Easy monetary policy and commodity prices

This box aims to analyse the factors affecting commodity prices over the last 15 years, including the hypothesis that the influence of financial institutions on commodity markets is rising. A marked rise in the number of open traded positions on commodity futures markets (of 270% on average) has been visible since around 2004 across the entire commodity spectrum (see Chart 1). From the investor perspective, a large shift of funds has been apparent among large financial institutions and long-term commodity funds1 (see Chart 2), which invest in a wide range of commodity futures and subsequently create “commodity baskets” containing various portfolios from selected types of commodities2.

Most commodity funds hold long positions in the expectation that prices will go up in the long run. As each futures contract is time-limited, regular “rollover” takes place, meaning that futures which are almost due are sold before expiration and replaced by contracts with longer maturities. As can be seen in Chart 1, contract rollover started to be used on a larger scale in 2004. Unlike the number of open positions, however, the physical volume of sugar, maize, coffee and other commodities has not risen exponentially. Exchange traded funds (ETFs) make investing in commodities accessible to small investors by reducing their trading costs and leverage. More small investors can thus contribute to commodity price developments by purchasing shares in a fund.

Easy monetary policy in advanced countries may also have played a significant role in the greater interest of portfolio managers in commodity markets. Very low yields on traditional instruments and an expected negative relationship between real interest rates and commodity prices led to transfers of investment capital from financial instruments with low fixed yields towards commodity contracts promising potentially higher yields. This could indeed have caused commodity prices to rise. The hypothesis that the influence of large financial institutions on commodity markets is rising is also supported by Chart 2, which shows the breakdown of WTI oil futures holdings by category of market participants. While producers and processors had the largest share of positions on the WTI oil market in the previous period, a marked rise in the positions of banks and funds managing large amounts of money (“large investors”) can be observed from 2004 onwards. Small investors play a marginal role on commodity futures markets.

1For details, see also Global Economic Outlook, May 2012, CNB, p. 12. These mutual funds also include exchange traded funds (ETFs), whose portfolios may contain futures for certain commodities. The shares of such funds thus follow the prices of the commodities contained in the portfolio.

2This also partly explains why prices have not gone up equally across all commodities.