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ICI Research Shows That Commodity Mutual Funds Are Not Driving Commodity Markets
By Paul Schott Stevens
May 9, 2012
Investors benefit greatly from funds that provide investors exposure to a broad basket of commodities—from energy to precious metals to agricultural products. These investments offer valuable portfolio diversification, because commodities prices historically have not been strongly correlated with stock or bond returns. And as raw materials for the goods that businesses and consumers buy, commodities offer investors an opportunity to protect themselves from inflation.
Despite these benefits, we’ve seen a few political leaders seeking to blame rising oil prices on mutual fund investors. They charge that investors’ expanded use of commodity investing—through relatively new products such as commodity mutual funds—is responsible for rising and volatile prices. They attack such funds as “speculators.”
These critics are wrong on the facts, and, as a new ICI research report shows, wrong on the economics. I had the opportunity today to discuss this new research in my remarks before ICI’s General Membership Meeting.
In the report, ICI Senior Economist Chris Plantier reviews how careful studies by a range of academics have demonstrated that the so-called financialization of commodities markets is not driving price developments in individual markets. Nor is it increasing volatility.
Chris’s paper also looks specifically at the impact of investment flows into commodity mutual funds on commodity prices. As Chris explained in his Viewpoints post last month, and as you can see in the figure below, there is no impact.
Forecasts: Economic Fundamentals Versus Commodity Mutual Fund Flows
*Data and dynamic forecasts are from February 2004 to November 2011.
Note: The correlation coefficient between the Dow Jones-UBS Commodity Index and the forecast based on economic fundamentals is 0.80. It is -0.05 for the forecast based on flows.
The blue line on this chart illustrates the Dow Jones-UBS Commodity Index from 2004 through 2011. Note the elevated price levels prior to the financial crisis, the drop during the recession, and the price recovery since—just what you would expect if commodity prices were driven by economic fundamentals.
In fact, that’s what’s going on. Our paper uses statistical techniques to predict how the value of the U.S. dollar and growth in emerging markets would affect commodities prices. As you can see by the red dotted line, those two economic factors alone explain most of the change in commodities prices. And this doesn’t even include other fundamental factors—such as crop failures, political uncertainties in the Middle East, or inflation fears.
Chris’s study also considers whether flows into commodity mutual funds could explain commodity prices. What’s clear from this figure is that those flows don’t explain much. There’s scarcely any connection between flows to commodity mutual funds and prices in commodity markets. And that’s not surprising—how much impact could $48 billion in commodity mutual fund assets have on markets where trillions of dollars worth of goods and derivatives are exchanged?
Sadly, we don’t expect facts and evidence to persuade all of the critics. There’s too much political payoff in finding scapegoats for high prices of gasoline and other commodities.
Two things, however, are certain. Commodity mutual funds are not driving commodity markets. And penalizing those funds unjustly will only hurt millions of average American investors.
Paul Schott Stevens has served as President and Chief Executive Officer of the Institute since June 2004.
TOPICS: Commodity Investments
Commodity Price Trends: It’s Fundamentals, Not Funds
By Chris Plantier
April 17, 2012
As gasoline prices approach a national average of $4 per gallon, the role that financial investment flows into commodities markets play is once again in focus. In a forthcoming paper, I examine the relative importance of economic fundamentals and financial investment flows in explaining broad commodity price movements.
All Funds and Investors Have a Stake in Our Challenge to CFTC
By Paul Schott Stevens
April 17, 2012
ICI and the U.S. Chamber of Commerce have joined together in a legal challenge to a rule by the Commodity Futures Trading Commission (CFTC). We are asking the U.S. District Court for the District of Columbia to vacate and set aside the CFTC’s recent amendments to its Rule 4.5.
CFTC Decision Imposes Inconsistent Requirements on Funds, Hurts Shareholders
By: Karrie McMillan
March 5, 2012
The Commodity Futures Trading Commission (CFTC) recently finalized a rule—known as Rule 4.5—that will require many advisers to mutual funds that invest in commodity futures, commodity options, and swaps to register with the agency. This development is deeply troubling for at least two reasons:
- It will impose duplicative and fundamentally inconsistent requirements on these funds.
- Shareholders will pay the ultimate price for this rule in the way of increased fees and fewer investment options.
Amended CFTC Rule 4.5 Appears to Impose Unnecessary Burdens on Many Mutual Fund Advisers
By: Rachel McTague
February 10, 2012
On February 8, the Commodity Futures Trading Commission (CFTC) issued amended Rule 4.5, a regulation governing commodity pool operators (CPOs), as well as a related rule proposal. Among other changes, the amendments to the rule significantly narrow the ability of registered investment advisers to rely on the rule’s exclusion from regulation as a CPO. As a result, many advisers will be required to register with the CFTC even though they are already regulated by the Securities and Exchange Commission (SEC).
Fund Investment in Commodities Provides Opportunity and Diversification for Investors
By Karen Lau Gibian and Rachel H. Graham
January 26, 2012
On Capitol Hill, a hearing at the Permanent Subcommittee on Investigations (PSI) raises questions about mutual fund investors’ ability to get commodity exposure in their portfolios and suggests the Internal Revenue Service (IRS) should no longer allow this type of investment.
ICI Responds to Hearing on Excessive Speculation
By Stephanie Ortbals-Tibbs
November 3, 2011
ICI issued the following statement in response to today’s hearing, “Excessive Speculation and Compliance with the Dodd-Frank Act,” before the Senate’s Permanent Subcommittee on Investigations.
The Uphill Path to Better Economic Analysis in Rulemaking
By Paul Schott Stevens
August 10, 2011
Last month, the United States Court of Appeals for the District of Columbia Circuit vacated the Securities and Exchange Commission’s rule on proxy access. The unanimous ruling marked the fifth time since 2005 that the DC Circuit has struck down an SEC rule, and the third decision based on the agency’s failure to properly weigh economic consequences and to consider—as the law requires—the effects of its rules on efficiency, competition, and capital formation.
Wall Street Journal Falls Short with Story on Funds’ Commodity Investments
By Ianthe Zabel
April 26, 2011
Today’s Wall Street Journal included an article that attempted to analyze the debate over regulation of commodity investments through mutual funds. Unfortunately, the story omitted basic facts about mutual fund regulation and oversight, and thus fell short of providing an accurate explanation of the issue and debate.
CFTC Proposal Would Subject Funds to Duplicative, Conflicting Regulatory Requirements
By Sarah Bessin and Rachel Graham
April 15, 2011
Funds use swaps and other derivatives in a variety of ways to manage their investment portfolios, and many of these uses are unrelated to speculation. This is why we have been particularly concerned by a proposal from the Commodity Futures Trading Commission (CFTC) to revise Rule 4.5, which provides an exclusion for funds and certain “otherwise regulated” entities from regulation as commodity pool operators (CPOs).
ICI Letter Details Benefits of Having Diversified Funds Investing in the Futures and Swaps Markets
By Heather L. Traeger
January 12, 2011
We’ve just filed a letter to the Commodity Futures Trading Commission (CFTC) on the use of position limits for derivatives. Our letter urges the CFTC to establish an exemption from position limits for funds that comply with the diversification and leverage requirements of the Investment Company Act of 1940.