Investor demand and spot commodity prices

The on-going debate over the influence of investor demand on spot commodity prices largely attempts to assess this influence by measuring the growth in investor demand in recent years. Given the serious data problems that plague such analyses, this article pursues another approach in the hope of providing useful insights into the impact of investor demand on spot commodity prices. It focuses on the mechanisms by which investor demand affects spot prices, and in particular on two questions. First, how does an increase in investor demand on the futures markets affect the spot market and spot price? Second, when investor demand is increasing and pushing a commodity's price up, do physical stocks of the commodity also have to be rising, as economists and others widely assume?On the first question, the article concludes that a surge in investor demand raising prices on the futures markets will have a direct and comparable effect on the spot market prices when these markets are in strong contango. However, when markets are in weak contango or backwardation, price movements in the futures markets have a much looser effect on spot prices. As a result, changes in investor demand on the futures markets may have little or no influence on spot prices in the absence of a strong contango. Instead, changes in fundamentals (that is, producer supply and consumer demand) and possibly changes in investor demand taking place directly on the spot market largely determine the spot price at such times.On the second question, the article shows that investor demand can be pushing up a commodity's price even when investor stocks are falling, despite the widespread presumption to the contrary.     

Iron ore spot price volatility and change in forward pricing mechanism

To examine the impact of the change in forward pricing mechanism on the volatility of iron ore spot prices, we model the iron ore daily price of Platts IODEX from October 7, 2008 to September 21, 2012. The identified iron ore spot price tends to be less volatile after the introduction of quarterly pricing mechanism. Our main approaches are as follows: (i) to decompose the spot price of Platts IODEX into two subsamples and relate the result of the structural break to the date of the switch in the iron ore forward pricing mechanism; (ii) to apply the EGARCH (1, 1) model to simultaneously capture the long memory and the asymmetric effect on the volatility of the iron ore spot price; and (iii) to delineate the news impact curve to further interpret the asymmetric effect.     

Feasibility,forward pricing and returns: Recent developments in the literature on futures trading

In recent years the feasibility conditions for market establishment and the information value of futures markets have been central issues in futures market research. This paper first discusses recent developments under the heading of feasibility conditions, including the obsolescence of the commodity characteristics approach and the search for a comprehensive framework. Second, futures markets collect and disseminate information, and in so doing they are centres of rational price formation, and the forms of tests that have been developed to ascertain whether they perform this function efficiently are considered. Futures markets also perform a forward pricing function: their prices may be regarded as market anticipations of subsequent cash prices. 1970s' literature has addressed this question, finding differences in performance between continuous and non-continuous inventory commodities. This paper discusses the reasons for and economic implications of these results.     

Influence of production costs and inventories on mineral prices

The purpose of this article is to broaden understanding of the factors which exert major influences on prices for industrial metals beyond the widely recognized tendency for prices and inventories to move in opposite directions. Specifically, the relationship between inventory levels and price volatility is examined. In addition, the relationship between prices and production costs is also examined. A few thoughts are expressed on the relationship between prices and industry structure. The paper includes a qualitative discussion about why a link should exist between prices and production costs, a graph illustrating the relationship between prices and inventories, and econometric equations quantifying the relationship between prices, production costs and inventories.     

Estimating the volatility of mining projects considering price and operating cost uncertainties

In the real option pricing model of valuation and decision making, the estimation of future volatility is a key input parameter. For traded commodities or financial assets, past volatility is used as a proxy for predictions. But, for projects, this approach is not feasible because, in most cases, historical data of traded projects are not available. As an alternate solution, it is usually assumed that project volatility is equal to that of commodity price. In order to investigate this assumption, we estimate the project volatility considering that both commodity price and operating cost evolve as a geometric Brownian motion (GBM). Results of a hypothetical gold mining project indicate that project volatility is higher than that of commodity price and it only drops to price volatility under very unrealistic industry conditions, such as very high prices or very low production costs. In addition, we find that project volatility is independent of production capacity and taxation, but depends on increments in price and cost, as well as strongly on their degree of correlation.     

Is the convenience yield a good indicator of a commodity's supply risk?

A strong increase in the demand for some commodities over the last decade will have a major impact on their future supply situation. Of increasing importance, therefore, is an assessment of a commodity's criticality, and especially its supply risk, by appropriate indicators. The literature has proposed numerous indicators of the supply risk. Here, we use the convenience yield of commodity futures as a supply risk indicator to address some of the major shortcomings of existing indicators, especially regarding their predictive power. This paper aims to test the applicability of the convenience yield as an indicator of a commodity's future supply risk. Therefore, we calculate historical convenience yields for 3-, 15-, and 27-month futures contracts for five major industrial metals (aluminum, copper, lead, nickel, and zinc) during the period 1999 to 2011. We compare the convenience yields at the beginning of the contract period to known indicators at maturity to find that the convenience yield has generally predictive power for the static stock lifetime (i.e., inventory volume/turnover) and future spot prices. Furthermore, we find that, with some restrictions, the convenience yield is an applicable indicator of a commodity's supply risk.     

Comment: Investor demand and spot commodity prices

Tilton et al. claim in their article “Investor demand and spot commodity prices” to show that “investor demand can be pushing up a commodity's price even when investor stocks are falling.” In the present comment, it is argued that in both the cases described by Tilton et al., investors are supplying the market, putting physical material into it, rather than adding to demand. Thus, the reasoning by Tilton et al. is not concerned with the phenomenon referred to in the traditional theory, where, in the absence of changes in demand and supply fundamentals, prices rise as a result of increased investor demand for futures contracts.     

Long memory and chaotic models of prices on the London Metal Exchange

Many financial time series exhibit irregular behaviour. Economic theory suggests that this irregular behaviour might be due to the existence of nonlinear dependence in the markets. Thus, economic time series are governed by nonlinear dynamics.The purpose of this paper is to investigate price behaviour in the London Metal Exchange market. Thus, this study will test the two most attractive nonlinear models—long memory and chaos—on six metal commodities to ascertain which model is consistent with the observed metal price nonlinear dynamics.Application of long memory and chaos analysis provides new approaches for assessing the behaviour of metal prices. We identified, in tin, a case of chaos. Our empirical results in the case of aluminium support the long memory hypothesis. A short memory model explains the underlying processes of the nickel and lead returns series, while zinc returns reflect an anti-persistent process. To our knowledge, this is one of the first attempts to apply long memory and chaos analysis in the evaluation of the behaviour of metal prices.     

Forward pricing and efficiency in the silver market

If futures prices ‘fully reflect’ all available information, then these prices may be interpreted as market anticipations of spot (cash) prices at the delivery date of the futures contract. This hypothesis, which has tended to find most support among established markets for storable commodities, is investigated for the Chicago silver futures market. Using instrumental variable estimation and a joint (χ²) test, the unbiased prediction hypothesis is rejected, and a tentative explanation is offered for this outcome. This result, however, does not necessarily imply that the market is inefficient, and two tests of the weak form efficient markets hypothesis suggest that, while there is some slight dependence in past prices, this is only marginally more than would be expected from normal sampling variation.     

The significance of futures trading in minerals and oil

Futures trading has been introduced for aluminium and oil in recent years and the range of contracts available on various minerals and oil products continues to widen. Concern has been expressed by producers of a number of minerals, including nickel and platinum, that the introduction of futures trading may introduce a speculative element to price determination that will create inappropriate or excessively volatile prices. It is the purpose of this article to analyse the role of futures trading in relation to trade in underlying commodities in general and especially for trade in minerals and oil. Evidence from oil and platinum markets, in particular, is adduced and examined in the light of earlier evidence of the influence of futures trading on underlying commodities. The contribution of futures trading is examined in detail and conclusions are reached on the significance of futures trading for minerals and oil.     

Mixed signals: market incentives, recycling, and the price spike of 1995

Environmental economics assumes that reliance on price signals, adjusted for externalities, normally leads to efficient solutions to environmental problems. We explore a limiting case, when market volatility created ‘mixed signals’: prices of waste paper and other recycled materials were suddenly extremely high in 1994–1995, then plummeted back to traditional low levels in 1996. These rapid reversals resulted in substantial economic and political costs. A review of academic and business literature suggests six possible explanations for abrupt price spikes. An econometric analysis of the prices of wood pulp and waste paper shows that factor which explained price changes in 1983–1993 contribute very little to understanding the subsequent price spike. From the econometric analysis and from other sources, we conclude that speculation must have played a major role in the price spike, perhaps in combination with modest effects from changes in government policy and in export demand. If speculatively driven price spikes can disrupt an environmentally important industry such as recycling, what is the appropriate role for public policy? When price volatility is sufficiently disruptive, then measures to control or stabilize prices, rather than interfering with the market, might help to make it more efficient.     

EXTERNALITIES,WATER PRICES,AND WATER TRANSFERS1

Discussing, estimating or analyzing the value of water is a difficult task. In addressing the value of water as reflected in its price — either as charged by a water utility, as the price of a water transfer, or a water sale in some market — this paper will examine three propositions regarding water pricing. The paper will consider the marginal scarcity rent of water, estimates of externalities, the full cost pricing of water and the consequences of these considerations on water prices, transfers and the efficiency of water use.     

Commodity futures and market efficiency: A fractional integrated approach

In financial time series, persistence or inertia is a feature usually observable in absolute returns, i.e., a proxy for volatility. Moreover, asset return series should be essentially unpredictable according to the efficiency market hypothesis (EMH) in its weak form. Surprisingly, recent literature has found evidence of anti-persistence in technology stocks and commodity futures returns. Anti-persistence would be indicative of an overreaction of asset prices to incoming information.     

Market imperfections in recycling markets: conceptual issues and empirical study of price volatility in plastics

The effectiveness of recycling depends upon efficient functioning of secondary material markets. This paper focus on the role that price volatility can play in slowing investment and market development. However, a statistical analysis of the relative volatility of secondary and primary material prices does not confirm the widely-held belief that relative price volatility is higher in secondary than in primary materials, at least at national levels.An econometric estimation of the determinants of plastic recovery volumes in Seattle contributes to the literature in four ways: the use of monthly (as opposed to annual) data; the use of local (as opposed to national) data; the use of an explanatory variable to reflect price volatility; and, the focus on plastics, which have not been examined previously. Some tentative conclusions can be made: the results generally support the principal hypothesis that price volatility has a negative effect on recovery of secondary materials; in addition, and consistent with previous studies, price elasticities are low and insignificant; and finally, policy factors are clearly important. The concluding section treats the economic and policy implications of market inefficiency in secondary material markets.     

The macroeconomic determinants of volatility in precious metals markets

This paper models the monthly price volatilities of four precious metals (gold, silver, platinum and palladium prices) and investigates the macroeconomic determinants (business cycle, monetary environment and financial market sentiment) of these volatilities. Gold volatility is shown to be explained by monetary variables, but this is not true for silver. Overall, there is limited evidence that the same macroeconomic factors jointly influence the volatility processes of the four precious metal price series, although there is evidence of volatility feedback between the precious metals. These results are consistent with the view that precious metals are too distinct to be considered a single asset class, or represented by a single index. This finding is of importance for portfolio managers and investors.     

An empirical approach to determine specific weights of driving factors for the price of commodities—A contribution to the measurement of the economic scarcity of minerals and metals

In recent years, commodity markets show a large amount of volatility and substantial price jumps, indicating an increasing economic scarcity in many cases. As this scarcity makes commodity procurement a critical issue for national economies, industry sectors and manufacturing companies, a number of criticality indices have been presented and utilized in science as well as in practice. These indices are mostly based on an aggregation of different key figures, both qualitative and quantitative. However, the weighting of the different factors is in most cases arbitrary or based on rough estimates.     

The supply and demand outlook for energy in the Asia—Pacific region

Years of strong economic growth in the Asia—Pacific region have resulted in unprecedented increases in energy demand in the region, particularly for oil and gas. The supply of oil and gas to the region will become more problematic as the decade progresses. Already 50% dependent on imported oil, this figure will rise to nearly 65% by 2000. Because high rates of domestic oil demand growth among traditional petroleum exporters - Indonesia. China and Malaysia - will absorb exportable surpluses, the region will find itself dependent on the Middle East for at least 90% of its imported oil needs by 2000. Currently linked to oil, LNG prices cannot justify the investments needed to bring new greenfield projects on line. With demand expected to exceed 67 million tonnes (Mt) in 2000 and 100 Mt in 2010. over 50 Mt of new capacity will be needed; satisfying this demand will necessitate a new pricing structure for LNG, raising the price substantially above the relative price of crude oil.     

Electricity price and Southern California’s water supply options

This paper evaluates the impact of fluctuating electricity prices on the cost of five options to increase the water supply to urban areas in Southern California—new surface storage, water purchases, desalination, wastewater recycling, and conservation.We show that the price of electricity required to produce and transport water influences the cost of water supply options and may alter the decision makers economic ranking of these options. When electricity prices are low, water purchase is the cost effective option. When prices exceed US$ 86/MWh, conservation of electricity and water through installation of high efficiency clothes washers is the most effective option.     

Reply: Investor demand and spot commodity prices

In a recent article (Tilton, Humphreys, and Radetzki, 2011), Tilton et al. argue that even when investor stocks are declining an increase in investor demand can cause a commodity's price to rise. They contend that this conclusion, which is based on two hypothetical examples, is both contrary to conventional wisdom and counter-intuitive. In my comment on the article (Olle Östensson, 2011), I challenged this finding. In a reply to my article, Tilton et al. maintain that their original finding is valid: investor demand can be driving commodity prices higher even when stocks are falling. In my present reply, I contend that their argument with respect to the first example confuses the actions of a minority of investors with those of all investors and is well accommodated within the framework of traditional theory. I further argue that their second example rests on an assumption regarding investor behavior that is unproven and that in any case falls outside the framework of analysis of futures markets.     

Impact of crude oil price volatility on economic activities: An empirical investigation in the Thai economy

This paper empirically examines the impact of oil price volatility on key macroeconomic indicators of Thailand. Following Andersen et al. [2004. Analytical evaluation of volatility forecasts. International Economic Review 45(4), 1079–1110], quarterly oil price volatility is measured by using the realized volatility (RV). The impact of the oil price volatility is investigated using the vector auto-regression (VAR) system. The Granger causality test, impulse response functions, and variance decomposition show that oil price volatility has significant impact on macroeconomic indicators, such as unemployment and investment, over the period from 1993Q1 to 2006Q4. Perron's [1997. Further evidence on breaking trend functions in macroeconomic variables. Journal of Econometrics 80(2), 355–385] test identifies structural breaks in all the concerned variables during the time of the Asian Financial Crisis (1997–1998). A VAR for the post-crisis period shows that the impact of oil price volatility is transmitted to budget deficit. The floating exchange rate regime introduced after the crisis may be the key contributor to this new channel of impact.