effect

Different price developments 

for individual commodities 

require recomposition of relative 

investment positions to preserve 

a predetermined index weight 

pattern; sharp price declines may 

cause disinvestment

Reaction to changes 

on other markets

Operate only in commodity 

markets; normally concentrate on 

one or a few commodities, and 

thus react little to developments in 

other markets

Operate across different asset 

classes. Commodities tend to 

have a fixed weight in managed 

fund portfolios, so that price 

movements in other markets 

can lead to position changes in 

commodity markets

Operate across different asset 

classes. Potentially strong links 

between commodity futures 

market activity and developments 

on equity and bond markets, in 

two ways: (i) risk-return combinations in other asset classes can 

become more attractive, causing 

a withdrawal from commodity 

markets; (ii) margin calls on other 

investments can trigger closing 

of positions in commodities and 

accelerate contagion across asset 

classes

Classification in 

CFTC Commitment 

of Traders Reports

Non-commercial user category Mostly in non-commercial user 

category

Mostly in commercial user 

category

Source: UNCTAD secretariat.
64 Trade and Development Report, 2009

commercial or non-commercial traders. Positions 

of this order are likely to have sufficiently strong 

financial power to influence prices (Capuano, 2006). 

As a result, speculative bubbles may form, and price 

changes can no longer be interpreted as reflecting 

fundamental supply and demand signals. All of this 

can have an extremely detrimental effect on normal 

trading activities and market efficiency, despite position limits that exist to contain speculation.11

During the period 2006–2008, index traders 

actually exceeded speculative position limits in wheat 

contracts on the Chicago Board of Trade (CBOT), and 

for other commodities they came much closer to these 

limits than did the other trader categories (right-hand 

panel of table 2.2). This is perfectly legal, as index 

traders are generally classified as commercial traders, 

and therefore are not subject to speculative position 

limits. But, as noted by Sanders, Irwin and Merrin 

Table 2.2

Futures and options market positions, by trader group, sel

agricultural commodities, January 2006–December 2

(Per cent and number of contracts)

Long positions

Percentage share in total positions Average position size

Speculative

limits

Commodity

NoncommercialCommercial IndexNonreportingNoncommercialCommercial Index

Maize 42.4 23.4 22.8 11.3 1 134 1 499 16 260 22 000

Soybeans 42.1 20.4 25.2 12.2 590 1 052 6 024 10 000

Soybean oil 38.0 28.4 23.8 9.8 790 1 719 4 418 6 500

Wheat, CBOT 39.0 12.3 41.1 7.5 553 964 8 326 6 500

Wheat, KCBOT 38.1 23.4 21.0 17.5 680 632 1 816 6 500

Cotton 41.0 20.1 30.7 8.3 363 1 010 4 095 5 000

Live cattle 39.3 12.0 39.7 9.0 580 409 4 743 5 150

Feeder cattle 42.5 15.7 24.6 17.2 258 162 469 1 000

Lean hogs 36.3 8.7 43.8 11.3 419 712 3 983 4 100

Short positions

Percentage share in total positions Average position size

Speculative

limits

Commodity

NoncommercialCommercial IndexNonreportingNoncommercialCommercial Index

Maize 34.7 47.2 1.2 16.9 618 2 469 1 579 22 000

Soybeans 36.4 44.6 1.2 17.8 365 1 696 736 10 000

Soybean oil 29.1 63.2 0.9 6.7 512 3 385 720 6 500

Wheat, CBOT 41.7 42.3 3.0 12.9 554 2 124 1 218 6 500

Wheat, KCBOT 20.4 56.0 0.5 23.1 378 1 123 221 6 500

Cotton 39.8 54.1 1.0 5.1 380 2 706 496 5 000

Live cattle 34.5 43.8 0.7 21.0 456 879 487 5 150

Feeder cattle 34.0 20.9 1.0 44.2 166 150 213 1 000

Lean hogs 38.3 43.1 0.8 17.9 405 1 952 353 4 100

Source: UNCTAD secretariat calculations, based on data from CFTC; speculative limits from Sanders, Irwin and Merrin (2008: 25).

Note: Following the methodology applied by Sanders, Irwin and Merrin (2008), spread positions were added to both long and short 

positions for the percentage shares in total positions. Average size of spread positions is not reported here.

CBOT = Chicago Board of Trade.

KCBOT = Kansas City Board of Trade.
The Financialization of Commodity Markets 65

(2008: 8), “it does provide some indirect evidence 

that speculators or investors are able to use ... [existing] instruments and commercial hedge exemptions 

to surpass speculative limits”.

While the COT reports cover only 12 agricultural commodities, the data which they provide can 

be used to gauge the importance of index trading 

more generally. One way of making such an estimation is to assume that: (i) all index traders follow the 

energy-heavy S&P GSCI and the agriculture-heavy 

DJ-UBSCI, with an imposed fixed market share of 

50 per cent each in the S&P GSCI and the DJ-UBSCI; 

and (ii) the shares of the specific commodities within 

each of the two indexes have remained unchanged 

since January 2006 (i.e. when the COT data began to 

be collected).12 To prevent different price movements 

for different commodities from unduly influencing the results, the estimation is based on data on 

the number of contracts, and is expressed as index 

numbers. It should be noted that it is a conservative 

estimate of the size of financial investments in commodities, because it only relates to index trading 

but does not include positions taken by pension and 

hedge funds, investments in other vehicles (such as 

commodity mutual funds, exchange-traded funds and 

notes), equities of commodity companies and direct 

physical holdings. Neither does it include similar 

contracts that are traded over the counter, or trading 

activities outside the exchanges that are overseen by 

the CFTC.

The estimation suggests that the size of net long 

positions of index traders on commodity markets 

almost doubled between January 2006 and May 2008 

(see chart 2.2). Index trader positions recorded sharp 

rises in the first quarter of 2006 and between the 

fourth quarter of 2007 and the second quarter of 2008, 

while they fell sharply in the third and fourth quarters 

of 2008. The chart also shows that the evolution of 

non-energy commodity prices is strongly correlated 

with that of index trader positions (the correlation coefficient being 0.93 for the period January 2006–June 

2008), while the correlation between energy prices 

and index trader positions is somewhat weaker (the 

correlation coefficient being 0.84). 

Chart 2.2

Estimated index trader positions and commodity prices, January 2006–M

(Index numbers, January 2006 = 100) 

Source: UNCTAD secretariat calculations, based on Bloomberg; Goldman Sachs; and CFTC. 

Note: The positions of commodity index traders are estimated based on the January 2006 weights of both the S&P GSCI and DJUBSCI, and index trader positions reported in the CFTC's Commodity Index Trader Supplement. 

50

60

70

80

90

100

110

120

130

140

150

160

170

180

190

200

210

220

1 2 3 45 6 78 910 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2345

2006 2007 2008 2009

Estimated net long positions of 

commodity index traders

S&P GSCI non-energy 

official close index

S&P GSCI energy official 

close index
66 Trade and Development Report, 2009

Correlation alone does not indicate causation. 

But there is little reason to believe that price changes 

caused position changes. On the contrary, given that 

index traders tend to follow a passive trading strategy, it is most likely that position changes caused 

price changes. Overall, the chart 

indicates that the effect of position taking by index traders 

appears to have been particularly pronounced in the smaller 

commodity markets, such as 

for food products, rather than 

in the much publicized energy 

markets. The following section 

sheds more light on this.

In sum, commodity futures 

exchanges do not function in accordance with the efficient market hypothesis. Rather, they function in such a way that 

commodity prices may deviate, at least in the short 

run, quite far from levels that would reliably reflect 

fundamental supply and demand factors. Financial 

investors that do not trade based on commodity market fundamentals have gained considerable weight 

in commodity markets. Given that commodity trading is based on partial and uncertain data on only a 

small number of signals, it is likely that large-scale financial investments provide price 

impulses. The herd behaviour of 

many commodity market participants can reinforce such impulses, which will persist if the 

short-term inelasticity of supply 

and demand prevents an immediate response that would push 

prices back to levels determined 

by fundamentals. Thus the traditional mechanisms – efficient 

absorption of information and 

physical adjustment of markets 

– that have normally prevented 

prices from moving away from levels determined 

by fundamental supply and demand factors have become weak in the short term. This heightens the risk 

of speculative bubbles occurring.

The financialization of 

commodity markets has 

weakened their efficient use 

of information and physical 

adjustment mechanisms ... 

this heightens the risk of 

speculative bubbles occurring.

1. Commodity prices, equity indexes and 

exchange rates

As already mentioned, financial investors in 

commodity markets aim to diversify their asset portfolios and/or hedge inflation risk. Their decisions to 

invest in commodities thus depend on broad-based 

portfolio considerations that also include the risk and 

return characteristics of other asset classes, including 

equities, bonds and exchange rates.

There is substantial historic evidence of the 

improved risk-return characteristics of portfolios that 

include commodity futures contracts in addition to 

equities and bonds. Gorton and Rouwenhorst (2006), 

for example, provide such evidence for the period 

1959–2004. Investment in commodities appears 

to have been a particularly effective hedge against 

inflation and dollar depreciation since 2005, as the 

correlation between these two variables and commodity prices was much higher during the period 2005 to 

early 2009 than in previous years (chart 2.3A).

By contrast, there are indications that commodity prices, equity markets and the exchange rates 

of currencies affected by carry trade speculation13

moved in tandem during much of the period of the 

commodity price hike in 2005–2008, and in particular 

during the subsequent sharp correction in the second 

D. The impact of financialization on commodity price developments
The Financialization of Commodity Markets 67

half of 2008. Commodity and equity prices were 

largely uncorrelated between 2002 and 2005, but 

were positively correlated during much of the period 

2005–2008 (chart 2.3A). There has also been a strong 

correlation of commodity prices 

– particularly since 2004 – with 

the exchange rate of carry trade 

currencies such as the Icelandic 

krona and the Hungarian forint 

(chart 2.3B). This correlation 

was particularly strong during 

the unwinding of speculative 

positions in both currency and 

commodity markets during the 

second half of 2008 (UNCTAD, 

2009: 28). Commodity index 

traders started unwinding their 

positions in commodities because their swap agreements with banks began to be exposed to significantly 

larger counterparty risks, while managed funds started 

unwinding their exposure in commodities when their 

leveraged positions faced refinancing difficulties.

Taken together, this evidence for the past few 

years indicates that, relative to the historic importance 

of strategic diversification considerations, tactical 

reasoning may recently have played a greater role 

for financial investors in commodities. Indeed, the search 

for higher yields through commodities trading may have been 

based on the illusion of riskfree profit maximization, given 

the historic diversification and 

hedging characteristics of financial investment in commodities. 

Financial investors started to 

unwind their relatively liquid 

positions in commodities when 

their investments in other asset 

classes began experiencing increasing difficulties. 

This strong correlation between commodities and 

other asset classes during the second half of 2008 

suggests that financial investors may have strongly 

influenced commodity price developments.

Chart 2.3

Correlation between movements in commodity prices

selected financial variables, January 2002–December 2

Source: UNCTAD secretariat calculations, based on Bloomberg.

Note: The data shown are six-month moving averages of 60-day rolling correlations between the S&P GSCI and the respective 

financial variable. Expected inflation is the difference between nominal and real United States 10-year bonds.

The close correlation 

between commodities and 

other asset classes during the 

second half of 2008 suggests 

that financial investors may 

have had a strong influence 

on commodity prices. 

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

01/01/2002 01/07/2003 01/01/2005 01/07/2006 01/01/2008

Expected inflation

S&P 500 index

Euro per dollar

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

01/01/2002 01/07/2003 01/01/2005 01/07/2006 01/01/2008

Icelandic krona 

Hungarian forint per 100 yen

per 100 yen

A. Correlation between movements in 

commodity prices and equity prices,

 dollar exchange rate and inflation

B. Correlation between movements in 

commodity prices and selected 

 exchange rates

19/12/08 19/12/08
68 Trade and Development Report, 2009

2. Position taking and price developments

To gauge the link between changes in the positions of different trader categories and price changes, 

chart 2.4 shows, for the period January 2002–May 

2009, net long non-commercial positions for crude 

oil, copper, wheat, maize, soybeans and soybean 

oil, as well as the net long index-trader positions for 

wheat, maize, soybean and soybean oil, for which 

separate data from January 2006 onwards began to 

be published by the CFTC. The chart confirms that 

market participants in the commercial category account for an overwhelming proportion of index trader 

positions (see also table 2.2).

However, chart 2.4 provides only scant evidence of a correlation between position and price 

changes.14 While there clearly are periods and commodities where positions and prices have moved 

together, especially during the recent downturn and 

occasionally during the previous price upturn, there 

are other times when positions have not risen during 

periods of rapid price appreciation. For example, 

in the wheat market there was no increase in either 

non-commercial positions or index trader positions 

during the steep price increase from mid-2007 to the 

end of the first quarter of 2008. By contrast, during 

the same period there appears to have been a positive 

correlation between market positions and prices in 

the maize and soybean markets, while the evidence 

is mixed for the soybean oil market. 

For oil and copper, for which separate data on 

index trader positions are not available, non-commercial positions declined along with prices in the 

second half of 2008. On the other hand, evidence for 

the earlier price increase does not suggest a correlation between non-commercial positions and prices: 

non-commercial copper positions declined during the 

period of the sharpest price increases – roughly from 

the beginning of 2004 through mid-2006. For oil, 

non-commercial positions exhibited strong volatility, even as oil prices rose almost continuously from 

the beginning of 2007 through the second quarter of 

2008, by which time net oil positions had dropped 

roughly to zero.

Since the beginning of 2009, there has been an 

increase in the net long positions of both index traders and non-commercial participants excluding index 

traders (chart. 2.4). This may indicate that after the 

strong decline in their positions during the second 

half of 2008, both these groups are once again taking 

large positions on commodity markets.

While the evidence in chart 2.4 does not point 

to a long-standing correlation between position and 

price changes, for most commodities some correlation is present over sub-periods, as peaks and turning 

points seem to occur around the same time across 

the two series. This suggests that any analysis of a 

relationship between position and price changes may 

be sensitive to the choice of time period.15

Generally, Granger causality tests, which examine causal lead and lag dynamics between changes 

in the positions of financial investors on commodity 

futures exchanges and changes in commodity prices, 

have not found evidence of a systematic impact on 

prices of positions taken by non-commercial traders. 

However, they have tended to find a statistically significant causal relationship between the movement of 

commodity futures prices and measures of position 

changes (see, for example, IMF, 2008b). However, 

the results of these studies suffer from a number of 

data problems. These include the aggregation of 

trader positions across maturities, the fact that weekly 

data cannot identify very short-term effects, even 

though intra-week trading activity may be significant (for example when index traders roll over their 

positions), and the fact that they usually concentrate 

on non-commercial positions thereby ignoring the 

positions of index traders.16

Using Granger causality tests to examine the effects of index-based investments on futures prices for 

grains on the Chicago Board of Trade, and CFTC’s 

supplementary data reports in order to distinguish 

between positions held by index investors and those 

of other traders, Gilbert (2008a) found significant 

and persistent effects from index-based investments 

on the soybean market over the period February 

2007–August 2008 (also apparent in chart 2.4), but 

failed to find such effects for maize, soybean oil or 

wheat futures. Investigating the same hypothesis 

in relation to the IMF food commodity price index 

using monthly data for the period April 2006–August 

2008, Gilbert (2008b) found evidence that index investments in agricultural futures markets had raised 

food commodity prices. He explained this by the 

tendency of financial investors to look at the likely 

returns on commodities as an aggregate asset class, 

and not at likely returns on specific commodities. 
The Financialization of Commodity Markets 69

Chart 2.4

Financial positions and prices, selected commodities, January 2002–May 

Source: UNCTAD secretariat calculations, based on Bloomberg; and CFTC. 

Note: CIT = commodity index traders. Price refers to $/barrel for crude oil, cents/bushel for wheat, maize and soybeans, and cents/lb 

for copper and soybean oil.

Crude oil, light sweet (NYMEX)

01/01/2002 06/01/2004 03/01/2006 01/01/2008

0

20

40

60

80

100

120

140

160

26/05/2009

Copper (NYMEX)

-40

-30

-20

-10

0

10

20

30

40

50

60

01/01/2002 06/01/2004 03/01/2006 01/01/2008

0

50

100

150

200

250

300

350

400

450

26/05/2009

Wheat (Chicago Board of Trade)

-100

-50

0

50

100

150

200

250

01/01/2002 06/01/2004 03/01/2006 01/01/2008

0

200

400

600

800

1 000

1 200

1 400

26/05/2009

Maize (Chicago Board of Trade)

-200

-100

0

100

200

300

400

500

01/01/2002 06/01/2004 03/01/2006 01/01/2008

0

100

200

300

400

500

600

700

800

26/05/2009

Soybeans (Chicago Board of Trade)

-100

-50

0

50

100

150

200

250

01/01/2002 06/01/2004 03/01/2006 01/01/2008

 0

 200

 400

600

800

1 000

1 200

1 400

1 600

1 800

26/05/2009

Soybean oil (Chicago Board of Trade)

-60

-40

-20

0

20

40

60

80

100

01/01/2002 06/01/2004 03/01/2006 01/01/2008

0

10

20

30

40

50

60

70

80

26/05/2009

Net long non-commercial positions; futures and options contracts (thousands)

Net long non-commercial positions excl. CIT; futures and options contracts (thousands)

Net long CIT positions; futures and options contracts (thousands)

Price (right scale)

-50

0

50

100

150

200
70 Trade and Development Report, 2009

This may have increased price correlations across 

markets and transmitted upward price movements 

in the energy and metals markets to the agricultural 

commodities markets. Gilbert concluded that, overall, 

“there is weak evidence that index investment may 

have been partially responsible for raising at least 

some commodity prices during the recent boom” 

(Gilbert, 2008a: 24).

Causal analysis of price formation for specific 

commodities is usually undertaken with the help 

of structural econometric models that incorporate 

both the role of current fundamental supply and 

demand factors and expectations about the future 

development of those factors. These models enable 

a distinction to be made between the relative impact 

of the fundamental factors and financial investments 

on price developments.

Kaufmann et al. (2008) have attempted to explain oil price developments on the basis of supply 

and demand levels, refinery capacity and expectations 

which provide an incentive for inventory storage that 

bolsters demand.17 Crude oil prices predicted by the 

model were fairly close to actual prices until about 

mid-2007, when the predicted prices began to grow 

rapidly but the actual prices increased even more 

rapidly and started to exceed the predicted prices by 

a substantial margin (chart 2.5). This result suggests 

that fundamental supply and demand factors pushed 

stocks downwards and prices upwards starting from 

2003, but in 2007-2008 prices rose above their fundamental levels.18

3. Statistical properties of price 

developments

(a) Price volatility

Price volatility is a key feature of commodity 

markets; indeed, annual price changes sometimes 

exceed 50 per cent (chart 2.4). In addition to reasons 

particular to each commodity, the low short-run price 

elasticity of both supply and demand is the main 

reason for sharp price fluctuations. As a result, price 

changes tend to overshoot any supply and demand 

shock.

It is possible to gauge how the greater presence 

of financial investors on commodity exchanges has 

affected commodity price volatility by examining the 

standard deviation of weekly price changes (chart 2.6). 

During the period 1997–2001, commodity price developments were relatively smooth and financial investments in commodity markets were low. Booms in 

commodity prices and financial investments started 

roughly in 2002, commodity prices and index trader 

investments sharply increased in 2007 and peaked 

roughly in mid-2008. This analysis therefore distinguishes three periods: January 1997–December 2001, 

January 2002–December 2006, and January 2007–

June 2008. The chart reveals that price volatility was 

highest in the third period for all commodities except 

oil, and for most of the commodities it was lowest 

in the first period. The fact that price volatility also 

increased for commodities that are not included in the 

major commodity indexes, such as rice and palm oil, 

may suggest that factors other than the financialization 

of commodity markets must have caused the increase 

in price volatility of exchange-traded commodities. 

However, there are clearly substitution effects between commodities of the two groups in terms of 

both production and consumption, as between wheat 

Chart 2.5

Actual and predicted cru

oil prices, 1997–2008

(Dollars per barrel)

Source: Kaufmann et al., 2008; and private communication from 

RK Kaufmann.

0

20

40

60

80

100

1234123412341234123412341234123412341234123412

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 08

NYMEX

Predicted
The Financialization of Commodity Markets 71

and rice, and between palm oil on the one hand and 

soybean oil and crude oil on the other.

Time-series evidence based on daily price data 

for the period January 2005–August 2008 also shows 

that price volatility increased, except for crude oil 

(Informa Economics, 2009, part 3). What is more, this 

examination of non-public data indicates that positions taken by money managers, 

and in particular those taken by 

index traders, were positively 

correlated with price volatility 

in agricultural markets, as mentioned earlier. This speculative 

activity may well have been 

attracted by higher volatility. 

However, given that index traders generally follow a passive 

trading strategy, it is more likely 

that it was an increase in their 

activity that caused greater price volatility. Taken 

together, the evidence suggests that the growing 

participation of financial investors in commodity 

markets has increased price volatility.

(b) Price co-movements

The financialization of commodity markets 

is likely to have caused a greater co-movement of 

prices across individual commodities, because financial investors generally lack commodity-specific 

knowledge and allocate funds to commodities by 

investing in a commodity index. Given that various commodities are included 

(according to some specified 

weights) in such indexes, the 

entire range of commodities 

is affected by changes in the 

prices of other asset classes. 

This triggers a change in the exposure of financial investors in 

commodities. Moreover, some 

commodity categories, such as 

energy and especially oil, often 

have a much greater weight in 

commodity indexes than, for example, food products. 

As a result, changes in energy markets based on actual 

or expected market conditions may be transmitted to 

other commodity markets, even though there may 

Chart 2.6

Commodity price volatility, selected commodities and p

(Per cent)

Source: UNCTAD secretariat calculations, based on Thomson Financial Datastream.

Note: Volatility is measured as the standard deviation of 12-month moving averages of weekly price changes.

The evidence suggests that 

the greater involvement of 

financial investors in 

commodity markets has 

increased price volatility.

0 1 2 3 4 5 6 7 8

Aluminium

Copper

Nickel

Zinc

Tin

Palm oil

Rice

Soybean oil

Soybeans

Wheat # 2, soft red

Wheat # 2, hard (Kansas)

Maize

Crude oil (Brent)

Crude oil (WTI Spot Cushing)

January 2007–June 2008

January 2002–December 2006

January 1997–December 2001
72 Trade and Development Report, 2009

have been no change in the fundamentals of those 

other markets.

A further examination of the three sub-periods 

cited above (January 1997–December 2001, January 

2002–December 2006, and January 2007–June 2008) 

reveals an increase in the co-movement of all the commodities (listed in table 2.3) with oil prices between 

the first and the two subsequent periods. Indeed, there 

was a continuous increase in their co-movements over 

the three time periods, except 

for aluminium and rice between 

the first and second period, and 

nickel and zinc between the 

second and third period. 

The greater co-movement 

with oil prices is particularly 

striking for the food items in 

the table: their price movements 

tended to have a very low, or 

even negative, correlation with those of oil in the 

first period. This could reflect the greater effect of oil 

price changes on food transport and production costs. 

However, Mitchell (2008) estimates that the increase 

in energy and transport costs combined raised production costs in the United States agricultural sector by 

only 15–20 per cent. Part of the greater co-movement 

between oil and food prices may also be due to the 

diversion of food crops – particularly maize in the 

United States and oilseeds in Europe – into biofuel 

production. However, Gilbert (2008a: 15) examines 

the link between crude oil, biofuels and food prices 

and concludes that “there is as yet little econometric 

evidence that can substantiate the claim that the oil 

price and biofuel demand are driving food commodity prices”. The co-movement between oil prices 

and the prices of other commodities was extremely 

high in the period July 2008–December 2008 (table 2.3, fourth panel), during which the strong price 

correction occurred. This may be partly due to the 

generally worsened economic outlook during that period. However, it is likely that most of this increased 

co-movement was caused by the withdrawal of index 

traders from commodity markets and the associated 

deleveraging of their energy-heavy futures positions 

across the different commodities. Moreover, the comovement of prices of food items strongly declined 

(table 2.3). Taken together, this evidence suggests that 

the greater impact of oil price movements on food 

prices may have been due to the financialization of 

commodity futures trading.

(c) Extrapolative behaviour and speculative 

bubbles

There is a strong probability of speculative bubbles occurring on commodity markets. This is because 

short-term price effects resulting from changes in index traders’ positions may be misinterpreted by other 

traders as incorporating new market information, as 

already mentioned. More importantly, in the presence 

of uninformed traders that use statistical analyses, 

such as trend extrapolation, to 

determine their position taking, 

such short-run effects may well 

give rise to “explosive extrapolative behaviour” that causes 

speculative bubbles (Gilbert, 

2008a, b).19

Such behaviour was found 

on the market for non-ferrous 

metals over the period February 

2003 to August 2008, during which ten months of 

explosive behaviour were detected (Gilbert, 2008a). 

Similar results were obtained for Chicago grain markets in the period 2006–2008, including numerous 

instances of explosive behaviour of soybean oil prices 

(Gilbert, 2008b).20 The finding of explosive behaviour 

of soybean and soybean oil prices is of particular 

importance because of the pivotal role of soybeans 

as substitutes for wheat and maize in production, of 

other vegetable oils and animal feedstuffs in consumption, and of crude oil in energy. Taken together, 

these results indicate that explosive extrapolative behaviour is widespread in commodity futures markets, 

and that this may have contributed to price volatility 

in recent years. The evidence also suggests “that the 

efficient markets view that uninformed speculation 

has no effect on market prices and volatility should 

be rejected” (Gilbert, 2008a: 21).

4. Conclusions

In sum, the above findings suggest that part 

of the commodity price boom between 2002 and 

mid-2008, as well as the subsequent sharp decline 

in commodity prices, were due to the financialization of commodity markets. Taken together, these 

findings support the view that financial investors 

have accelerated and amplified price movements 

The greater impact of oil 

price movements on food 

prices may have been due 

to the financialization of 

commodity futures trading.
The Financialization of Commodity Markets 73

Table 2.3

Co-movements of price changes, selected commodities and per

(Correlation coefficients, per cent)

AluminiumCopper Nickel Zinc TinPalm 

oil Rice

SoybeanoilSoybeansWheat, 

soft red Maize

Crude oil 

(Brent)

Crude oil 

(WTI)

January 1997–December 2001

Aluminium 100.0

Copper 60.5 100.0

Nickel 43.4 47.7 100.0

Zinc 48.9 41.2 36.5 100.0

Tin 21.2 21.2 19.9 16.9 100.0

Palm oil -12.8 -3.5 -12.8 -7.2 -1.2 100.0

Rice 12.3 6.1 3.2 3.8 7.9 -6.8 100.0

Soybean oil -0.1 14.6 3.3 -3.1 2.1 29.0 -2.5 100.0

Soybeans 16.1 17.4 19.7 4.6 8.5 0.2 -7.6 55.2 100.0

Wheat, soft red 2.7 4.6 6.5 1.5 7.0 1.6 -6.2 27.2 38.5 100.0

Maize -1.3 4.4 10.6 -1.8 4.2 2.5 -6.6 45.5 64.9 56.9 100.0

Crude oil (Brent) 16.3 12.7 19.6 3.2 -1.1 -17.7 3.3 -4.6 -1.9 5.1 -3.0 100.0

Crude oil (WTI) 16.7 13.7 19.4 5.9 -4.7 -17.1 2.8 -6.0 -1.9 3.5 -0.5 82.0 100.0

January 2002–December 2006

Aluminium 100.0

Copper 65.4 100.0

Nickel 43.2 50.3 100.0

Zinc 58.3 69.7 45.8 100.0

Tin 33.2 36.7 32.5 37.6 100.0

Palm oil 6.0 9.4 2.3 7.0 10.6 100.0

Rice -2.4 6.0 -4.8 -3.7 7.1 8.4 100.0

Soybean oil 8.8 11.5 2.8 13.2 12.7 43.4 3.5 100.0

Soybeans 4.8 8.9 2.4 7.4 18.9 27.4 0.6 61.1 100.0

Wheat, soft red 16.2 14.1 7.4 18.9 15.4 2.6 -8.1 24.3 26.9 100.0

Maize 12.6 13.6 3.8 18.6 26.0 17.1 1.7 38.4 48.3 41.9 100.0

Crude oil (Brent) 15.0 23.1 25.0 24.7 22.2 -4.6 -5.7 5.8 7.8 11.1 2.6 100.0

Crude oil (WTI) 14.5 19.4 19.7 21.0 17.4 -0.7 -6.1 9.4 7.7 11.8 7.0 87.4 100.0

January 2007–June 2008

Aluminium 100.0

Copper 62.1 100.0

Nickel 48.3 42.4 100.0

Zinc 56.0 67.1 43.4 100.0

Tin 38.2 41.0 26.6 48.5 100.0

Palm oil 36.9 31.1 33.9 32.7 10.7 100.0

Rice -14.9 -0.4 2.7 -6.3 -2.8 -7.5 100.0

Soybean oil 41.4 20.3 26.5 17.8 16.3 61.5 -26.4 100.0

Soybeans 34.3 15.3 26.3 9.9 12.4 51.6 -21.3 85.9 100.0

Wheat, soft red 9.4 13.7 -10.1 3.2 6.4 4.7 -28.2 19.3 23.2 100.0

Maize 13.8 2.2 10.8 8.8 11.2 18.5 7.1 22.0 35.5 23.8 100.0

Crude oil (Brent) 28.9 26.1 6.0 5.6 19.2 15.7 0.7 31.5 22.8 13.9 9.7 100.0

Crude oil (WTI) 18.9 21.4 -1.5 0.8 23.0 10.6 1.7 27.6 21.2 17.0 2.6 86.4 100.0

July 2008–December 2008

Aluminium 100.0

Copper 48.9 100.0

Nickel 43.9 55.3 100.0

Zinc 52.4 71.4 63.6 100.0

Tin 19.8 38.3 72.6 43.5 100.0

Palm oil 22.2 49.0 10.2 33.2 -11.5 100.0

Rice 29.7 22.3 -5.2 11.2 -13.1 -15.5 100.0

Soybean oil 27.6 57.4 32.5 36.7 13.7 74.7 -2.7 100.0

Soybeans 30.8 31.3 33.6 26.3 11.7 48.4 -3.5 79.2 100.0

Wheat, soft red 13.4 11.1 -8.4 4.8 -29.2 37.3 -8.0 41.4 49.1 100.0

Maize 27.6 31.9 26.5 17.2 -0.1 33.6 15.1 66.5 79.6 62.4 100.0

Crude oil (Brent) 19.0 62.1 31.7 27.6 26.0 61.9 8.4 78.6 45.8 29.1 45.4 100.0

Crude oil (WTI) 11.9 59.1 25.0 16.0 25.4 46.9 21.1 69.7 37.4 22.4 41.9 93.1 100.0

Source: UNCTAD secretariat calculations, based on Thomson Financial Datastream.

Note: Co-movement measured in relation to weekly price changes.
74 Trade and Development Report, 2009

driven by fundamental supply and demand factors, 

at least in some periods of time. This acceleration 

and amplification of price movements can be traced 

for commodities as a group. Regarding the impact of 

financial investors on individual commodities, some 

effect can be observed in the oil market, but it appears that most of the impact occurred in the smaller 

and less liquid markets for agricultural commodities, 

including food products. Some of these effects may 

have been substantial and some persistent. However, 

the non-transparency of existing data and the lack of 

a comprehensive breakdown of data by individual 

commodity and trader category preclude more detailed empirical analysis.

If the financialization of commodity trading 

causes futures market quotations to be driven more 

by the speculative activities of financial investors 

and less by fundamental supply and demand factors, 

hedging against commodity price risk will become 

more complex, and this may discourage long-term 

hedging by commercial users.

To the extent that financial investors increase 

price volatility, hedging becomes more expensive, 

and perhaps unaffordable for developing-country 

users, as they may no longer be able to finance margin 

calls. For example, during the 

period January 2003–December 

2008, margin levels as a proportion of contract value increased 

by 142 per cent in maize, 79 per 

cent in wheat and 175 per cent in 

soybean on the Chicago Board 

of Trade (CME, 2008: 17–18). 

In early 2007, the LME raised 

its margin requirement by 500 

per cent over the space of only 

a few months (Doyle, Hill and 

Jack, 2007). Larger, well-capitalized firms can afford 

these increases, but smaller participants may need 

to reduce the number of contracts they hold. This 

itself could reduce liquidity, add to volatility and 

discourage more conservative investors. Hedging 

food commodity exposure may become particularly 

risky because of the typically long-term nature of 

such hedges, which correspond to harvest cycles. 

Indeed, evidence reported by the Kansas City Board 

of Trade (2008) pointed to a reduction in long-term 

hedging by commercial users at the beginning of 

2008, caused by higher market volatility.

Moreover, since 2006, there have been numerous instances of a lack of price convergence between 

spot markets and futures contracts during delivery, 

for maize, soybean and wheat. The price of a futures 

contract that calls for delivery 

may differ from the current cash 

price of the underlying commodity, but these prices should 

very closely match when the 

futures contract expires. The difference between the futures and 

the cash price (“basis”) tends to 

widen when storage facilities are 

scarce, and shrink when physical supply becomes tight. If, in 

an otherwise balanced market, 

prices diverge by more than the cost of storage and 

delivery, arbitrageurs usually act to make the prices 

converge eventually. Failure to do so would cause 

increased uncertainty about the reliability of signals 

emanating from the commodity exchanges with 

E. The implications of increased financial investor activities 

for commercial users of commodity futures exchanges

To the extent that financial 

investors increase price 

volatility, hedging becomes 

more expensive, and perhaps 

unaffordable for developingcountry users.
The Financialization of Commodity Markets 75

respect to making storage decisions and managing 

market position risks. This could eventually result 

in decreased hedging, as commercial users seek 

alternative mechanisms for transferring and managing price risk (Irwin et al., 2008). Commercial users 

might also decide to reduce their use of commodity 

exchanges because the non-convergence of futures 

and spot prices not only increases uncertainty but 

also the cost of hedging (Conceição and Marone, 

2008: 56–57).

Price discovery and price risk management 

traditionally have been considered the main benefits 

that commodity futures exchanges can provide to 

developing-country users. Hedging on commodity 

futures exchanges, by reducing price risk, has also 

been viewed by some observers as an alternative to 

supply management under international commodity agreements. Meanwhile, commodity exchanges 

have begun to assume a broader developmental role, 

as they are increasingly seen to be useful to developing countries in terms of removing or reducing the 

high transaction costs faced by 

entities along commodity supply chains (UNCTAD, 2007). 

However, the financialization 

of commodity futures trading 

has made the functioning of 

commodity exchanges controversial. It has therefore become 

necessary to consider how their 

functioning could be improved 

so that they can continue to fulfil their role of providing reliable price signals to producers and consumers of 

primary commodities and contributing to a stable 

environment for development. This section seeks to 

address this issue by examining whether regulatory 

changes have been keeping pace with commodity 

market developments, in particular the participation 

of new trader categories such as index funds. The 

subsequent section addresses broader international 

policy measures.

1. Regulation of commodity futures 

exchanges

Regulation of commodity exchanges has to find 

a reasonable compromise between imposing overly 

restrictive limits on speculative position holdings and 

having overly lax surveillance and regulation. Being 

overly restrictive could impair market liquidity and 

reduce the hedging and price discovery functions of 

commodity exchanges. On the other hand, overly lax 

surveillance and regulation would 

allow prices to move away from 

levels warranted by fundamental 

supply and demand conditions, 

and would thus equally impair 

the hedging and price discovery 

functions of the exchanges.

A substantial part of com

modity futures trading is executed on exchanges located in the 

United States, which the CFTC 

is mandated to regulate. Abuse of futures trading by 

speculators is addressed by applying limits on “excessive speculation”, defined as trading that results in 

“sudden or unreasonable fluctuations or unwarranted 

changes in the price” of commodities underlying 

futures transactions (section 4a of the Commodity 

Exchange Act (CEA)). In principle, speculative trading is contained by speculative position limits set by 

the CFTC (see section C above). 

F. Policy implications

The functioning of commodity 

futures exchanges has to be 

improved so that they can 

provide reliable price signals 

to producers and consumers 

of primary commodities.
76 Trade and Development Report, 2009

While it is often held that commodity exchanges 

have generally functioned well, the recent, very 

sizeable price changes occurring, sometimes within 

a single trading day, have raised growing questions 

about the appropriateness of existing regulations. 

These questions relate to both the adequacy of information that the CFTC is mandated to collect, and the 

extent of regulatory restrictions on financial investors 

relative to those imposed on participants with genuine 

commercial interests. The need for tighter regulations 

has been discussed under three headings: the “Enron 

loophole”, the “London loophole” and the “swap 

dealer loophole”.

The Commodity Futures Modernization Act 

(CFMA) of 2000 created the so-called “Enron Loophole” by exempting over-the-counter energy trading 

undertaken on electronic exchanges from CFTC oversight 

and regulation. The Enron loophole was addressed by legislation 

that entered into force on 18 June 

2008. This legislation provides 

for the previously exempt electronic exchanges to become selfregulatory organizations. It also 

gives the CFTC greater authority 

to require data reporting on trading and on the positions of hedgers and speculators, 

and to suspend or revoke “the operations or regulatory status of an electronic trading facility that fails 

to comply with the core principles, fails to enforce its 

own rules, or violates applicable CFTC regulations” 

(Jickling, 2008: 5). However, some observers argue 

that this legislation has not gone far enough, because 

it covers only electronic trading but does not extend 

to bilateral swaps, and because it does not place energy commodities on the same regulatory footing as 

agricultural commodities that must be traded on the 

CFTC-regulated exchanges (Jickling, 2008; Greenberger, 2008).

The “London loophole” is closely related to 

the “Enron loophole”, as only one of the active 

markets exempted from CFTC regulations handles a 

volume of energy trading similar to that handled by 

CFTC-regulated exchanges (CFTC, 2007). A large 

proportion of West Texas Intermediate crude oil 

contracts is traded on NYMEX, which is regulated 

by the CFTC. However, “look alike” contracts are 

traded in London on ICE Futures Europe (owned by 

Atlanta-based Intercontinental Exchange), which is 

regulated by the Financial Services Authority (FSA) 

of the United Kingdom. This means that traders can 

execute transactions in similar crude oil contracts 

on NYMEX and ICE, arbitraging between the two 

markets, yet the CFTC can oversee and regulate only 

the trading on NYMEX. The significance of this loophole may be illustrated by the fact that, in principle, 

under section 8a (9) of the CEA, the CFTC has the 

authority, “whenever it has reason to believe that an 

emergency exists”, to take measures “including, but 

not limited to the setting of temporary emergency 

margin levels on any futures contract [and] the fixing of limits that may apply to a market position”. 

However, the CFTC did not apply this mandate, for 

example, when on 6 June 2008 the price on oil futures 

contracts rose by about $11 per barrel in a single day. 

Greenberger (2008: 21) argues that the CFTC may 

not have done so because it had 

data only on contracts traded 

on NYMEX but not on similar 

contracts traded on ICE.

Proposed legislative action 

to close the London loophole 

was presented to the United 

States Congress on 12 June 2008 

(Chilton, 2008), but so far it has 

not resulted in actual legislative 

changes. In the meantime, the CFTC introduced 

changes to the ‘No-Action’ letter issued in 1999 that 

granted the ICE permission to make its electronic 

trading screens available to trading in the United 

States. These changes provide for ICE trading and 

position data to be reported to the CFTC, and for 

the imposition of position limits (including related 

hedge exemption provisions) comparable to those 

applicable on the CFTC-regulated exchanges.

The “swap dealer loophole” has received con

siderable attention in the current debate on the changes 

needed in the CFTC’s regulatory mandates. This is 

because swap agreements are concluded on OTC 

markets and thus escape the CFTC’s supervisory 

and regulatory oversight.21 Moreover, the greater 

involvement of financial investors in commodity 

futures trading has significantly increased the positions that swap dealers hold in commodity futures 

contracts. Swap dealers typically sell OTC swaps 

to their customers (such as pension funds that buy 

commodity index funds) and hedge their price exposures with long futures positions in commodities. 

Swap dealers are generally included in the category 

Given the global nature of 

commodity futures trading, 

international collaboration 

among regulatory agencies 

is needed.
The Financialization of Commodity Markets 77

“commercial traders”, as they use commodity exchanges for hedging purposes. This has allowed them 

to be exempted from regulation of speculative position limits. But contrary to traditional commercial 

traders, who hedge physical positions, swap dealers hedge financial positions. The combination of 

significant trading activity on OTC markets and the 

exemption of swap dealers from speculative limits 

on futures exchanges has severely constrained the 

ability of regulators to access sufficient information 

about positions. They would need such information 

in order to identify undue concentrations of positions, 

evaluate the overall composition of the market and 

assess its functioning.

Several proposals have been advanced on how 

to close the swap dealer loophole. For example, the 

Kansas City Board of Trade (2008) has proposed addressing the index fund hedge exemptions by limiting 

their total direct or indirect futures hedge positions to 

a maximum percentage in the contracts that have a 

remaining maturity of one or two months. This would 

create an additional incentive to spread the total position across several months and ease position concentration. It has also suggested changes to the definition 

of a bona fide hedger and a related distinction to be 

made in margin requirements between those that 

have true commercial hedge positions and those that 

hedge financial positions. In addition, it has proposed 

alleviating strains in financing margins by accepting 

commercial agricultural collateral (such as warehouse receipts). These last two 

changes, in particular, would 

tend to improve the functioning 

of commodity exchanges with 

respect to participants with truly 

commercial interests.

Given the global character 

of commodity futures trading, and 

the fact that through trading arbitrage some contracts involve the 

jurisdiction of regulatory author

ities in more than one country, international collaboration among regulatory agencies is 

required. Such collaboration would involve not only 

the sharing and publishing of information, some of 

which is already in place, but also greater cooperation 

and harmonization of trading supervision.22 It seems 

particularly urgent that exchanges whose legal base 

is London should be required to provide data on positions by trader categories similarly to those made 

publicly available by the CFTC for some agricultural 

products through its COT supplementary reports. In 

addition, the product coverage of these supplementary reports needs to be enlarged. Product coverage 

has remained limited because for many commodities 

traded on United States exchanges, look-alike contracts can be traded in London. As a result, data on 

positions on United States exchanges provide only 

a partial picture of the total positions of traders that 

are active on both the United States and London exchanges. Moreover, in the absence of such data for 

energy products, legislation enacted in the United 

States to address the London loophole is probably 

unlikely to be effective unless similar data on positions taken on ICE are made available. 

2. International policy measures

In addition to regulatory issues, the financialization of commodity futures trading confronts the 

international community with the issue of how supply-side measures can address excessive commodity 

price volatility. This issue is of particular importance 

for food commodities because, despite some recent 

improvement, grain and oilseed stocks remain very 

low so that any sudden increase in demand or a major shortfall in production, or both, will rapidly cause 

significant price increases (see annex to chapter I). 

Hence, physical stocks of food 

commodities need to be rebuilt 

urgently to an adequate level 

in order to moderate temporary 

shortages and buffer sharp price 

movements.

It has often been argued 

that it is difficult to finance and 

guarantee the accumulation of 

sufficiently high physical inventory stocks, especially of food 

commodities, so that they could 

function as physical buffer stocks. Moreover, holding 

large inventories around the world has often been 

judged economically inefficient, and it has been 

recommended that net food importing countries 

should rely on global markets rather than on building 

their own reserves. However, there can be little doubt 

that newly imposed trade restrictions (particularly 

for rice) played a role in exacerbating the spiralling 

Physical stocks of food 

commodities need to be 

rebuilt urgently, and should 

be sufficiently large to be 

able to moderate temporary 

shortages and buffer sharp 

price movements. 
78 Trade and Development Report, 2009

increase in food prices in early 2008. This has added 

to anti-globalization sentiments and to more favourable assessments of the protection that national food 

reserves can provide.

Partly to counter such anti-globalization sentiments, and in particular as part of efforts to prevent 

humanitarian crises, von Braun and Torero (2008) 

– echoed by the G-8 summit in June 2008 – have 

proposed a new two-pronged global institutional 

arrangement: a minimum physical grain reserve for 

emergency responses and humanitarian assistance, 

and a virtual reserve and intervention mechanism. 

The latter would enable intervention in the futures 

markets if a “global intelligence unit” were to consider market prices as differing significantly from 

an estimated dynamic price band based on market 

fundamentals. However, adopting such a mechanism 

would commit a public agency to second-guess 

market developments. More importantly, in order 

to stem speculative price bubbles, the agency would 

need to be prepared to sell large amounts of physical 

commodities. Given the certainty that any accumulated stocks will eventually be exhausted, there is 

considerable risk that speculators could mobilize 

significantly more financial funds than any public 

agency’s capacity to provide physical commodities. 

Hence it is likely that the funds allocated to such an 

agency would be an easy target for speculators.

Even if a virtual reserve and intervention mechanism could be made to work satisfactorily, it would 

not make more physical commodities available on 

markets, except for emergency situations. Given 

that the historically low level of inventories was one 

determinant of the abrupt price hike in food commod

ities in early 2008, the question remains as to how 

incentives to increase production and productivity 

in developing countries, particularly of food commodities, could be fostered. Such incentives could 

include a reduction of trade barriers and domestic 

support measures in developed countries. 

G. Conclusions and outlook

The financialization of commodity futures trading has made commodity markets even more prone 

to behavioural overshooting. There are an increasing 

number of market participants, sometimes with very 

large positions, that do not trade based on fundamental supply and demand relationships in commodity 

markets, but, who nonetheless, influence commodity 

price developments.

Due to the limited transparency of existing 

data, as well as the lack of a comprehensive breakdown of data by individual commodity and trader 

categories that would enable a determination of the 

position changes of different trader categories, it is 

difficult to conduct a detailed empirical analysis of 

the link between speculation and commodity price 

developments. Nevertheless, various existing studies 

and new results provided in this chapter indicate that 

the activities of financial investors have accelerated 

and amplified commodity price movements. More

over, these effects are likely to have been substantial, 

and in some cases persistent. The strongest evidence 

is found in the high correlation, particularly during 

the deleveraging process in the second half of 2008, 

between commodity prices and prices on other markets, such as equity and currency markets, which 

were particularly affected by carry-trade activities. 

In these markets, speculative activity played a major 

role.

These effects of the financialization of commodity futures trading have made the functioning 
The Financialization of Commodity Markets 79

of commodity exchanges increasingly contentious. 

They tend to reduce the participation of commercial 

users, including those from developing countries, 

because commodity price risk hedging becomes 

more complex and expensive. They also cause greater 

uncertainty about the reliability of signals emanating 

from the commodity exchanges with respect to making storage decisions and managing the price risk of 

market positions.

It is unclear whether financial investors will 

continue to consider commodities as an attractive 

asset class. The trading strategy of index investors 

has proved to be strongly dependent on specific 

conditions (i.e. rising or backwardated markets) to 

be profitable. Moreover, since their strategy is fairly 

predictable, other market participants may make 

sizeable profits by trading against index investors. 

Hence, financial investors are likely to move away 

from investing passively in indexes towards more 

active trading behaviour, either by adopting a more 

flexible approach in determining how and when to 

roll forward positions, or by concentrating on other 

investment vehicles such as commodity-exchangetraded funds.23 This implies that the distinction 

between short-term oriented managed funds and 

other financial investors will become less clear. Its 

effect on commodity prices will largely depend on 

the extent to which such a shift in financial investors’ 

trading strategy leads to a greater concentration on 

specific commodities, instead of commodities as an 

aggregate asset class. But such a potential shift in 

financial investors’ trading behaviour is unlikely to 

reduce the relative size of their positions. Thus they 

will continue to be able to amplify price movements, 

at least for short periods of time, especially if they 

concentrate on individual commodities.

Data for the first few months of 2009 indicate 

that both index traders and money managers have 

started to rebuild their speculative positions in commodities. This makes a broadening and strengthening 

of the supervisory and regulatory powers of mandated 

commodity market regulators indispensable. The 

ability of any regulator to understand what is moving 

prices and to intervene effectively depends upon its 

ability to understand the market and to collect the 

required data. Such data are currently not available, 

particularly for off-exchange derivatives trading. Yet 

such trading and trading on regulated commodity 

exchanges have become increasingly interdependent. Hence, comprehensive trading data need to be 

reported to enable regulators to monitor information 

about sizeable transactions, including on similar 

contracts traded over the counter that could have an 

impact on regulated futures markets.

In addition to more comprehensive data, broader 

regulatory mandates are required. Supervision and 

regulation of commodity futures markets need to 

be enhanced, particularly with a view to closing the 

swap dealer loophole, in order to enable regulators 

to counter unwarranted impacts from OTC trading 

on commodity exchanges. At present, banks that 

hold futures contracts on commodity exchanges to 

offset their short positions in OTC swap agreements 

vis-à-vis index traders fall under the hedge exemption and thus are not subject to speculative position 

limits. Therefore, regulators are currently unable to 

intervene effectively, even though swap dealer positions frequently exceed such limits and may represent 

“excessive speculation”.

Another key regulatory aspect concerns extending the product coverage of the CFTC’s COT 

supplementary reports and requiring non-United 

States exchanges, particularly those based in London 

that trade look-alike contracts, to collect similar data. 

The availability of such data would provide regulators with early warning signals and allow them to 

recognize emerging commodity price bubbles. The 

resulting enhancement of regulatory authority would 

enable the regulators to prevent bubble-creating trading behaviour from having adverse effects on the 

functioning of commodity futures trading.

Developing-country commodity exchanges 

might want to consider taking similar measures, 

where relevant,24 though their trading generally 

tends to be determined more by local commercial 

conditions than by any sizeable involvement of inter

nationally operating financial investors.
80 Trade and Development Report, 2009

1 Notional amount refers to the value of the underlying 

commodity. However, traders in derivatives markets 

do not own or purchase the underlying commodity. 

Hence, notional value is merely a reference point 

based on underlying prices.

2 The Bank for International Settlements (BIS) is the 

only source that provides publicly available information about OTC commodity trading. However, 

commodity-specific disaggregation is not possible 

with these data.

3 In the DJ-UBSCI, weights primarily rely on the relative amount of trading activity of a particular commodity, and are limited to 15 per cent for individual 

commodities and to one third for entire sectors. In 

the S&P GSCI, on the other hand, weights depend 

on relative world production quantities, with energy 

products usually accounting for about two thirds of 

the total index.

4 A commodity exchange is a market in which multiple 

buyers and sellers trade commodity-linked contracts 

according to rules and procedures laid down by 

the exchange and/or a mandated supervisory and 

regulatory body. Such exchanges typically act as a 

platform for trade in futures contracts (i.e. standardized contracts for future delivery). For further details, 

see UNCTAD, 2006.

5 The study was done using daily data. Such data are 

not publicly available, but could be used by Informa 

Economics (2009) as their study was commissioned 

by a consortium of futures exchanges. The authors 

conclude that the positive correlation between the 

trading activities of index traders and those of 

momentum-trading money managers on agricultural 

markets may simply indicate that in this period, 

during most of which prices were rising strongly, 

money managers favoured the same “long” strategy 

that index traders routinely use.

6 More precisely, among the types of firms engaged in 

business activities that can be hedged and therefore 

classified as “commercial” by the CFTC are merchants, manufacturers, producers, and commodity 

swaps and derivative dealers. The CFTC classifies 

as “non-commercial” all other traders, such as hedge 

funds, floor brokers and traders, and non-reporting 

traders (i.e. those traders whose positions are below 

the reporting thresholds set by an exchange).

7 These 12 commodities are: feeder cattle, live cattle, 

cocoa, coffee, cotton, lean hogs, maize, soybeans, 

soybean oil, sugar, Chicago wheat and Kansas 

wheat.

8 Using data on bank participation in futures markets, 

Sanders, Irwin and Merrin (2008: 9) show that index 

trader activity in grain markets started in 2003, and 

that the most rapid increase in trader positions occurred between early 2004 and mid-2005. Given that 

the CFTC’s index trader data start only in 2006, they 

cannot reflect these events.

9 A long position is a market position that obligates 

the holder to take delivery (i.e. to buy a commodity). This contrasts with a short position, which is 

a market position that obligates the holder to make 

delivery, (i.e. to sell a commodity). Net long positions are total long positions minus short positions.

10 Open interest is the total number of futures contracts – long or short – in a market, which have been 

entered into and not yet liquidated by an offsetting 

transaction or fulfilled by delivery.

11 Speculative position limits define the maximum position, either net long or net short, in one commodity 

futures (or options) contract, or in all futures (or 

options) contracts of one commodity combined, that 

may be held or controlled by one person other than a 

person eligible for a hedge exemption, as prescribed 

by an exchange and/or the CFTC.

12 The results do not materially change if commodity 

shares are based on 2009 weights.

13 For a discussion of carry trade speculation, see 

TDR 2007, chapter I.

14 The absence of any systematic difference in recent 

price developments between commodities that are 

traded on futures exchanges and those that are not is 

sometimes cited as further evidence for an absence 

of any significant impact of financial investors on 

price developments (ECB, 2008: 19). This evidence 

Notes
The Financialization of Commodity Markets 81

is interpreted as supporting the view that commodity prices have been driven entirely by supply and 

demand fundamentals, and that futures exchanges 

have simply provided the mechanism through which 

information about fundamentals is reflected in market prices.

15 Informa Economics (2009) uses the concept of “price 

pressure” to investigate the effects that daily changes 

in position taking by different trader categories have 

on daily final prices. They consider price pressure 

that pushes prices towards their daily end level, 

which they call “true value”, as beneficial, and price 

pressure that pushes prices away from that level as 

detrimental. For all the analysed agricultural products, except cotton, the study finds that commercial 

traders had the lowest ratio of beneficial to detrimental price pressure, while money managers and index 

traders had the highest such ratios. In other words, 

among all the trader categories, commercial traders, 

who supposedly trade on the basis of information 

on fundamental supply and demand conditions, 

exerted the least influence on daily price discovery, 

and financial investors exerted the most influence. 

Informa Economics (2009, part 4: 34) interprets this 

finding as indicating that commercial traders are only 

concerned about hedging their price risk, but do not 

care much about whether commodity prices reflect 

fundamental supply and demand conditions. But the 

finding could also be interpreted as meaning that the 

weight of financial investors in commodity futures 

trading is such that more often than not it moves 

prices away from levels that would have occurred 

on the basis of fundamental market conditions. The 

concept of price pressure applied to arrive at this 

finding nonetheless raises methodological issues. 

It assumes, for example, that all price changes 

result from position changes (i.e. based on private 

information), and that prices do not react to newly 

available public information. According to Grossman and Stiglitz (1980), this implies an assumption 

of complete information inefficiency of commodity 

markets.

16 Most existing studies that use Granger-causality tests 

have had to rely on publicly available weekly data 

on positions in commodity markets. However, a frequently quoted study by the Interagency Task Force 

on Commodity Markets conducted Granger causality 

tests for the oil market using non-public data on daily 

positions of both commercial and non-commercial 

traders, as well as those of various sub-groups of 

traders for the period January 2003–June 2008 

(CFTC, 2008). This study also found no evidence 

that daily position changes by any of the trader subcategories had systemically caused price changes in 

oil futures contracts over the full sample period. This 

means that, at least in the crude oil futures markets, 

results of Granger-causality tests appear to be largely 

unaffected by using either daily (instead of weekly) 

data or position changes for sub-groups of traders 

instead of aggregated data.

17 More precisely, Kaufmann et al. (2008) specify 

the near-month price of crude oil on the New York 

Mercantile Exchange (NYMEX) as a function of: 

(i) the equivalent of days of consumption of existing OECD crude oil stocks; (ii) a factor that reflects 

OPEC capacity utilization, OPEC’s share of global oil production and the extent to which OPEC 

members cheat on their quota; (iii) United States 

refinery utilization rates, which may be subject to 

abrupt temporary disturbances during the hurricane 

season; and (iv) expectations as reflected by the 

difference between the price for the 4-month and 

the price for the 1-month futures contract for West 

Texas Intermediate on NYMEX. This difference 

indicates whether the market is in backwardation 

or contango, with contango providing an incentive 

to build and hold stocks, thereby bolstering demand 

and ultimately prices. On the basis of this relationship, price changes can be estimated with an error 

correction model, where first differences of the above 

variables as well as the forecasting errors of previous 

periods are taken as independent variables.

18 Prometeia (2008) adopts a similar approach in 

examining whether the strong increase in oil prices 

between mid-2007 and mid-2008 can be explained 

by rational pricing behaviour of market participants 

or whether it reflects a bubble. The tests cannot 

reject the presence of a bubble. Prometeia (2008) 

interprets the evidence as pointing to the role of 

financial investor activities on commodity futures 

markets in accelerating and amplifying price movements that in the medium and long run are driven 

by fundamentals. However, other structural models 

for the oil market ascribe much of the recent price 

developments to fundamental supply and demand 

factors. These models do not infer demand shocks 

from an econometric model, but treat repeated revisions of forecasts of real income growth in emerging 

and advanced economies as a series of exogenous 

demand shocks for the global crude oil market (e.g. 

Kilian and Hicks, 2009). However, it is hard to believe that informed oil traders would be repeatedly 

surprised by the impact on oil demand of buoyant 

growth in emerging economies. Moreover, any such 

calculation is extremely sensitive to assumptions 

about the short-run price elasticity of supply and 

demand.

19 More formally, tests for explosive extrapolative 

behaviour are based on the following equation: 

lnf

t

= α + βlnf

t-1 + εt

, where ftand f

t-1 are the current 

and past prices respectively, β is the autoregressive 

factor, and ε is an error term. 

20 The number of these instances indicates that 

there is a higher probability of them being due to 
82 Trade and Development Report, 2009

explosive speculative behaviour than merely chance 

occurrences.

21 On 13 May 2009, the United States Government 

unveiled a plan designed to increase the transparency 

of OTC trading and tighten its oversight and regulation (see http://www.ustreas.gov/press/releases/

tg129.htm). The centrepiece of the announced plan 

is to allow regulators to mandate the clearing of all 

standardized OTC derivatives through regulated 

central clearinghouses that would require traders to 

report their activities and hold a minimum level of 

capital to cover losses. While details of the proposed 

legislative changes still need to be determined, it 

appears from the plan that standardized derivatives 

would be traded on exchanges or through clearinghouses, while customized or individualized derivative products would not. This means that the plan 

would not cover swaps. Some commentators argue 

that this distinction between customized and other 

derivatives and the fact that swap-based transactions 

“would be reported privately to a ‘trade repository’, 

which apparently would make only limited aggregate 

data available to the public”, is a serious shortcoming 

of the proposed plan (Partnoy, 2009).

22 The Financial Services Authority (FSA), which 

monitors commodity markets in the United Kingdom, considers commodity markets as specialized 

markets which are dominated by professional participants, and hence require less regulatory attention 

than equity and bond markets. It supervises firms 

that are active in commodity markets in order to 

ensure the financial stability of market participants 

so that contract settlements can take place on time 

and without default by any party. In addition, it 

mandates commodity exchanges to regulate their 

own markets with a view to providing clearly defined 

contract terms and ensuring against manipulation. In 

their advice on the European Commission’s review 

of the commodity trading business, the Committee 

of European Securities Regulators (CESR) and 

the Committee of European Banking Supervisors 

(CEBS) pointed to potential problems relating to 

the low levels of transparency in OTC commodity 

derivatives trading and the current client categorization rules and transaction reporting requirements. 

However, they concluded that there was not much 

benefit to be gained by mandating through legislation greater pre- and post-trade transparency in 

commodity derivatives trading, and that the current 

practice of how regulated markets reported trading 

was sufficient (CESR, 2008).

23 Commodity exchange traded funds are listed securities 

backed by a physical commodity or a commodity 

futures contract.

24 To the extent that history is a guide for current events, 

developing countries would be ill-advised to close 

their commodity futures exchanges. For example, 

Jacks (2007) provides a historical account of the 

establishment and prohibition of commodity futures 

markets and shows that such markets have generally 

been associated with lower, rather than higher, price 

volatility.

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