Federal Reserve Paper Says Speculators Not Driving Oil Prices

from the New Republic:

Not according to a Federal Reserve paper released today. The study, written by George Korniotis, looks at a number of different factors that could suggest speculators' influence on commodity prices, but finds little evidence that any of them have been at work.

First, we should see a break-down in the correlation of price changes between tradable and non-tradable commodities once speculators started trading commodity futures in larger volumes at the beginning of this decade. (The theory being that speculation wouldn't affect the prices of non-tradable commodities):

I test the comovement hypothesis by studying the time patterns of metals with and without futures contracts. Over the period 1991 to 2008, I find that the correlation of metal price growth rates was consistently positive and did not decrease after 2000.

Second, Korniotis thinks that the big jump in nearly all commodity prices earlier this decade can be explained by the surge in global economic growth:

I use the world GDP growth rate to capture world economic activity. I find that world growth rate is positively correlated with metal price growth. Also, similar to metal price growth rates, world growth started to steadily rise after 2002. Therefore, accounting for world growth reduces the statistical significance of the structural break in metal spot prices.

(If you're unfamiliar with the term, the easiest way to think about a structural break is to imagine a smooth looking chart of stock prices or population growth, etc. which all of a sudden jumps to a new level. It typically means that something about the state of the world has changed. Here's a nice example.)

Third, Korniotis finds that there's no relationship between the returns of the S&P Goldman-Sachs Commodity Index--which he argues is a proxy for profits earned by investors--and commodity price changes. And fourth, Korniotis tests the theory that commodity suppliers could be affecting prices by hoarding inventories and then entering into futures contracts with speculators:

My analysis finds no evidence of physical hoarding. In particular, inventory growth is negatively correlated with price growth. Also, this negative relationship is present even after 2002.

This first chart from the paper shows the quarterly annualized growth rates in spot (i.e., current rather than futures) prices for traded and non-traded metals. The shaded area is the time period when prices accelerated upward:

And this next chart shows the annual correlations across all metals (solid line) and between traded and non-traded metals (dashed line) and that they have remained fairly constant over time:

While this is all circumstantial evidence, it should give the CFTC at least some pause before going ahead with stricter limits on speculative activity. On the other hand, there are some very suspicious signs right now that hoarding is influencing oil prices (and which are too recent to appear in the Korniotis paper). From Paul Krugman:

This time, however, oil inventories are bulging, with huge amounts held in offshore tankers as well as in conventional storage. So this time there’s no question: speculation has been driving prices up.

Now, “speculation” isn’t a synonym for “bad”. If the underlying assumptions that seem to have been driving oil markets were right — namely, that a vigorous recovery is just around the corner, and demand will shoot up soon — then it would be perfectly reasonable to accumulate oil inventories right now. But those assumptions are looking less reasonable by the day.

Since this is such a contentious issue these days, it's also worth pointing out that the paper doesn't necessarily represent the views of the Fed and Ben Bernanke, just the author.

--Zubin Jelveh