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  The interest shown in commodities by many investors as an alternative asset to include in their portfolio strategies has grown considerably over the last decade. At the beginning, this approach was justified by the traditionally low correlation observed between commodities and other assets (especially equity), as well as by the fact that they could be used to hedge against sustained rises in inflation. In a few years, this phenomenon, which some call the «financialization» of commodities, has reached astounding proportions that have led to controversy. Specifically, it is accused of causing disproportionate increases in the prices of basic products for citizens.

  Since 2005, the main commodities indices have appreciated significantly and have been highly volatile in a process involving a wide range of products, particularly energy, foods and precious metals. Many observers have blamed this situation on the growing presence of financial investors such as investment banks and hedge funds, whose actions have been linked to speculation (usually through the derivative markets and structured products). Others blame rising prices on the massive flows of savings from institutional investors (such as retirement funds) and private investors. For the latter, it has become much easier to channel their savings towards commodities thanks to a highly successful new product: ETFs (Exchange Traded Funds).(1) Over the last three years, the volume of assets managed by commodity ETFs has doubled and now accounts for almost half the total financial assets linked to commodities, as can be seen in the graph below.

  (1) ETFs (Exchange Traded Funds) are traded funds whose investment policy consists of tracking an index. A participation in these funds can be made up of shares, bonds or commodities and they are traded on stock markets as if they were shares.

  In a debate that is very often dominated by demagogy and self-interest, a number of academic economists have attempted to examine, with as much conceptual and empirical thoroughness possible, the relationship between the increase in flows of financial capital and rising commodity prices. This issue became particularly relevant in the middle of 2008, when the indices for these assets reached a record high, coinciding with the sharp rise in the price of crude oil. The new spike occurring in 2010 merely increased the interest of more researchers. Unfortunately, the findings of these studies are not sufficiently conclusive to reach any resounding final verdict regarding the accusation in question. However, they do allow us to reasonably shift the discussion towards a short but useful list of conclusions.

  On a conceptual level, positions are divided along terms analogous to the already long and prolific debate regarding efficiency in financial markets. Those who claim that financial markets are efficient believe that the «financialization» of commodities does not entail drawbacks but advantages: it improves the price discovery mechanism, increases market liquidity and depth, provides stability, etc. Meanwhile, those who believe that markets are inefficient in disseminating and processing information suspect that, in the commodities markets, «financialization» has amplified phenomena such as herding, the formation of bubbles, predatory trading, panic, etc. Up to the financial crisis of 2008, the pro-efficiency paradigm was dominant but the commotion caused by the many different dysfunctions observed in the last few years in markets such as the monetary, mortgage and stock market seem to be moving the balance towards approaches that question their efficiency.

  In any case, many different empirical studies have attempted to identify, measure or estimate the impact of financial activity in these markets. Some use sophisticated statistical techniques while others resort to basic data that can be observed directly, without processing. Among the former, there are many that use the database of the Commodity Futures Trading Commission (CFTC), the regulatory body in the United States for derivative markets, including commodities. This is one of the few sources of high frequency data where, in principle, the actions (transactions and positions) of «speculative» investors can be monitored. Evaluated as a whole, these analyses(2) do not find any significant or consistent causal relationship between financial/speculative activity and rising commodity prices. This is, for example, the interpretation proposed by the World Bank(3) in the conclusions of its report on Global Economic Prospects. On the one hand, the number of futures contracts of speculative investors tends to be much lower than that of non-speculative investors. More importantly, the behaviour of the former has a low correlation with trends in major commodity prices, such as crude and foods. And even more decisively, it has been statistically found in a range of episodes (the main ones in relation to crude) that variations in commodity prices led to modifications in the net positions of investors and not the opposite, as claimed by those against speculation.

  Several criticisms have been levied against the family of studies based on the CFTC data, particularly the omission of transactions in very important areas of the market through which financial/speculative flows can also be channelled (other products and other countries), the use of sample periods that are not always representative (in particular the emphasis on studying the case of petrol in 2008), as well as weaknesses in the econometric techniques used.(4) In this respect, those studies that cover the events of 2010 tend to identify a more significant causal relation between speculation and rising prices.(5) Those claiming the innocence of speculation respond to this by providing another kind of «evidence». One piece is related to trends in stocks, which have not grown as would be expected if the actions by speculators had driven the market price above the equilibrium price between the final supply and demand (fundamentals). Another is the observation that products not involved in any financial activity, merely due to the absence of vehicles (derivatives or ETFs), have moved as or more sharply than commodities as a whole. For example, coal.

  (2) For example, the following: J. Hamilton, Causes and Consequences of the Oil Shock of 2007-08, Brookings Papers on Economic Activity, Spring 2009: 215-259. R. Alquist, and O. Gervais. The Role of Financial Speculation in Driving the Price of Crude Oil. Bank of Canada. Discussion paper 2011. S. Irwin, D. Sanders and P. Meerin, Devil or Angel. The Role of Speculation in the Recent Commodity Price Boom. Journal of Agricultural and Applied Economics No. 41, 2009.

  (3) For more details, see «Global Economic Prospects - Maintaining Progress Amid Turmoil». World Bank. June 2011.

  (4) K. Singleton, Investor Flows and the 2008 Boom/Bust in Oil Prices; working paper Graduate School of Business Stanford University, July 2011.

  In summary, and with the necessary provisos due to the lack of sufficient consensus among the different studies, it seems reasonable to propose three important notions. Firstly: financial activity's long-term effect on the level of commodity prices is small; price trends are determined by fundamental variables (demand, stock, supply and production costs). Secondly: effects on the level of prices may be significant in the short term, generally pushing in the same direction and amplifying the fundamental forces, but these effects vary over time and are disparate, depending on the type of commodity. Thirdly, there are significant effects on price volatility in the short term.

  Given these conclusions, we would expect a balanced judge to give a verdict of «not guilty», accompanied by provisions to prevent the harmful short-term effects from becoming greater than is acceptable. This is what the regulators are attempting in regions as important as the United States and the European Union, introducing different reforms (limits to positions in derivative contracts, obligations regarding transparency, etc.) for which, in fact, balance is highly advisable.

  (5) For example: M. Lombardy and I. Van Robays, Do Financial Investors Destabilize The Oil Price?, ECB Working paper no. 1346, June 2011.

  This box was prepared by the Financial Markets Unit Research Department, "la Caixa"

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