An Analysis of the Impact of the Financialization of Commodity Markets

There is growing evidence that the dramatic increase in real commodity prices from 2002-2011 cannot be attributed solely to fundamental (demand and supply) factors. Over this period, there was major growth in the trading activities of financial investors in commodity derivative markets. This process, termed “financialization”, had important effects on price dynamics. This paper calculates rolling correlations for futures and spot returns for different commodities both for the period 2002-2011 when commodity prices were rising, and also from 2011-2015, when prices were falling. The paper finds a rise in correlations of index-based commodities during the period of rising prices, when commodity assets under management grew rapidly, and a fall during the period of declining prices, when commodity assets under management halved, supporting the view that financialization played a role in driving prices. This conclusion is reinforced by the finding that the same increase and decrease in correlations did not occur for bulk commodities. Granger causality tests reveal evidence of futures prices driving spot prices during the financialization period when prices were rising. However, there is a shift to more bi-directional relationships when prices (and correlations) fell. These findings support the role of financialization during the period of rising prices, as investor exposure to index-based commodities was usually achieved through the futures market.