Does Index Speculation Impact Commodity Prices? An Intraday Analysis

• Date: 01 August 2013
• Published date: 01 August 2013
• DOI: http://doi.org/10.1111/fire.12007

The Financial Review 48 (2013) 365–383

Does Index Speculation Impact Commodity

Prices? An Intraday Analysis

Yiuman Tse∗

University of Missouri-St. Louis

Michael R. Williams

Governors State University

Abstract

Using intraday data, we findunidirectional causality from commodity index-linked futures

to nonindex-linked commodity futures for up to one hour which disappears when using daily

data. Also, the economic significance of index-linked to nonindex commodity transmission

declines to zero within about an hour. Finally, we find that the magnitude of index-linked to

nonindex return transmission is positively related to the amount of speculation, both long and

short, in S&P GSCI commodity index futures. We conclude that speculative pressures exerted

by commodity index futures can impact nonindex commodities, mainly through the activity of

uninformed, positive feedback traders.

Keywords: index speculation, commodity prices, intraday data

JEL Classifications: G13, G14

∗Corresponding author: University of Missouri-St. Louis, College of Business Administration One

University Blvd, St. Louis, MO 63121-4400; Phone: (314) 516-6828; Fax: (314) 516-6420; E-mail:

tseyi@umsl.edu.

We thank the anonymous referees, the editor (Robert Van Ness), and the seminar participants at the

University of Texasat San Antonio and the FMA meeting in 2011 for comments.

C2013, The Eastern Finance Association 365

366 Y. Tse and M. R. Williams/The Financial Review 48 (2013) 365–383

1. Introduction

Does speculation distort commodity futures prices and increase price volatility?

Debate over the issue has been increasing. First, a 2008 report by the United States

Commodity Futures Trading Commission (CFTC) finds a coincident increase in

commodity index activity and commodity prices. The CFTC believes that this is

evidence of commodity index speculation causing pricing distortions in individual

commodities. However, two recent articles refute this explanation.

Blanch, Schels, Soares, Haase and Hynes (2008) of Merrill Lynch findthat com-

modity index futures open interest and volume mitigate futures price volatility.Thus,

it seems that commodity index futures activity has a price stabilizing influence. Also,

they find that both index-linked and nonindex commodity prices increased during

the recent commodity price boom. However, the prices of nonindex commodities

as well as those of commodities which were dropped from the S&P GSCI index

have increased more than index-linked prices. They argue that if speculation was to

blame, index-linked commodities would have had higher price increases than non-

index commodities. They conclude that the run up in commodity prices was due to

loose monetary policy rather than a result of speculative pressures from commodity

index futures.

Stoll and Whaley (2010) study the impact of commodity index futures specu-

lation and the price dynamics of individual commodity futures. They conclude that

index speculators did not bring about increases in individual commodity prices. Stoll

and Whaley (2010) make this claim based on three findings. First, they examine

the comovement among different commodity futures. They find that correlations are

“low” except for highly fungible commodities. They also find a high correlation

between index-linked and nonindex commodity futures. That is, the returns of com-

modity futures in commodity index funds (e.g., S&P GSCI and DJ-AIG) have a high

correlation with commodities that are not included in commodity index funds.

Second, Stoll, and Whaley (2010) focus on causality between index fund flows

and individual commodity returns. They analyze causality by regressing weekly fund

flows and own-returns onto future (individual) commodity returns. Finding little

statistical evidence of causal relationships, they conclude that speculation does not

impact commodity prices. Third, Stoll and Whaley (2010) note that while fund flows

into commodity index futures doubled during the commodity price bubble, a large

percentage of these flows originated from traders motivated by portfolio rebalancing

or index maintenance needs. Discounting the possibility that portfolio rebalancing

done on purely fundamental grounds could lead to both upward commodity price

pressures as well as vicious cycles of price destabilizing speculation, Stoll and Whaley

(2010) conclude that activity in commodity index funds is “by definition” neither

speculatory nor price destabilizing.

However, the above reports and the literature refuting the price impact of spec-

ulation on commodity prices suffer from the use of low frequency data. This is a

critically important issue given that futures markets are generally active, liquid, and