Were exchange traded funds (ETFs) and speculative funds responsible for the sharp jumps and volatility in commodity prices seen last year?

It is no surprise that huge chunks of speculative money flooded the crude oil futures market in 2008 sparking a bull run for black gold and sending the commodity’s price all the way up to $147 per barrel, only to see it fall back down to around $45 per barrel, probably closer to its intrinsic value.

There are three sides of the argument:

• On the one hand, many funds did turn to commodities as they diversified their portfolios away from bonds and stocks. Additionally, a research study conducted by Informa Economics suggests that in certain markets, such as the agricultural markets the presence of index traders and money managers is somewhat correlated with volatility.

• On the other hand, the Commodity Futures Trading Commission (CFTC) , which regulates the futures industry, states that the buy-and-hold strategy of most index funds is fairly transparent and cannot squeeze the futures market to make money from the positions of other investors, reports K.T. Arasu of Reuters. Additionally, the CFTC has regulations and is mandated to curb excessive speculation by limiting trading and position limits and raising margin calls to execute its duties; this further prevents the possibility of contributing to volatility.

• Lastly, at least in the crude oil market, speculative bubbles are generally indicative of inventory numbers and not an increase in trading volumes.  And according to the Department of Energy, U.S. inventories were below-average levels when the price of crude was at record highs.

This research indicates that is pretty safe to bet that ETFs and mutual funds didn’t play a significant role in the volatility of the commodities markets. There was evidence of a bubble forming from around 75 or 50 days until 25 days until a futures contract expired.

Tags: Agriculture, Commodity ETFs, Energy, Mutual Funds, Oil