COMMODITY TRADING
including commodities, since the onset of the Global Financial Crisis. For example, in April 2012, Williams et al. (2012) explained, “In a world where disparate assets move in lockstep, their individual identities become lost. Assets now behave as either risky assets or safe havens … Synchronised markets provide little diversification …” The authors refer to this new market behaviour as “Risk On – Risk Off (RORO).” RORO may be a “consequence of a new systemic risk factor.” According to Williams et al. (2012),
Figure 4: Return Correlation Coefficient Between Commodity Index & Equity Index
Daily Return, (1/2/90 – 2/17/12)
0.2 0.4 0.6 0.8 1
“We have seen global intervention, QE [Quantitative Easing] and policy response of an unprecedented scale across many countries – and markets are pricing in the bimodal nature of their consequences. Ultimately, either policy response works and there is indeed a global recovery, or they fail and the sovereign debt issues across the developed world lead to new and even more serious [financial] crises. Individual assets [including commodities], while still influenced by their fundamentals, are dominated by the changing likelihood of such a recovery. Disparate markets now have an ascendant common price component and correlations surge whenever an unsettling event increases the degree of uncertainty.” Cheng et al. (2012) provide convincing evidence of one aspect
-0.6 -0.4 -0.2 0
Source: Based on Kawamoto et al. (2011), Chart 2. The figure shows the one-year rolling correlation coefficients between the return of the global equity index (MSCI AC World Index) and that of the commodity index (S&P GSCI). Note: The vertical line demarks the second half of 2008. [Bloomberg tickers: MSCI AC World USD: MSEUACWF Index; and S&P GSCI Excess Return: SPGCCIP Index.]
commodity risk. This is similar to the advice provided by Williams et al. (2012) in advising asset managers to rethink portfolio construction in an era of assets losing their “individual identities.” Regarding the Cheng et al. (2012)
of the “RORO” environment, which began after the 2008 Lehman crisis. “… [W]hile financial traders accommodate the needs of commercial hedgers in normal times, in times of financial distress, financial traders reduce their net long positions [in commodities] in response to an increase in the VIX[,] causing the risk to flow to commercial hedgers.” Their “analysis shows that while the positions of CITs [Commodity Index Traders] and hedge funds complement the hedging needs of commercial hedgers in normal times, their own financial distress rendered them liquidity consumers rather than providers during the financial crisis.” The G20 Study Group on Commodities (2011) acknowledged
this new state-of-the-world: “The expansion of market participants in commodity markets increases market liquidity (including in longer term contracts), thereby accommodating the hedging needs of producers and consumers. … On the other hand … (the) increased correlation of commodity derivatives markets and other financial markets suggests a higher risk of spillovers.” [Italics added.] In debating the significance of the “higher risk of spillovers,”
one could also note, as the Deputy Governor of the Bank of Canada did, that “similar, if not larger, [price] spikes were witnessed during the Great Depression and the tumultuous 1970s and 1980s,” according to Hickley (2011). What this means for commodity market participants, whether
they are hedgers or speculators, is that results such as those in the Cheng et al. (2012) study have to be considered in managing
study, one should add that it is not a new phenomenon for commercial market participants to have to step in when risk-bearing-specialists become in distress. As discussed in Till (2008), the hedge fund, Amaranth, took on price risk from physical natural gas participants, who had wanted to hedge their forward production. When the hedge fund became in distress in 2006, it is likely that these commercial hedgers were then the
... increased correlation of commodity derivatives markets and other financial markets suggests a higher risk of spillovers
ultimate risk takers on the other side of Amaranth’s distressed trades, and so benefited from the temporary dislocations that ensued from the fund’s collapse. In other words, it does not appear that the commercial natural-gas industry was damaged by the crisis caused by Amaranth; in
fact, commercial-market
participants likely benefited. Natural gas commercial hedgers would have
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