More investors are turning to exchange traded funds as an easy way to access commodity market moves. As the commodity ETFs grow in size, the funds are beginning to play a larger role in commodity price formation.
In a recent Société Générale note, Mark Keenan, head of commodity research Asia, and Dr. Michael Haigh, global head of commodities research, argue that recent exchange traded product, which include both ETF and exchange traded note, flows have affected the prices of underlying commodities.
The recent surge in oil ETP flows were enough to support oil prices as they fell, or cushion the recent fall as more investors jumped onto oil ETFs in a bid to catch the falling knife.
“We estimate a 20% decline ($9) in oil price increases flows into ETPs (long) by 114 percent,” according to Société Générale. “These flows result in oil prices rising almost $3, offsetting some of the initial decline. If ETP flows remain elevated and increase in popularity, their impact on the oil price formation may be significant and warrant closer tracking, as one does with managed money net length.”
For instance, while United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate oil futures, fell 11.2% over the past three months, USO still added $862.4 million in new assets over the third quarter. [Enthusiasm for Oil Wanes]
However, Société Générale also found that outflows typically rise when prices rise, which is not too surprising as short-term traders will typically engage in the time-honored tradition of profit taking.
“ETP inflows (and outflows) are a moderating influence on price decreases (and increases),” Société Générale said.
However, ETF moves may be seen more as a reaction, instead of a direct cause of the price movements. As large and professional traders buy the dips and sell the highs, the futures-based ETPs may also help smooth out volatility in the energy market.
“Oil based ETF, ETP and ETN products tend to have inflows when prices are at extreme lows and outflows when prices are at extreme highs,” Sal Gilbertie, president of Teucrium, told ETF Trends. “Importantly, these flows of money seem to be a reaction to price movement, not a cause of price movement. Intuitively, it makes perfect sense that inflows of capital (buying) could help ease an oil price decline, and, conversely, outflows of capital (selling) might help dampen oil price increases. The SocGen paper is a welcome clinical example of how futures based energy ETF/ETNs may actually help stabilize prices, which would be good news for both markets and consumers.”
Additionally, gold bullion has also experienced greater price swings as investors plowed into precious metal ETFs and exited in droves to exacerbate the recent declines.
According to Société Générale data, gold ETPs attracted the equivalent of 279 tonnes of inflows in 2012. However, the gold ETP market experienced a huge 880 tonnes of outflows in 2013, which equates to about 30% of gold’s entire production in 2013, and has since continued to experience outflows.
So far this year, the SPDR Gold Shares (NYSEArca: GLD) has experienced $541.6 million in net outflows, according to ETF.com. GLD saw $3.2 billion in redemptions over 2014 and a lost a staggering $25.0 billion in assets over 2013.
“Flows out of gold ETPs have had an enormously bearish impact on the price of gold,” Société Générale said. “The importance of ETPs on gold’s price formation cannot be overstated. So much so, that in addition to speculative flows from managed money traders, ETP flow are also included in the precious metals drivers scorecard.”
For more information on the commodities space, visit our commodity ETFs category.
Max Chen contributed to this article.