Speculation and Commodity Price Dynamics

Stephan Schulmeister

Workshop „Financial Crash, Food Speculation and Development“ Berlin, 17th November, 2008

2

Overview

Theoretical basics

Price dynamics

Supply & demand conditions in the markets for physical commodities

Technical trading and price dynamics

Dynamics of exchange rates and stock prices

Trading volume in overall financial markets

Concept of a general financial transaction tax

3

“Fundamentalist hypothesis”

Economic Mainstream

Supply and demand in spot markets

Rational actors in derivatives markets >

Price discovery process >

Destabilizing speculation only a temporary phenomenon >

No persistent/systematic mispricing

Holds for asset prices in general

4

“Bull-bear hypothesis”

Fundamentals matter

Speculation as driving force

(Fundamental) News > overshooting

Trend-following trading systems

Feed-back upon price pattern >

(Commodity) Prices move in trends >

“Manic-depressive” fluctuations

Typical for asset prices in general

5

Crude oil futures price

2005 - 2008 (J uly)

1/ 17/ 07 (51.7)

2/ 7/ 2008

7/ 11/ 08 (147.2)

40

50

60

70

80

90

100

110

120

130

140

150

1/ 2005 7/ 2005 1/ 2006 7/ 2006 1/ 2007 7/ 2007 1/ 2008 7/ 2008

Do

llar

pe

r b

arr

el

6

Corn futures price

2005 - 2008 (J uly) 6/ 27/ 08 (795.0)

10/ 9/ 07 (340.0)

100

200

300

400

500

600

700

800

1/ 2005 7/ 2005 1/ 2006 7/ 2006 1/ 2007 7/ 2007 1/ 2008 7/ 2008

US

ce

nts

pe

r b

ush

el

7

Wheat futures price

2005 - 2008 (J uly)

4/ 4/ 07 (425.0)

3/ 13/ 08

(1265.0)

200

400

600

800

1000

1200

1400

1/ 2005 7/ 2005 1/ 2006 7/ 2006 1/ 2007 7/ 2007 1/ 2008 7/ 2008

US

ce

nts

pe

r b

ush

el

8

Rice futures price

2005 - 2008 (J uly) 4/ 24/ 08 (24.7)

7/ 19/ 07 (10.2)

5

7

9

11

13

15

17

19

21

23

25

1/ 2005 7/ 2005 1/ 2006 7/ 2006 1/ 2007 7/ 2007 1/ 2008 7/ 2008

US

do

llars

pe

r 10

0 p

ou

nd

s

9

Market for physical crude oil

0

10

20

30

40

50

60

70

80

90

100

1994 1996 1998 2000 2002 2004 2006 2008

Mill

. ba

rre

l pe

r d

ay

2300

2350

2400

2450

2500

2550

2600

2650

2700

2750

Mill

. ba

rre

ls

Supply/productionDemand/consumptionNet imports of C hinaC ommercia l OEC D inventories (end of period; right scale)

10

Crude oil prices

0

20

40

60

80

100

120

140

1Q1994 1Q1996 1Q1998 1Q2000 1Q2002 1Q2004 1Q2006 1Q2008

Do

llar

pe

r b

arr

el

0

100

200

300

400

500

600

Mill

. ba

rre

l pe

r d

ay

C rude o il futures price (WTI)

C rude o il spot price (Brent)

Trading volume of o il futures contracts (right scale)

11

Market for physical corn

400

450

500

550

600

650

700

750

800

850

1989/1990 1992/1993 1995/1996 1998/1999 2001/2002 2004/2005 2007/2008

1000

me

tric

ton

s

100

120

140

160

180

200

1000

me

tric

ton

s

Supply/productionDemand/useInventories/ending stocks (right scale)

12

Market for physical wheat

320

340

360

380

400

420

440

1989/1990 1992/1993 1995/1996 1998/1999 2001/2002 2004/2005 2007/2008

1000

me

tric

ton

s

70

80

90

100

110

120

130

140

150

160

1000

me

tric

ton

s

Supply/produc tionDemand/useInventories/ending stoc ks (right sc ale)

13

Market for physical rice

450

470

490

510

530

550

570

590

610

630

650

1989/1990 1992/1993 1995/1996 1998/1999 2001/2002 2004/2005 2007/2008

1000

me

tric

ton

s

100

120

140

160

180

200

220

240

1000

me

tric

ton

s

Supply/production

Demand/use

Inventories/ending stocks (right scale)

14

Commodity futures prices

40

100

160

220

280

340

400

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

02/0

1/20

05 =

100

C rude oilWheatC ornRough rice

15

Commodity derivatives trading

All exchange-traded commodity derivatives

5

10

15

20

25

30

35

40

45

50

1Qu00 1Qu01 1Qu02 1Qu03 1Qu04 1Qu05 1Qu06 1Qu07 1Qu08

Ou

tsta

nd

ing

co

ntr

ac

ts in

Mill

.

80

140

200

260

320

380

440

500

Tra

de

d c

on

tra

cts

in M

ill.

Open interest

Trading volume (right scale)

16

Trend-following trading system

2/ 11/ 2008

L(2/ 21/ 2008)

S(1/ 25/ 2008)

L(9/ 7/ 2007)S(8/ 27/ 2007)

50

60

70

80

90

100

110

120

130

140

150

$ p

er

ba

rre

l

Daily price15-day moving average (M AS)60-day moving average (M AL)

17

Trading signals and oil price dynamics

WTI crude oil futures contract

2/21/2008

2/7/2008

75

85

95

105

115

125

135

145

$ p

er b

arr

el

-100

0

100

Net position index of 1092 technical trading systemsReihe2Reihe3

18

Dollar exchange rate and oil price fluctuations

70

80

90

100

110

120

130

1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006

1986

= 1

00

0

10

20

30

40

50

60

70

In $

Effectiv e dolla r excha nge ra teO il p rice (right sca le)

19

Stock prices and real accumulation

0

200

400

600

800

1960 1963 1966 1969 1972 1975 1978 1981

Stoc k pric es

M arket c apitalisation

Real c apital stoc k

Net w orth

1960 = 100

0

200

400

600

800

1000

1200

1982 1985 1988 1991 1994 1997 2000 2003

1982 = 100

Germany

Source: Wifo-databank.

20

Profitability and price effects of technical commodity futures

trading1092 models tested over 1989/2008 (June)

Annual average return 12.7% (oil), 3.8% (corn), 2.4% (wheat) and 12.6% (rice).

Much higher during 2007/2008

Leverage factor ~15

Profitability due to “trending”

Aggregate trading > strengthens “trending”

21

Additional evidence on the role of commodity futures

speculation

•Commodity derivatives funds rose from 13 bill.$ (2003) to 260 bill. $.

•Main actors: Hedge funds, commodity index funds, banks (Goldman, Morgan, Deutsche).

•Also an increasing number of amateurs.

•Profits of Goldman and Morgan from commodity trading 2007: 7,5 bill. $.

•Trading activities

22

Daily US dollar/euro exchange rate 1999-2005

0.8

0.9

1.0

1.1

1.2

1.3

1.4

Daily pric e

35-day moving average (MAL)

04/12/30

00/10/26 02/01/31

23

Intraday US dollar/euro exchange rates, June, 6-13,

2003

1.16

1.17

1.18

1.19

5-minute pric e

35-period moving average (MAL)6/9:10

9/13:1011/13:45

13/21:55

13/12:35

9/6:55

6/14:15

11/1:50

24

Technical trading signals for S&P 500 futures contract

1420

1440

1460

1480

1500

1520

154030-minutes price

15-period moving average (MA L)

Oscillators

-3

-2

-1

0

1

2

3 Momentum (time span = 12)Moving average (MAS=1/MAL=15)

L(7/6)

S(7/5)

L (7/10)

25

Overall financial transactions in the world economy

0

10

20

30

40

50

60

70

80

1990 1994 1998 2002 2006

Wo

rld-G

DP =

1

Total

Spot markets

Derivative markets

26

Financial transactions in the world economy by instruments

0

5

10

15

20

25

30

35

40

45

50

1990 1992 1994 1996 1998 2000 2002 2004 2006

Wo

rld-G

DP

= 1

Stocks and bonds (spot)

Foreign exchange (spot)

Exchange-traded derivatives

OTC derivatives

27

Some conclusions

• Discrepancy real/financial transactions

• Speculation in derivatives grows fastest

• Hedging almost irrelevant

• Short-term price runs accumulate to

• „Manic-depressive“ fluctuations of the most important prices >

• Depresses real economy

• A small FTT would affect only very short-term transactions with high leverage >

• A FTT would dampen asset price fluctuations.

28

A general transaction tax

• Tax base:

• All transactions of „financial assets“

• Spot und derivatives

• On exchanges and „over-the-counter“ (OTC)

• Three tax rates: 0,1%, 0,05%, 0,01% of asset value

• Three scenarios about the reduction of trading due to the FTT (differentiated by types of instruments)

29

FTT receipts at a rate of 0.01

Reduction in transaction volume

In % of GDP In Bill. $ In % of GDP In Bill. $

Low 0.30 146.7 0.31 47.0

Medium 0.27 128.6 0.27 41.2

High 0.23 110.5 0.23 35.4

Low 0.55 266.0 0.78 118.2

Medium 0.49 234.0 0.68 103.9

High 0.42 201.7 0.59 89.4

World

Exchange traded derivatives

All transactions

Europe

30

Steps towards the realization of a FTT

• Step 1: Transactions on organized exchanges in EU.

• Step 2: OTC-transactions within Euro area.

• Step 3: Global OTC-transactions (including foreign exchange).

• Administrative costs extremely low due to electronic settlement systems.

• FTT would be highly concentrated on countries with big financial centers.

• Tax circumvention not (very) relevant due to low tax rate and network externalities (> successful stamp duty of even 0.5% in UK).