COLUMN-Fundamentals and behaviour in commodity prices: Kemp

Wed Mar 27, 2013 12:11pm EDT
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By John Kemp

LONDON, March 27 (Reuters) - Fundamental changes in supply and demand account for less than a third of short-term movements in commodity futures prices, according to an authoritative new study by researchers at UNCTAD and the Swiss Federal Institute of Technology.

Reflexive trading, when prices respond to past price changes rather than new information about fundamentals, now accounts for 60 to 70 percent of price moves in the main futures contracts, up from less than 40 percent before 2005.

The authors examined price moves in Brent oil, U.S. crude, soybeans, sugar, corn and wheat futures using an elaborate procedure designed to separate movements related to the arrival of new information from those in which one price change begets another.

"We find an overall increase in the level of short-term endogeneity since the mid-2000s to October 2012, with a typical value nowadays around 0.6-0.7, implying that at least 60 to 70 percent of commodity price changes are now due to self-generated activities rather than novel information", according to Vladimir Filimonov, David Bicchetti, Nicolas Maystre and Didier Sornette in a paper published on March 21.

The paper marks a breakthrough in research into the formation of commodity futures prices. It brings research on commodity markets into the academic mainstream, integrating behavioural and fundamental approaches, and follows pioneering work in other asset classes by George Soros ("The Alchemy of Finance" 1987), Sornette ("Why Stock Markets Crash" 2003) and Robert Shiller ("Irrational Exuberance" 2009).

If their paper is correct, commodity futures markets may actually have become less efficient at discovering prices in recent years, not more, as a result of high-frequency trading and other aspects of financialisation.

Sornette is one of the world's foremost authorities on price formation and market microstructure, so the findings cannot easily be dismissed by researchers and policymakers who insist markets are efficient and all changes reflect fundamentals.   Continued...