To: Commodity Futures Trading Commission 

 Washington, DC 

 The Agricultural Market Roundtable, sponsored by the CFTC on April 22, 2008, 

was highly informative with respect to building cross-industry knowledge of the working 

of the markets and included discussions on how commodity index investors are viewed 

by other market participants. I enjoyed the opportunity to participate in person, and am 

pleased to offer follow up thoughts. 

Futures Market Objectives

 Index investors, many of whom are also consumers of commodities, support any 

activity that improves the efficiency of the markets that produce what they consume. 

Index investors know that commodity futures markets meet another objective – they 

allow investors to reduce the risk of their portfolio while also protecting it from inflation. 

They perform this activity while at the same time assuming price risk that commodity 

producers and holders of commodity inventories wish to mitigate. In a properly 

functioning market both parties benefit over time. 

What is a Commodity Index Investor?

 Diversified commodity indexes represent the return that an investor would 

achieve by holding and rolling forward a broad range of commodity futures contracts on 

a fully collateralized basis, and without taking a position on whether individual 

commodity prices would go up or down. “Fully collateralized” typically means that, for 

every dollar of notional exposure to a commodity futures contract, the investor holds a 

dollar of collateral backing, with no borrowing or leverage. The mechanics of rolling 

forward their positions means that, not only will index investors never take delivery on a 

contract, but they will not maintain positions in the delivery month. The index investor 

may implement his exposure directly in the futures markets, or by engaging in over–the–

counter swaps on commodity indexes. 

 The index investor must not be confused with discretionary commodity pools or 

hedge funds, who may move in and out of individual markets based on their expectation 

of rising or falling prices, and who might rapidly change their views. The index investor 

holds consistent long positions, and therefore consistently assumes price risk which 

producers and inventory holders wish to mitigate. And once an index investor establishes 

his initial position, his market activity typically is simply that of “rolling” his positions. 

That is, he simultaneously sells a nearby contract and buys a more distant contract, so 

that there is no net buying pressure across the overall futures curve. 

Concerns Expressed at the CFTC Roundtable

 Participants expressed concern over the following issues: 
• Sometimes in some markets there has been a lack of convergence between cash 

and futures price, with futures in the delivery month trading higher than cash 

prices. This creates a burden on hedgers of inventory who are expecting that 

convergence. 

• Futures prices have become more volatile. 

• Commodity futures prices have risen dramatically, causing margin financing 

difficulty for market participants who hedged inventory or production by selling 

short at lower prices. 

I would like offer my view of whether commodity index investors were a factor in these 

issues. 

Convergence

 At the Roundtable we saw quantitative evidence that, sometimes in some grain 

markets, there was a lack of convergence of futures to cash in the delivery month. 

Solutions discussed included a change in delivery specifications, revised storage charges, 

more delivery points, and even a move to a cash-settled contract. In cotton, the evidence 

was more anecdotal but nevertheless compelling, that futures have traded above cash 

after the first delivery day. There were even suggestions that, specific to cotton, the 

CFTC should investigate recent market behavior. For instance, a participant in the cash 

cotton market stated, outside the formal Roundtable, that he could not tender cotton for 

delivery since all delivery warehouses were full. 

 Commodity index investors, like all commodity investors, support efforts for 

futures prices generally to converge to cash prices, with a basis that varies as little as 

necessary. This is a critical part of the economic rationale that supports their return 

expectations, and it also is essential for efficient (and therefore low cost) operation of 

commodity producers, whose products the index investors, since they are also consumers, 

purchase. Therefore any moves to improve convergence are supported. But participants 

should recognize that the commodity index investor is not a participant in either the cash 

market or the delivery month, which are the two prices that are expected to converge. 

Even more to the point, the commodity index investor, by rolling his position prior to the 

first delivery day, may exert some downward pressure on the nearby (non-spot) contract. 

So the index investor is not contributing to lack of convergence, when futures trade 

higher than cash in the delivery month. And the commodity index investor certainly 

owns none of the cotton inventory that was reportedly filling delivery warehouses earlier 

this year. 

Volatility

 Volatility in futures prices can be caused by large and sudden flows of 

buying/selling pressure, which in turn might be driven by A) a change in expectation of 

what the future price will be, or B) a change in the desire to be invested in a particular 

commodity. The index investor, by definition, is not influenced by A), since they do not 

change positions in individual commodity markets based on price predictions. 
Regarding B), index investment has slowly increased over the last five years, but as a 

percent of daily volume or open interest, the new investment over a day or a month is 

small relative to the overall liquidity of the futures markets. 

 Hedge funds and commodity pools, on the other hand, might at times contribute 

to more futures volatility. Commodity pools, if they follow trends, can swing from long 

to short and back to long positions. Hedge funds might also, based on fundamental or 

technical or quantitative analysis (or liquidity requirements elsewhere in their portfolios) 

move rapidly and in large size in and out of individual markets. But these flows don’t 

necessarily occur on a daily basis nor in the longterm do they have meaningful impact on 

price levels of the physical commodities in the cash markets. On the other hand, low 

inventories in a commodity, which is a condition that can persist day after day, can in and 

of itself, be a source of increased volatility, as a small change in fundamental factors can 

create a large change in expected price due to the low price elasticity of physical 

products. 

Index investors, with their stable long positions, could provide liquidity to any 

sale program and could actually be an offset to volatility caused by other factors. 

Rising Commodity Prices

 Commodity index investors, in their role of investor and not as individual 

consumer, do not own, store, or consume a single bushel or ton of any agricultural 

commodity. While their participation in the markets may aid price discovery, which is an 

objective of those markets, any impact in terms of higher cash prices is both 

immeasurable and not nearly as important as supply, demand, and inventories in the 

physical markets. For instance, rice, which is not part of the portfolios of index investors, 

has seen price rises comparable to that of wheat and corn. 

 In the CFTC roundtable, some market participants who had hedged by shorting 

futures at low prices, described how they were adversely affected by the cost or 

availability of margin financing as prices rose. If a producer, or holder of inventory, had 

adequate margin financing, they might withstand the strong rise in prices we have seen 

(though perhaps regretting that they established their hedge so soon). The scarcity of 

margin financing is not due to the market activity of index investors. It is due to the 

broader lack of liquidity in U.S. credit markets. 

Some Final Thoughts

 Commodity market participants are witnessing a current environment of increased 

price volatility, occasional lack of futures/cash convergence, and lack of margin 

financing. Index investors understand those stresses and hope they can be relieved 

through contract modifications and eventual increased liquidity in the U.S. financial 

system, as this would contribute to more efficient operation of the U.S. agricultural 

economy. Index investors hope that the increase in prices compared to the unsustainably 

low levels early in this decade will signal the need for increased production to meet 
global demands to build inventories and thus reduce price volatility. In the meantime 

index investors, subject to existing regulations, will continue to provide risk mitigation to 

commodity producers and inventory holders, while also providing inflation hedging and 

risk diversification to individual investors, retirement plans, endowments, and 

foundations. Under existing regulations, this is a win-win situation. 

The view expressed herein are my opinion and may or may not be the views of my 

employer. 

Bob Greer 

Executive Vice President 

PIMCO