Monday, April 09, 2007

Financial investments in commodities

Commodities investments have caught the supervisory eye, it seems. In its latest Quarterly, the BIS published interesting research about Financial investors and commodity markets. Specifically, it addresses the questions whether the exploitation of perceived profit opportunities by financial investors has fundamentally changed the relationship between prices and the physical characteristics of commodity markets and whether the broadening of the investor base has led to significant market deepening and hence affected features such as short-term price fluctuations.

The latter question is answered quite in the affirmative, while the former is more difficult to address. The BIS notes a significant divergence of long-dated futures prices (in crude oil and copper) from estimates of current marginal production costs since 2003. In efficient markets, expected marginal costs should act as anchors for long-dated futures prices. However, the research offers several fundamental reasons for such divergences, hence they are not necessarily a consequence of portfolio investments.

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