Large Traders Do Not Adversely Affect Futures Mkts - Study
News Date: 02/27/2009
Outlet: Dow Jones Newswires - Chicago Bureau
Contact: Carlson, Debbie

26 February 2009 Time: 18:20

CHICAGO (Dow Jones)--There is little evidence that specific trader groups such as index funds and others that move large volume have had a consistently detrimental impact to commodity futures, according to a research study released Thursday.

The study, commissioned by the CME Group (CME) for a group of futures exchanges and conducted by private analytical group Informa Economics, found "very little evidence that the trader groups of interest, index funds and managed money, were routinely detrimental to any of the studied markets. All of the trader groups displayed instances of non-optimal behavior (including small traders), but none were consistently harmful to the studied markets."

Informa's research focused on data from the Commodity Futures Trading Commission's weekly commitment of traders report. In particular, the study was to evaluate the impact large traders such as index funds and managed money had on market liquidity, volatility, price discovery and convergence. The timeframe for the study was Jan. 1, 2005, to June 30, 2008.

In recent years non-traditional investors began to enter the commodity markets as a way to diversify portfolios. This led to massive inflows of money and record volume to commodity futures. During this demand for physical commodities also rose. Some traditional users of futures markets said the new investors were distorting the basic mechanisms of futures markets. Among complaints were that markets had become too liquid and volatile.

Furthermore, particularly in the wheat futures, commercial market participants said some futures contracts were not accurately reflecting fundamentals. Because of that they said the futures and cash prices did not come together when the futures contracts were in delivery ahead of expiration, known as convergence.

The study said gains in liquidity couldn't be consistently linked to any particular trader group mostly, except for a weak relationship between the presence of index funds and liquidity in the Kansas City wheat and crude oil markets.

There also was no strong evidence to suggest that index traders or money managers caused increased volatility. The study noted that there was some correlation between index traders and money managers in most of the agriculture markets, but Informa said, "we suspect this is because markets trended higher during the study period, causing trend-followers (money managers) to adopt the same position as index traders (long)."

Regarding price discovery, there was little proof that any group had a "sustained and significant" influence on price as groups of all size could have both a beneficial influence on prices, meaning prices moved in sync with the fundamentals, or negative, if prices moved opposite of fundamentals.

Convergence is one of the most contentious issues with the influx of non-traditional commodity traders. The Informa study said no particular group had routinely helped or hindered convergence.

The firm said it used its methodology in investigating price discovery and focused on the last 20 trading days of a contract. It said "in most commodities, prices had a tendency to trend upwards during the final days of a contract's life, suggesting that prices were not consistently inflated above fundamental value."

It did point out that cotton and natural gas routinely "over-priced" but they said this could be because of the limited timeframe of the study.