Ici Research: Perspective

ICI RESEARCH PERSPECTIVE
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WHATS INSIDE
2
Introduction
Fundamentals Drive Commodity

Prices
12 Did Financialization of
Commodities Drive Commodity
Prices?
15 The Market for Commodity Mutual
Funds
19 Commodity Mutual Funds and
Commodity Prices
23 Conclusion
24 Appendix: Regression Analysis of
Monthly and Weekly Data
MAY 2012 | VOL. 18, NO. 3
Commodity Markets and Commodity Mutual Funds

KEY FINDINGS
Fundamentals, not funds, drive commodity prices. Fundamental economic factors
market demand and supply conditionsprovide the most consistent explanation
for recent trends in commodity prices. The rise and fall of commodity prices on a
monthly basis since 2004 has been strongly linked to the value of the U.S. dollar and
the world business cyclein particular, to the strength or weakness in emerging
market economies such as China, Brazil, India, and Russia.
Financialization has not driven commodity prices. Despite concerns raised by

some policymakers that increased commodity index investment (the financialization
of commodities) has driven commodity price movements, numerous academic
studies have concluded that index-based investing has not moved prices or
exacerbated volatility in commodity markets in recent years.
28 Notes
30 References
L. Christopher Plantier, Senior Economist in

ICIs Industry and Financial Analysis section,
prepared this report.
Suggested citation: Plantier, L. Christopher.
2012. Commodity Markets and Commodity
Mutual Funds. ICI Research Perspective 18,
no. 3 (May).
Investing in commodity mutual funds provides important benefits for investors.

Commodity mutual funds typically invest in a broad basket of commodities. Investing
in a broad index of commodities can help investors offset the risk of investing in
stocks or bonds. Commodity mutual funds also allow retail investors to offset or
hedge against increases in their costs of living, especially increases in food and
energy prices.
Flows to commodity mutual funds have little or no influence on commodity

prices. An examination of ICI data on weekly and monthly net flows into commodity
mutual funds reveals that these flows have little or no effect on the overall growth
rate of commodity prices. In particular, weekly flows into commodity mutual funds
do not lead to future commodity price changes. These results are consistent with
academic papers that find little or no impact of commodity index investors on
commodity prices in individual markets.
Three key factors illustrate why flows into commodity mutual funds cannot
explain commodity price movements since 2004. First, commodity mutual
funds experienced net outflows on average from January 2006 to June 2008
while commodity prices rose. Second, flows into commodity mutual funds are
spread across a wide range of markets and thus do not concentrate investment in
a particular commodity. Finally, the $47.7billion in commodity mutual funds as of
December 2011 is miniscule relative tothe size of global commodity markets.
Introduction
Products such as gold, silver, crude oil, natural gas,
corn, wheat, and soybeans are generally thought of
as commodities. These and hundreds of other types
of commodities are traded daily around the world.1
Commodities are traded in the spot market, where a buyer
takes immediate (physical) delivery of the commodity.
Commodities are also traded in derivatives markets through
such instruments as forwards, futures, options, or swaps.
These derivatives allow buyers and sellers to set prices for
exchanges of commodities at a future date, in the case of
forwards and futures, or to hedge against price changes and
other risks. 2
global financial crisis hit global growth, commodity prices

plummeted in late 2008 and early 2009. They quickly
rebounded with the worlds economic recovery.
The rise in raw material prices has raised production and
distribution costs for many manufacturers. On the other
hand, some U.S. producers, such as corn growers, have
benefitted from higher commodity prices. For consumers,
the rise in commodity prices has pushed up the cost of living
and increased uncertainty over the future cost of food and
energy.
Over the past decade, the prices of many commodities

have risen dramatically and have varied widely (Figure 1).
In December 1998, crude oil prices troughed at around $10
per barrel, gold was less than $300 per ounce, and corn
was less than $100 per metric ton. From there, commodity
prices rose considerably, and in 2008 the prices of many
commodities hit all-time highs. For example, oil rose above
$130 per barrel, gold cost more than $900 per ounce, and
corn rose to about $280 per metric ton. As the recent
Recent developments in commodity prices have raised

concerns among policymakers and sparked widespread
debate over the causes of these price changes. Many market
participants, economists, and analysts believe that economic
fundamentalsmarket demand and supply conditions,
including special conditions affecting specific commodities
account for this pattern of change.
Other analysts, however, point to a trend sometimes
referred to as the financialization of commodity markets
the increase in commodity investment by participants
other than producers and users of commodities. In recent
FIGURE 1
Commodity Prices Rose over the Last Fifteen Years

Monthly, 19972011*
Price per unit
Price per unit
Dollars
Dollars
$2,000
Gold (left scale), price per ounce
1,800
$350
300
1,600
250
1,400
1,200
1,000
200
Corn (right scale), price per metric ton

150
800
600
100
400
50
200
WTIcrude oil (right scale), price per barrel

0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
*Data to December 2011.

Source: World Bank
ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012
years, hedge funds, pension funds, university endowments,

and others, including mutual fund investors, increasingly
have sought exposure to commodity investments to
diversify their portfolios and to protect against inflation.
Some commentators have called these investors massive
passives, because they use commodity indexlinked
instruments, such as commodity index swaps, to
establish long-term diversified positions in commodity
markets. Critics of the trend toward the financialization
of commodities, including some policymakers, argue that
excessive speculation by these long-term passive investors
is responsible for rising and volatile commodity prices. 3
Their argument is that the large increase in long-term
passive investments is driving commodity prices higher and
de-linking commodity prices from fundamentals.
This paper examines these two competing explanations for
the pattern of commodity prices during the last decade. It
concludes that fundamental factorsmarket demand and
supply conditionsprovide the most consistent explanation
for recent trends in commodity prices. The paper shows that
the rise and fall in commodity prices on a monthly basis
since 2004 has been strongly linked to the value of the
U.S. dollar and the world business cyclein particular, to
strength or weakness in emerging market economies such
as China.4 When world growth accelerates, so too does
production of goods such as automobiles and consumer
electronics, the need for raw materials, and worldwide

demand for commodities. Moreover, rising incomes in
emerging market economies rapidly have improved
standards of living in such countries as China, India, and
Brazil, where increased demand for food and energy has
served to boost commodity prices. Strong global and
emerging market growth dramatically reduced inventory
levels and spare capacity in many commodity markets from
2003 to 2008. This diminished spare capacity combined
with supply-side factorsbad weather, crop failures, and
political uncertainties in some oil-producing countriesto
produce high and volatile commodity prices.
The paper briefly reviews the academic literature on
financialization to determine whether commodity index
swaps or traders of these swaps might explain recent
patterns in commodity prices. As discussed, the literature
does not support the view that investment in commodity
index swaps is behind the rise in commodity prices. On
the contrary, the view that flows into commodity index
investments explain the patterns in commodity prices is
largely circumstantial and anecdotal, arising primarily from
the increasing popularity and availability of commodityrelated investments such as commodity mutual funds,
commodity exchange-traded funds (ETFs), and commodity
exchange-traded notes (ETNs).
FIGURE 2
Number and Assets of Commodity Mutual Funds

Monthly, 20042011*
Assets
Number of funds
Billions of dollars
30
$60
50
25
Number of funds (right scale)
20
40
30
15
Assets (left scale)
20
10
10
2004
2005
2006
2007
2008
2009
2010
2011
* Data to December 2011.

Source: Investment Company Institute
This papers chief contribution to the current policy debate

is to examine the growth of commodity mutual funds, put
this growth in its appropriate context, and assess the impact
of this growth on commodity markets and prices. The
assets and number of such funds have grown substantially
(Figure 2), in parallel with the rise in commodity prices.
The relationship between the assets of commodity mutual
funds and commodity prices has led some to argue that
commodity mutual funds are responsible for rising and
volatile commodity prices.
As the paper discusses, commodity mutual funds are a

relatively new development. They allow investors, especially
retail investors, to obtain the diversification benefits of
commodity investments, benefits that were historically
much harder to achieve. But there is little if any evidence
indicating that commodity mutual funds have caused rises
in commodity prices over the past decade. As this paper
explains, the apparent relationship between commodity
prices and assets in commodity mutual funds is mostly
mechanical (Figure 3), arising because the value of a funds
holdings must rise when the prices of commodities rise,
even without any new investment on the part of mutual
fund shareholders. 5
FIGURE 3
Commodity Mutual Fund Assets and Commodity Price Indexes

Monthly, 20062011*
Assets
Index level
Billions of dollars
200
$60
S&P GSCI (right scale)
Dow Jones-UBS Commodity Index (right scale)
50
150
40
30
100
20
10
Commodity fund assets (left scale)

50
2006
2007
2008
2009
2010
2011
* Data to December 2011.

Note: Prices were indexed to 100 in January 2006.
Sources: Investment Company Institute and Bloomberg
The paper explores whether new investment to commodity

mutual funds might be responsible for rising commodity
prices.6 The answer is no. An in-depth statistical analysis
based on regression techniques indicates that flows to
commodity mutual funds, at either a monthly or a weekly
frequency, have little or no influence on commodity prices.
Finally, the paper explains why it is so unlikely that
commodity mutual funds have influenced commodity prices.
Commodity mutual funds comprise only a very small portion
of global commodity markets. By the end of 2011, these

funds held $47.7 billion in assets, while global commodity
markets measured in the trillions of dollars (see Size and
Composition of Global Commodity Markets on page 6).
Further, the assets of commodity mutual funds are spread
across a wide range of individual commodities, amounting
to no more than $8 billion in any individual commodity,
which greatly limits any potential influence on commodity
prices in those markets.
Size and Composition of Global Commodity Markets

Hundreds of commodities trade daily on dozens of exchanges around the world. The amount of commodity trading that
occurs in spot, futures, and options markets on these exchanges on a monthly basis is massive, measured in trillions of
dollars globally. The size of particular markets, however, varies for different commodities, and some commodity markets
see more trading than others do.
Figure 4 shows 12 highly traded commodities and the estimated value of the physical market for 2010, estimated futures
and options monthly volume as of October 2011, and the estimated value of futures contracts and options outstanding as
of October 2011. These numbers demonstrate that the spot market is much larger than the assets in commodity mutual
funds. The figure also demonstrates that futures and options monthly trading is quite large relative to the size of physical
markets. In fact, the value of monthly trading volumes in futures and options is in many cases much greater than the
estimated value of the physical market for the entire year.
FIGURE 4
Commodity Market Size

Billions of dollars
Commodity
West Texas Intermediate (WTI) and Brent crude oil
Live cattle CME
Total sales in
spot market
Trading volume
in futures and
options markets
Annual
Monthly
$2,500
$2,800
Futures and
options market
open interest
$279
1,500
76
21
Heating oil and gas oil
800
982
74
Unleaded gasoline
705
318
33
Gold
182
2,067
145
Silver
21
369
30
Zinc
27
1,910
13
144
1,228
58
89
484
47
Corn
104
291
64
Wheat CBOT
165
61
17
Copper
Aluminum
Soybean
Totals
120
375
55
6,357
10,964
835
Note: Spot (physical) market value is calculated using a quantity supplied and average price for 2010 for each individual commodity.
Futures and options data as of October 2011.
Source: Barclays Capital
Over the past decade, some have pointed to the large increase in open interestthe value of futures contracts
outstandingor the large increase in trading in futures markets as a sign that speculation is driving commodity
markets.7 That view ignores crucial differences between spot and futures markets. While trading volume in spot
markets is limited by the production of physical commodities, there is no supply constraint on the number of futures or
option contracts that can be created. Indeed, futures contracts are a zero-sum product; for every contract, one investor
is long in the commodity, and another is short. The vast majority of futures contracts never lead to delivery of the
physical product. Instead, longs and shorts are offset, and the contracts cancelled on the contracts delivery dates.
Irwin, Sanders, and Merrin 2009 point out that money flows to derivatives markets are not the same as demand for
other assets, since derivative contracts are zero-sum markets that can respond to increased flows by creating a large
number of identical contracts without moving prices. Indeed, one mark of a properly functioning futures market is that
price increases will be accompanied by an increase in open interest as the supply of contracts expands. During the
first decade of the 2000s, nearly every market included in the major commodity indexes experienced an increase in
open interest, suggesting that these markets were functioning properly during the period when investment flows into
commodity investments were growing rapidly.
U.S. commodity mutual funds are small relative to the size of the global commodity market. With almost $50 billion in
assets under management, U.S. commodity mutual funds constitute less than 10percent of the value of futures and
options market open interest. Each month, the $50 billion in U.S. commodity mutual funds must be effectively rolled
forward in futures markets, but this would constitute less than 0.5percent of the monthly turnover in futures and
options markets.
Fundamentals Drive Commodity Prices

Evidence strongly indicates that global growth, especially
rapid growth in emerging market countries, is the primary
source of commodity price pressure over the past decade.
Figure 5 plots the year-over-year growth rate in emerging
market industrial production versus the year-over-year
percent change in the Dow Jones-UBS Commodity Index.
The statistical relationship is quite strong (correlation is
0.82), indicating that growth in emerging market countries
has been the primary source of demand growth for
commodities. 8 A recent report on commodity markets by
the Group of Twenty Finance Ministers and Central Bank
Governors (G20) emphasized that demand growth for
metals, oil, and major food crops in the 2000s was largely
driven byemerging market economies. 9
According to the International Monetary Fund (IMF), the

annual real GDP growth in emerging markets averaged
6.5percent from 2002 to 2011, with growth in developing
Asia averaging almost 9percent over this period. For
example, China grew faster than 10percent per year on
average and significantly increased its imports of many
commodities. This widespread growth in emerging
economies was marked by industrialization and rapid
expansion of living standards; resource-intensive processes
directly led to a huge increase in the physical demand for
many commodities, including oil and other energy products,
metals like copper and aluminum, and major food crops.
The rapid increase in demand reduced inventories and
spare capacity in many commodity markets in the precrisis
period, and led to significant commodity price pressure.
FIGURE 5
Emerging Market Industrial Production Growth and Commodity Price Growth

Monthly, 20052011*
Percent change year over year

20%
Percent change year over year

50
Emerging market industrial production growth (left scale)
40
15
30
20
10
10
0
-10
-20
Dow Jones-UBS Commodity Index (right scale)
-30
-40
-5
-50
-10
2005
2006
2007
2008
2009
2010
2011
-60
* Data to October 2011.

Note: The correlation between the two growth rates is 0.82.
Sources: Netherlands Bureau for Economic Policy Analysis and Bloomberg
This strong economic growth will remain a key source of

demand growth going forward. It explains why commodity
prices recovered so quickly after the global recession, even
as economic growth remains subdued in many advanced
economies.
Supply factors have added to the pressure on prices
from emerging market demand. As Hamilton 2009 notes,
Somedegree of significant oil price appreciation during
20072008 was an inevitable consequence of booming
demand and [emphasis added] stagnant production. After
years of low oil prices in the 1990s, many oil producers
were reluctant to increase capacity, due in part to a fear of
creating overcapacity; in addition, they were concerned that
higher prices in the 2000s might only be temporary (which

would not justify significant new investment). Also, as prices
rose for many key soft commodities (e.g., wheat), some
countries implemented export restrictions or bans, limiting
supply to the rest of the world. Bad harvests and political
uncertainties added further price pressure.10
The U.S. dollar is an important factor in explaining
developments in commodity prices. Specifically, research
by the International Monetary Fund (IMF) confirms that
the U.S.dollar does affect commodity prices.11 As Figure6
shows, there is a close connection between commodity
prices (as measured by the S&P GSCI) and the strength or
weakness of the exchange value of the U.S. dollar.
FIGURE 6
Commodity Prices and Value of the U.S. Dollar

Monthly, 20042011*
Trade-weighted index
Commodity price index
Inverted scale
900
65
800
70
S&P GSCI (left scale)

700
75
600
80
500
85
400
90
300
Broad trade-weighted exchange value of U.S. dollar (right scale)

200
95
2004
2005
2006
2007
2008
2009
2010
2011
*Data to October 2011.

Note: The correlation between the two series is -0.87.
Sources: Bloomberg and the Federal Reserve Board
The inverse relationship between commodity prices and the

U.S. dollar operates in this waycommodities are typically
priced in U.S. dollars throughout the entire world, regardless
of whether they are bought or sold in New York, London,
Dubai, So Paulo, or Sydney. When the dollar depreciates,
foreign commodity producers, whose costs are in their own
currencies rather than U.S. dollars, will want to receive more
dollars to cover their local currency production costs, and
thus will demand higher prices.12 Also, because commodities
like oil are priced in U.S. dollars across the world, if a
countrys currency appreciates against the U.S. dollar, its
consumers will find oil more affordable and will buy more,
thus pushing prices upward.
Another factor that undoubtedly has played a role in both
boosting commodity prices and encouraging investment
flows recently is fear that inflation will reemerge in the near
future. Historically, holdings in commodities, especially gold,
have been thought of as a hedge against inflation.13 Thus,
during periods when inflation is high or expected to rise,
prices of and demand for commodities may rise. Concerns
about inflation have resurfaced in the aftermath of the
global financial crisis. After the global financial crisis hit,
major central banks moved rapidly to stimulate economies
10
by lowering interest rates and pursuing policies that

multiplied the size of their balance sheets. This development
has prompted questions on whether monetary policy is too
loose and might reignite inflation around the world.
Such concerns have been stoked by the deteriorating
fiscal positions of the governments of many advanced
economies in the postcrisis world. The outstanding debt of
the governments of many advanced economies increased
sharply after 2008 as these governments ran substantial
budget deficits to stimulate their economies and to provide
support to banks and other financial institutions in danger
of collapse. This massive increase in government debt
among advanced economies has led some economistsand
no doubt many market participantsto worry that these
governments might chose a politically easier expedient of
inflating their way out of this massive debt burden, rather
than risking voter displeasure by cutting expenditures or
raising taxes. Whether or not this concern is justified, it has
factored into the decisions of market participants, likely
putting upward pressure on commodity prices.
Estimating the Explanatory Power of Economic Fundamentals

The appendix of this paper presents a statistical analysis (i.e., regression models) to demonstrate the relative power
of economic and financial factors in explaining changes in commodity prices (as measured by the Dow Jones-UBS
Commodity Index Total Return).14 The analysis strongly supports the view that economic fundamentals drive commodity
price movements, and demonstrates that the U.S. dollar and emerging market growth both played a key role in
commodity price fluctuations from February 2004 to December 2011. In fact, these two fundamental factors are able
to explain more than one-third of the month-to-month variation in commodity prices and more than 90percent of the
movement in the level of commodity prices over this period.15
Several regressions were run to show the relative importance of economic fundamentals compared to net new cash
flows into commodity mutual funds. In all cases, the economic fundamentals explain much more of the monthly percent
changes in commodity prices than do commodity mutual fund flows, and the explanatory power of the economic
fundamentals is not diminished by the inclusion or exclusion of net new cash flows into commodity mutual funds.
FIGURE 7
Forecasts: Economic Fundamentals Versus Commodity Mutual Fund Flows

Monthly, 20042011*
Commodity price index

500
Dow Jones-UBS Commodity Index
450
400
Forecast based only on commodity mutual fund flows
350
300
250
200
Forecast based only on economic fundamentals

150
2004
2005
2006
2007
2008
2009
2010
2011
*Data and dynamic forecasts are from February 2004 to November 2011.
Note: The correlation between the Dow Jones-UBS Commodity Index and the forecast based on economic fundamentals is 0.80. The
correlation is -0.05 for the forecast based on flows.
Source: Bloomberg
Figure 7 illustrates the relative power of economic fundamentals to explain commodity prices changes since 2004 and
the inability of mutual fund flows to explain these movements. The figure plots commodity prices (as measured by the
Dow Jones-UBS Commodity Index Total Return) against the commodity prices predicted by two different statistical
models. The first uses only flows to commodity mutual funds to predict changes in commodity prices (green line). The
second uses economic fundamentalsthe exchange value of the U.S. dollar and growth in emerging marketsto predict
commodity prices. It is evident that the forecast based on the statistical model of economic fundamentals captures the
broad pattern in commodity prices. By contrast, the model based only on flows to commodity mutual funds does not
match the general pattern in commodity prices. Indeed, it incorrectly predicts that commodity prices should have fallen
in 2007 and 2008, when in fact they rose. This odd result stems from the fact that while commodity prices rose until
mid-2008, commodity mutual funds experienced net outflows from January 2006 to June 2008.
11
Did Financialization of Commodities Drive

Commodity Prices?
Numerous market participantscommodity producers,
such as farmers and oil producers, and commodity users,
such as auto manufacturers and airlinesemploy futures,
forwards, and other derivatives to hedge against changes
in commodity prices. In the past, these market participants
were often labeled hedgersproducers or end users of
the commodity who had a commercial interest in locking in
prices to reduce their risks.
Other market participantssuch as broker-dealers,
commercial banks, hedge funds, pension funds, and
university endowmentsalso seek exposure to commodities
for various reasons. These other participants are neither
commodity producers nor end users and thus have been
labeled by some as speculators. Speculators, thus defined,
are viewed by some as necessary counterparties; while they
do not have a commercial interest in physical commodities,
their trading can improve the liquidity of futures and other
derivatives markets, thus improving market conditions for
hedgers. Because every futures, forward, or derivatives
position in commodities by definition has two offsetting
positions (a long position and a short position), hedgers
must interact with a counterparty on the other side of the
trade.
12
In discussions of commodity price trends, hedgers are

frequently characterized as seeking stable prices with
little volatility, while so-called speculators are viewed as
destabilizing markets by causing volatility and unfavorable
price trends. This view does not match reality, however,
especially as the type and motivations of traders have
multiplied. For instance, fundamental traders seek to take
short or long positions depending on whether a particular
commodity market is overvalued or undervalued relative
to fundamental demand and supply factors. Fundamental
traders typically are speculating, not hedging, because they
usually do not have a commercial interest in commodities.
Nonetheless, they will likely have a stabilizing influence on
commodity markets and improve market liquidity.
In a similar vein, many non-hedging investors in todays
markets are described as massive passives because
they use commodity indexlinked instruments, such as
commodity index swaps, to establish long-term diversified
positions in commodity markets.16 A recent report by
Irwin and Sanders 2010 for the Organisation for Economic
Co-operation and Development suggests that commodity
index investors may reduce commodity price volatility
because the indexes fixed weights force them to sell into
markets with the greatest price increases and buy into
markets with falling prices.
Despite these potentially positive impacts of long-term

passive commodity investors, concerns have emerged as
the assets in commodity investments have grown over
the last several years. Much of this concern relates to the
amount of money being directed through index-linked
commodity investments into commodity markets after 2004,
and whether this financialization of these markets boosted
commodity prices and added to volatility. According to
Barclays Capital, worldwide assets under management in
pooled commodity investment products (which includes
exchange-traded products, commodity index swaps, and
medium-term notes) stood at $426 billion in November
2011, compared to $156 billion in November 2008. Most
of the increase ($170 billion) represents net inflows from
investors; the remainder$100 billionreflects the recovery

in commodity prices since 2008.
While $170 billion in total net inflows is not small, that
amount is spread across a number of commodity markets.
Figure 8 shows Barclays Capitals estimates of the 12-month
flow into global commodity markets into each sector over
the last three years. On average, the bulk of the flow is to
energy and precious metals markets. Flows to agriculture
and base metals have generally been much more limited.
The fact that this investment is spread across numerous
markets suggests that it is important to look at individual
markets to understand whether such flows have influenced
commodity prices.
FIGURE 8
Investment Flow into Global Commodity Markets by Sector, 12-Month Sum

Monthly, 20092011*
Billions
$30
Energy
Precious metals
25
20
Agriculture
15
10
Base metals
0
2009
2010
2011
*Data to November 2011.

Source: Barclays Capital
13
Data collected by the Commodity Futures Trading

Commission (CFTC) tracks commodity index traders, and
this data can be used to address the impact of the massive
passives on particular commodity markets. Through its
Commodity Index Trader Supplement, the CFTC collects
rich and detailed data that can be used to help understand
the size and effect of index fund investing on commodity
prices. Numerous studies using this data largely have
concluded that index-based investing has not moved prices
or exacerbated volatility in commodity markets in recent
years (see, for example, Stoll and Whaley 2010 and Irwin
and Sanders 2011a).
These studies reveal that, despite the recent growth
in index-linked investment, current levels of so-called
speculative interest remain well within historical norms for
commodity markets and that index-linked positions (as a
percentage of total open interest) have remained relatively
stable since 2005. In this regard, the links between
price levels, volatility, and fund flows ought to be most
evident before 2006, but existing research also examines
more-recent data.
In theory, index-linked investment might affect both the
level and variability of commodity prices if fund flows
overwhelm hedging demand. Additionally, the fact that
index-linked investments roll their positions forward each
monthreplacing expiring contracts with new positions
might raise concerns that these monthly rolls temporarily
disrupt markets. Stoll and Whaley 2010, however, find that
neither commodity indexlinked flows nor monthly rolls
cause futures price levels to change across a wide variety
of commodity markets. Likewise, Irwin and Sanders 2011b
find little evidence that index-linked investment affects
commodity market returns or volatility. Using internal
CFTC data, Aulerich, Irwin, and Garcia 2010 find negligible
evidence that daily index-linked investment affects
commodity returns in 12 agricultural markets, while indexlinked investment significantly reduces volatility in some
markets.
Other research using a different data setthe internal daily
CFTC Commitment of Traders dataalso fails to find any
adverse impact of index-linked investments in commodity
14
markets. Brunetti, Bykahin, and Harris 2011, for instance,

examine daily swap dealer positions (a proxy for index
investment) and find no evidence that these positions
contribute systematically to price changes or volatility in the
crude oil, natural gas, corn, and E-Mini Dow futures markets.
Additionally, Bykahin and Harris 2011 thoroughly
examine lead-lag relations at various measurement
intervals, and find little evidence that swap dealer positions
lead price changes in the crude oil market.
Both Mou 2010 and Frenk and Turbeville 2011 examine in
detail the period when index investors typically exit futures
positions and roll into new positions. They find that the
spread between prices for nearby and next-nearby contracts
widens during the roll, but that these effects do not raise
average price levels. Aulerich, Irwin, and Garcia 2010
show that index investors can dampen volatility. Similarly,
Kastner 2010, specifically examining the roll period, shows
that United States Natural Gas (a commodity ETF) appears
to reduce volatility in the natural gas market. The funds
positions in natural gas futures are estimated to have a
dampening effect on market volatility overall, and no
significant effect during the time the monthly roll occurs.
While this is direct evidence of a stabilizing effect, it is an
indication that such effects may be present more generally,
especially for more diversified commodity mutual funds.
Importantly, commodity index funds aim to replicate the
returns on the portfolio of commodities included in the
index. Any price impact from index funds likely stems from
two sourcesnew flows and the rebalancing of positions
over timewith the net effect depending on the relative
impact of each source. In theory, fund flows could impact
prices as some critics argue. Rebalancing behavior, however,
naturally stabilizes commodity market prices, since
increases in prices of individual commodities cause those
commodities to become overweight in a fund and create the
need to sell off positions. Likewise, when a commodity price
falls, the fund will increase positions to rebalance, creating
a countercyclical, stabilizing effect. This effect is illustrated
in Figure 9, which shows prices for West Texas Intermediate
(WTI) crude oil during 2008, when funds sold out of crude
oil as prices rose and did not begin repurchasing crude oil
until prices fell significantly.17
FIGURE 9
Oil Price Versus Futures Equivalent Position of Commodity Index Traders

Daily, December 2007 to December 2008
Number of contracts
Price per barrel
Thousands
420
$160
140
400
120
380
100
360
80
60
Oil price (left scale)
340
40
Futures equivalent (right scale)
320
20
0
12/3/07
300
3/3/08
6/3/08
9/3/08
12/3/08
Sources: Federal Reserve and the U.S. Commodity Futures Trading Commission
The Market for Commodity Mutual Funds

Large institutional investorshedge funds, university
endowments, defined benefit pension funds, and others
have long been able to hedge against or take advantage of
changes in commodity prices through financial derivatives.
For example, an institutional investor might invest in futures
contracts on a particular commodity such as gold, silver, or
oil. Alternatively, the institution might invest in a total return
commodity swap to gain exposure to a broad commodity
index.
Individual investors pursuing portfolio diversification
or wanting to hedge against inflation also may wish to
accomplish those goals by investing in commodities (see
Understanding the Benefits of Investing in Commodity
Mutual Funds on page 18). For retail investors, however,
these strategies traditionally have been neither easily
accessible nor cost effective. Using futures contracts to
gain exposure to commodities requires expertise and
active management. For example, such contracts must
be continually rolled forward when they expire to
achieve a continuous and seamless commodities exposure.

Commodity swaps, the most common tool for gaining
broad commodities exposure, historically have not been
traded on exchanges. Rather, commodity swaps are usually
set in bilateral contracts between two parties, typically
between large commercial banks and other institutional
investors.18 Furthermore, both futures and swaps generally
are packaged only in large sizes. One WTIcrude oil futures
contract, for example, is written on 1,000 barrels of oil, with
a value of more than $100,000.
Given these factors, retail investors, until recently, typically
only obtained commodity exposures indirectlyby buying
shares in gold mining companies or by investing in mutual
funds that bought shares in such companies. Until about a
decade ago, there were no products designed specifically
to allow retail investors to benefit directly from or to hedge
against commodity price movements. The needs of retail
investors have led to the creation of products that these
investors can use to achieve exposure to commodity prices.
15
FIGURE 10
Number of Commodity Exchange-Traded Products and Mutual Funds

Commodity ETFs1
Commodity ETNs1
Commodity mutual
funds 2
Managed futures strategy

mutual funds 3
December 1, 2004
1 (0)
0 (0)
December 1, 2006
6 (2)
3 (2)
December 1, 2008
18 (3)
42 (6)
12
December 1, 2010
28 (4)
43 (7)
23
13
September 30, 2011
34 (4)
61 (8)
30
20
Number in parentheses denotes number of broad-based commodity ETFs or ETNs.

Commodity mutual funds are mutual funds whose primary investment objective is to give investors broad exposure to commodities by
benchmarking to commodity indexes that are diversified across a wide array of commodities.
3
Managed futures strategy mutual funds are those that seek to give investors exposure to commodities, interest rates, and exchange rates through
derivatives such as futures and swaps. To date, these funds have not been invested predominantly in commodities; they are included in this table
purely for completeness.
Source: Morningstar
2
The most popular and best-known products are commodity

ETFs, commodity ETNs, and commodity mutual funds. The
number and variety of these products have increased
significantly since 2004 (Figure 10).
Commodity mutual funds, ETFs, and ETNs differ in their
regulation, investor access, and investment approach.
Regulation: Commodity mutual funds are regulated

under the Investment Company Act of 1940 (ICA) and
have all the features of other mutual funds. As with
other mutual funds, commodity mutual funds pool
the investments of a large number of investors, so
that a portfolio can be constructed in a cost-effective
manner. Like other mutual funds, commodity mutual
funds are regulated by the Securities and Exchange
Commission (SEC) as investment companies under
the ICA; additionally, as a result of recent regulatory
developments, they also may become subject to
CFTC regulation. By contrast, commodity ETFs are
not regulated like mutual funds and non-commodity
ETFs. ETFs that invest in commodities through the
derivatives markets are regulated primarily by the
CFTC as commodity pools. Those that hold physical
commodities such as gold are registered under the
Securities Act of 1933 and are subject to exchange
regulation, as are ETNs.
16
Investor access: Like common stocks, commodity

ETFs and ETNs may be purchased on stock exchanges.
Commodity mutual funds may be purchased directly
from fund sponsors or through financial intermediaries
(brokers or financial planners, for example).
Investment approach: As shown by the tallies of

broad-based funds in Figure 10, commodity ETFs
and ETNs tend to focus on single-commodity markets.
Indeed, as measured by assets under management,
commodity ETFs are focused predominantly on
precious metals. For example, the largest commodity
ETF, SPDR Gold Shares (GLD), holds more than
50percent of the assets under management in all
commodity ETFs, as of September 2011, and invests
in physical holdings of gold. A number of other
commodity ETFs also hold physical commodities, while
others track commodity prices through the derivatives
market. Commodity mutual funds, in contrast, only
invest through the derivatives market and typically
focus on a diversified basket of commodities, including
energy products, precious metals, agricultural goods,
and base metals.19,20 Commodity mutual funds thus
provide an efficient and inexpensive way for investors
to gain exposure to a basket of commodities.
Almost all commodity mutual funds pursue their investment

objectives by seeking to track the returns on one of two
commodity indexes: the Dow Jones-UBS Commodity Index
or the S&P GSCI. Of the top 12 commodity mutual funds by
asset size (which hold 97percent of the assets in commodity
mutual funds), nine funds judge their performance
relative to the Dow Jones-UBS Commodity Index and
three benchmark to the S&P GSCI. The nine commodity
mutual funds that link to the Dow Jones-UBS Commodity

Index account for more than 90percent of the assets in
commodity mutual funds. Both indexes are intended to
provide exposure to a broad basket of commodities, but
their compositions differ considerably (Figure 11): the S&P
GSCI has a much heavier weight on oil and other energy
products than does the Dow Jones-UBS Commodity Index. 21
FIGURE 11
Commodity Index Weights, 2011

Percent
Commodity
S&P GSCI
Dow JonesUBS
Commodity Index
WTIcrude
29.9%
14.7%
Brent crude
16.8
0.0
Gas oil
7.2
0.0
Heating oil
5.3
3.6
Corn
5.1
7.0
Unleaded gasoline
4.9
3.5
Copper
3.6
7.5
Wheat CBOT
3.4
4.6
Gold
3.4
10.5
Natural gas
2.8
11.2
Soybean
2.7
7.9
Live cattle CME
2.5
3.4
Aluminum
2.4
5.2
Sugar
2.4
3.3
Lean hogs CME
1.4
2.0
Cotton
1.3
2.0
Coffee
1.1
2.4
Wheat (KBOT)
0.9
0.0
Nickel
0.7
2.3
Silver
0.6
3.3
Zinc
0.6
2.9
Lead
0.5
0.0
Feeder cattle CME
0.4
0.0
Cocoa
0.3
0.0
Soybean oil
0.0
2.9
Tin
0.0
0.0
Palladium
0.0
0.0
Note: Weights on tin and palladium are zero in both indexes.

Sources: Dow Jones-UBS and Barclays Capital
17
Commodity mutual funds use futures, forwards, options,

total return swaps, structured notes, and other strategies
to deliver a return that is highly correlated with their
chosen benchmark index. Unlike pure index funds, however,
commodity mutual funds may use judgment in how best
to achieve this objective, and may not seek to match the
index exactly. Before 2004, there were only two commodity
mutual funds. By September 2011, however, there were at

least 30 commodity mutual funds according to Morningstar,
Inc. classifications. ICI received monthly data from 27 of
these funds in December 2011 (Figure 2). According to ICI
data, the assets of these funds have grown significantly,
from $2.6 billion in January 2004 to $47.7 billion in
December 2011.
Understanding the Benefits of Investing in Commodity Mutual Funds

Investor demand for commodity mutual funds has grown significantly for at least two important reasons. First and most
importantly, commodity mutual funds typically invest in a broad basket of commodities, and thus can help investors
offset the risk of investing in stocks or bonds. Historically, the returns from commodity investments are not highly
correlated with stock and bond returns. 22 Second, commodity mutual funds allow retail investors to offset or hedge
against increases in their costs of living, especially increases in the prices of food and energy. 23
A simple example illustrates investors incentives. Figure 12 compares the relative performance of the S&P 500 equity
index and the Dow Jones-UBS Commodity Indexthe commodity index used by commodity mutual funds with more
than 90percent of the assets in this categoryfrom January 2002 to December 2011. The figure shows the return over
time of $10,000 invested in the S&P 500 and the same amount invested in the Dow Jones-UBS Commodity Index Total
Return. 24 The monthly returns of these two indexes have had a relatively low correlation historically. Thus, investors who
included some commodity index exposure in their portfolios over this period would have reduced the variability in their
FIGURE 12
Commodity Index and S&P 500 Index Versus Consumer Price Index Food and Energy
Component
Monthly, 20022011*
Dollars invested
$35,000
Consumer Price Index, food

and energy component
30,000
25,000
Dow Jones-UBS Commodity Total Return Index
20,000
15,000
10,000
5,000
S&P 500 index (total return)
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011

Sources: Bloomberg and U.S. Bureau of Labor Statistics
18
overall returns. This is very important, as it helps address point-in-time risk, where an investor must access his or her
portfolio holdings at a given point in time because of a life event such as retirement, spending on college tuition, buying
a house, or medical payments.
A second observation from Figure 12 is that commodity index exposure can help retail investors hedge against increases
in the cost of living. The cost of food and energy (as measured by the food and energy component of the Consumer Price
Index) has risen steadily over the past decade. 25 Assume that, as of January 2002, a household was spending $10,000
annually on food and energy. The figure shows how this expenditure would have grown as the cost of food and energy
rose over the past 10 years. A $10,000 investment in a commodity mutual fund tied to the Dow Jones-UBS Commodity
Index Total Return would have returned significantly more than the increase in the price of food and energy for this
hypothetical consumer. The commodity index investment would have increased in value by more than 200percent from
January 2002 to June 2008, helping to offset some of the nearly 70percent increase in the annual cost of food and
energy. Investment in a commodity index that includes agricultural and energy products can therefore provide a natural
hedge to food and energy price inflation.
Finally, it is important to distinguish between commodity mutual funds, which invest in derivatives to obtain exposure
to commodity markets for their investors, and other mutual funds and ETFs whose investment objectives are exposure
to equities, bonds, or money markets, and that employ derivatives (typically financial futures, options, or swaps) to
manage risks or improve returns in a cost-effective manner.
For example, a stock fund may purchase S&P 500 index futures to gain equity returns on cash it is holding prior to
investment in individual stocks. Funds holding non-dollar-denominated stocks or bonds may use currency swaps
to hedge against exchange-rate risk. These activities occur in the futures markets, but are not intended to provide
commodity exposure for these funds investors. While these uses of derivatives have been a focus by some analysts and
policymakers, 26 they are not implicated in the discussion over commodity price trends and thus are not a topic of this
paper.
Commodity Mutual Funds and Commodity

Prices
The remainder of this paper will focus on whether
commodity mutual funds have an impact on commodity
prices. This focus reflects the direction of the debate
over financialization of commodity markets. ETFs large
concentration in precious metals, physical rather than
futures-based positions, and small emphasis on energy and
agricultural goods suggest that they cannot easily be linked
to rising food and energy prices. The question remains
whether the broad investment exposure of commodity
mutual funds may have influenced commodity prices
generally. 27
To understand correctly whether demand for commodity

mutual funds could be influencing commodity prices,
one must look at the relationship between commodity
prices and net new cash flowing to such funds. Net new
cash flowing into commodity mutual funds represents
the additional dollars flowing into such funds and thus
the new additional demand that, in theory, could boost
commodity prices. Examining net new cash flow eliminates
the misleading mechanical relationship between the level of
commodity mutual fund assets and the level of commodity
prices (see Figure 3 and the discussion in the introduction).
19
FIGURE 13
Net New Cash Flow to Commodity Mutual Funds and Monthly Commodity Price Changes
Monthly, 20042011*
Monthly percent change
Billions
80%
$2.0
1.5
Monthly net new cash flow (left scale)
60
1.0
40
0.5
20
0.0
-20
-0.5
Dow Jones-UBS Commodity Total Return Index (right scale)

-40
-1.0
2004
2005
2006
2007
2008
2009
2010
2011
*Data to December 2011

Sources: Investment Company Institute and Bloomberg (Dow Jones-UBS Commodity Total Return Index)
Figure 13 plots monthly percent changes in the Dow JonesUBS Commodity Index Total Return against monthly net
new cash flowing into commodity mutual funds. The figure
covers both the precrisis period, which many commentators
cite as evidence that investment flows cause commodity
price increases, as well as the financial crisis and the
postcrisis period.
In contrast, commodity mutual funds received inflows in

almost every month of 2011, with inflows over this period
totaling $8.9 billion. Despite these inflows, commodity
prices fell by 13.6percent in 2011 because commodity
markets became concerned the global economic recovery
might falter, thus slowing emerging market demand for
commodities.
The data in Figure 13 demonstrate that the relationship

between new investor demand for commodity mutual funds
and commodity prices is rather weak. 28 During the precrisis
period, there was no statistical correlation between these
flows and the commodity price index. In the precrisis period,
commodity prices posted increases in 21 of the 30 months
from January 2006 to June 2008 (as measured by the Dow
Jones-UBS Commodity Index Total Return). By comparison,
commodity mutual funds experienced outflows in 17 of
those 30 months; cumulatively, these outflows amounted to
$610 million.
Statistical analysis of weekly data, as explained in the

appendix, underscores the fact that flows to commodity
mutual funds do not cause commodity price changes.
Figure 14 plots weekly flows to commodity mutual funds
from January 2009 to December 2011 against the Dow
Jones-UBS Commodity Index Total Return. Visual inspection
reveals little contemporaneous relationship between net
new cash flows to commodity mutual funds and commodity
price changeswhile the cash flows are almost entirely
positive, commodity index returns are frequently negative.
Statistically, there is no evidence that increases in weekly
flows to commodity mutual funds drive future commodity
20
FIGURE 14
Net New Cash Flow to Commodity Mutual Funds and Weekly Commodity Price Changes
Weekly, 20092011*
Weekly percent change
Billions
$1.5
30%
Weekly net new cash flow (left scale)
1.0
20
0.5
10
0.0
Dow Jones-UBS Commodity Total Return Index (right scale)
-0.5
2009
2010
-10
2011

Sources: Investment Company Institute and Bloomberg (Dow Jones-UBS Commodity Total Return Index)
price changes. 29 Using regression analysis, weekly

commodity price changes cannot be explained by past flows
into commodity mutual funds, and past commodity price
changes are not statistically significant drivers of future
flows to commodity mutual funds. Thus, from week to week,
net inflows to commodity mutual funds cannot explain
future, or even current, changes in commodity prices well. 30
That commodity mutual fund flows have little or no influence
on commodity prices is hardly surprising. Compared to the
size of the commodity markets, both flows and assets in
commodity mutual funds are very small. Spot or physical
commodity markets deal with trillions of dollars of product
each year, and futures and options commodity markets
trade trillions of dollars of notional value every month.
To demonstrate this, it is helpful to estimate the size of the

exposure that commodity mutual funds hold in individual
commodity markets. Figure 15 shows the implied position
that commodity mutual funds hold in particular commodity
markets. The first column shows the implied weight
that U.S. commodity mutual funds place on particular
commodities. 31 The second column estimates the implied
position in dollars that commodity mutual funds have in
each market, based on multiplying the percentage in the
first column by the $47.7 billion invested in these funds
at the end of December 2011. The last column divides the
implied dollar position by the monthly turnover in futures
and options markets for that commodity (as measured by
Barclays Capital).
21
FIGURE 15
Commodity Mutual Funds Implied Position in Commodity Markets, December 2011

Implied weight in
individual commodities1
Implied dollar position in

commodities, assets 2
Share of index in
market volume
Percent
Billions
Percent
WTIcrude
16.2%
$7.7
0.5%
Natural gas
Market
10.4
4.9
1.5
Gold
9.7
4.6
0.2
Soybean
7.3
3.5
0.9
Copper
7.1
3.4
0.3
Corn
6.8
3.2
1.1
Aluminum
4.9
2.3
0.5
Wheat CBOT
4.5
2.1
3.5
Heating oil
3.7
1.8
0.5
Unleaded gasoline
3.6
1.7
0.5
Live cattle CME
3.3
1.6
2.1
Sugar
3.2
1.5
1.8
Silver
3.0
1.4
0.4
Soybean oil
2.6
1.3
N/A
Zinc
2.6
1.3
0.1
Coffee
2.2
1.1
1.3
Nickel
2.1
1.0
1.1
Lean hogs CME
1.9
0.9
2.3
Cotton
1.9
0.9
3.6
Brent crude
1.7
0.8
0.1
Gas oil
0.7
0.3
0.1
Wheat (KBOT)
0.1
0.0
0.1
Lead
0.0
0.0
0.0
Feeder cattle CME
0.0
0.0
0.2
Cocoa
0.0
0.0
0.1
Tin
0.0
0.0
0.0
Palladium
0.0
0.0
0.0
Implied weight is calculated from the weights in the DowJones UBS and S&P GS commodity indexes. Each is weighted according to the assets
of commodity mutual funds tied to the underlying index. For example, over 90 percent of commodity mutual fund assets are linked to the Dow
Jones-UBS Commodity Index and less than 10 percent to the S&P GSCI. Each index has a weight, respectively, of 29.9 percent and 14.7 percent on
WTIcrude oil. That implies an average weight for commodity mutual funds of 16.2 percent as of December 2011.
2
Implied dollar position is the corresponding weight multiplied by total assets in commodity mutual funds as of December 2011 ($47.7 billion).
For example, commodity mutual funds have an implied weight of 16.2 percent of their $47.7 billion in assets invested in WTIcrude oil, for an
estimated dollar position of $7.7 billion.
N/A = not available
Note: Based on December 2011 assets of $47.7 billion.
Sources: Dow Jones-UBS and Barclays Capital
22
The largest implied position by dollar amount is $7.7 billion

in the WTIcrude oil market, followed by $4.9 billion in
natural gas and $4.6 billion in gold markets. In relation to
options and futures markets through which commodity
mutual funds gain exposure, none of these three largest
positions constitutes more than 2percent of the monthly
turnover in options and futures markets, as shown in the
last column. In many cases, the effective dollar position
in particular commodity markets is very small (zinc,
nickel, cotton, and Brent crude oil) or zero (lead, tin, and
palladium).
Conclusion
Fundamental factors, including rapid growth in emerging
markets, sluggish global supply growth, and U.S. dollar
depreciation, provide a much better explanation for the
general pattern in commodity prices since 2004 than does
increased financial investment in commodities. The growth
in financial investment in U.S. commodity mutual funds
and in other commodity investments largely reflects the
financial innovation seen in the last decade, and much of
the increased investment occurred after the rapid increase
in commodity prices to mid-2008. In particular, commodity
mutual funds experienced net outflows from January 2006
to June 2008. It was only after the financial crisis that U.S.
commodity mutual funds began to receive steady inflows.
Commodity mutual funds received nearly $9 billion in net

inflows during 2011, but commodity prices (as measured by
the Dow Jones-UBS Commodity Index Total Return) fell in
2011 based on concerns that the global economic recovery
might falter.
The timing of this large increase in commodity investments
probably says more about investors desire to tap into
emerging market growth and their general lack of
confidence in the current mix of fiscal and monetary policy
in major advanced economies. Investors understand
that much of global growth is coming from emerging
markets and this increases demand for many commodities.
Investors also appear to be concerned that excessively
large budget deficits and loose monetary policy in major
advanced economies will eventually lead to higher inflation.
Restricting commodity investment through additional
regulation or legislation will not change the fundamental
drivers of global commodity price developments. However,
doing so would reduce liquidity in commodity markets to
the detriment of participants in these markets.
23
Appendix: Regression Analysis of Monthly

and Weekly Data
ICI collects monthly and weekly data from its members
on mutual fund sales, redemptions, assets, cash positions,
exchange activity, and portfolio transactions. The number
of funds in ICIs monthly sample is slightly lower than
Morningstars data because a few small funds do not report
data to ICIs monthly data collection. However, ICIs weekly
data has 29 commodity mutual funds reporting data as of
the end of 2011. Using monthly and weekly data, this study
examines the relationship between net new cash flows
into commodity mutual funds and commodity prices from
January 2004 to December 2011.
With the monthly regressions, this study estimates the
impact of monthly net new cash flows and compares this
basic regression to regressions that contain two economic
fundamentals: the monthly percent change in value of
the U.S. dollar and the monthly growth rate of industrial
production in emerging market countries.
The basic regression explores only the contemporaneous
relationship between net new cash flows into commodity
mutual funds, Ct, and commodity prices, Dln(P t), where Dln
denotes the rate of change in the natural log (the percent
change) and P stands for the Dow Jones-UBS Commodity
Index Total Return at time t. Because net cash flows into
commodity mutual funds, C, grow over the sample period,
this study divides Ct by the total net assets in commodity
24
mutual funds at time t-1, A t-1 . This normalization does

not affect the direction of the results. Note that Ct does
not equal A t due to changes in the net asset value of
commodity mutual funds and distributions for those funds.
Equation (1) specifies the first regression to be estimated on
monthly data,
(1)
Dln(P t ) = a + b*C t /A t-1 ,
where a is the intercept or average growth rate of

commodity prices, and b is the estimated impact of a
1percent increase in net new cash flows into commodity
mutual funds relative to their total net assets. This
regression assumes that there is only a contemporaneous
relationship between flows and prices, and does not allow
for other variables to impact commodity price changes or
flows.
The more general specification in the table below includes
four variables,
(2) Dln(P t ) = f(Dln(P t-1 ), C t /A t-1 , Dln(USD t ), Dln(EM t )),
where USD t is the Federal Reserves broad trade-weighted
value of the U.S. dollar at time t and EM t is the emerging
market industrial production index at time t. To focus on
short-term movements, both variables enter the regression
as monthly percent changes. This also solves the spurious
regression problem that arises when levels of assets and
levels of commodity prices are used.
FIGURE A.1
Intercept
Equation 1
Fund flows, Ct
Equation 2
USD only
Equation 2
EM only
Equation 2
All
Equation 2
Without Ct
-0.0062
(0.0093)
-0.0464
(0.5370)
-1.3131
(0.8889)
-1.80662
(0.7105)
-1.18951
(0.6807)
-0.1819
(0.1198)
-0.0296
(0.1044)
-0.31403
(0.0836)
-0.29443
(0.0969)
Dln(P t-1 )
C t /A t-1
0.28762
(0.1385)
0.26093
(0.0717)
-2.53333
(0.5625)
Dln(USD t )
Dln(EM t )
-2.42823
(0.4500)
-2.37033
(0.5285)
2.42423
(0.8163)
1.69172
(0.6472)
1.89483
(0.6327)
R-squared
0.0557
0.2985
0.1115
0.3955
0.3512
Adjusted R-squared
0.0456
0.2832
0.0920
0.3683
0.3296
Durbin-Watson statistic
1.738
1.946
2.106
2.012
1.995
Denotes statistical significance at the 10 percent level.

3
Note: For the first and second column of results, samples run from February 2004 to December 2011. For the third, fourth, and fifth column of
results, samples run from February 2004 to November 2011.
2
The results in Figure A.1 demonstrate that monthly

movements in the U.S. dollar and growth in emerging
market industrial production can explain 35percent of the
monthly percent changes in commodity prices seen from
early 2004 to late 2011. Specifically, these two economic
variables together are able to explain significantly more of
the variation in commodity prices (the R-squared is 0.3512 in
the last column) than do net new cash flows into commodity
mutual funds alone (the R-squared is 0.0557 in the first
column of results). The weak association between flows
and prices at the monthly frequency could very well reflect
the effect of news on supply and demand developments or
some other economic variable that might simultaneously
encourage flows and raise prices.
Weekly Regressions
The weekly regressions explore the relationship between
net new cash flows into commodity mutual funds and
commodity prices both on a contemporaneous basis and by
applying leads and lags. Net new cash flows into commodity
mutual funds are denoted as Ct and commodity prices as
Dln(P t), where Dln denotes the rate of change in the natural
log (the percent change) and P stands for the Dow JonesUBS Commodity Index Total Return at time t.
The study reestimates Equation (1) below using weekly data,
(1)
Dln(P t ) = a + b*C t /A t-1 ,
where a is the intercept or average growth rate of

commodity prices and b is the estimated impact of a
1percent increase in net new cash flows into commodity
mutual funds relative to their total net assets. This
regression assumes that there is only a contemporaneous
relationship between flows and prices, and does not allow
for other variables to impact commodity price changes or
flows.
25
FIGURE A.2
Equation 1
Fund flows, Ct
Equation 1
With S&P GSCI
a, intercept
-0.00157
(0.00173)
-0.00217
(0.00243)
b, slope
0.2776*
(0.1188)
0.3209*
(0.1611)
R-squared
0.0195
0.0138
Adjusted R-squared
0.0171
0.0114
Durbin-Watson statistic
2.002
1.996
* Denotes statistical significance at the 5 percent level.

Note: For both columns of results, samples run from January 12, 2004, to December 26, 2011.
For the first column of results in Figure A.2, b is significant

at the 5percent level, and the very low R-squared suggests
that weekly commodity mutual fund flows do not explain
weekly changes in commodity prices well. As a robustness
check, Equation (1) was also estimated using the S&P GSCI
Total Return Index as the commodity price change. For
Equation (1) with the S&P GSCI, the results in the second
column are even weaker. The R-squared falls, and b is
marginally significant at the 5percent level. Finally, it is
worth remembering that some third variable, like economic
data or news, may explain the weak association that remains
between these two variables.
Exploring the Lead/Lag Relationship Using Weekly

Regressions
In order to investigate the dynamic relationship between
flows and commodity price changes, this study also
estimates a vector autoregression (VAR) that uses lags of
both variables to explain future movements of flows and
commodity price changes. The general specification is as
follows:
(3)
Dln(P t) = f(Dln(P t-k ), C t-k /A t-1-k ),
(4)
C t /A t-1 = f(Dln(P t-k ), C t-k /A t-1-k ),
where k is the number of lagged regressors used to explain

current movements in commodity prices and net new cash
flows into commodity mutual funds. Lag exclusion tests
selected k = 3 as the appropriate number of lags. This
specification allows us to see whether flows have any impact
on future price changes and whether price changes have any
impact on future flows. The results are shown in Figure A.3.
26
FIGURE A.3
Equation 3
Dln(P t)
Equation 4
Ct/At-1
Intercept
-0.00008
(0.0016)
0.00122
(0.0005)
Coefficient on Dln(Pt-1)
0.0016
(0.0502)
0.0189
(0.0149)
Dln(Pt-2)
-0.0530
(0.0503)
-0.0121
(0.0149)
Dln(Pt-3)
0.0334
(0.0500)
-0.0018
(0.0148)
Coefficient on Ct-1/At-2
-0.0200
(0.1656)
0.24743
(0.0490)
Ct-2/At-3
0.30491
(0.1606)
0.31063
(0.0475)
Ct-3/At-4
-0.1482
(0.1516)
0.21723
(0.0448)
0.0125
0.5515
-0.0021
0.5448
R-squared
Adjusted R-squared
1

3
Note: For both columns of results, samples run from February 2, 2004, to December 26, 2011.
2
The first column shows results for Equation(3), which seeks

to explain commodity price changes. In that column, none
of the lagged regressors is statistically significant at the
5percent level, the R-squared is similar to the Equation(1)
results, and the adjusted R-squared is negative. These
results indicate that neither past commodity mutual fund
flows nor past commodity price changes are useful in
explaining weekly changes in commodity prices.
Instead, the second column of results (Equation4) shows
that flows into commodity mutual funds are explained
primarily by previous flows and that commodity price
changes do not cause future flows. All of the lagged flow
variables are statistically significant at the 1percent level,

the R-squared is 0.5515, and the adjusted R-squared is
0.5448. In general, this regression is able to explain well
over 50percent of the week-to-week variation in net new
cash flow to commodity mutual funds, and almost all of
the explanatory power comes from the lagged values of
past flows. In fact, almost 55percent of the variation in
weekly flows is explained by the three lagged terms of flows.
In other words, even though the first lag of commodity
price changes is positively signed, there is no statistically
significant evidence that flows respond to past price
changes (i.e., return chasing) at the weekly frequency.
27
Notes
A commodity is generally thought of as a homogeneous
product with all units selling at an identical price. A particular
type of commodity, however, may have differences in
characteristics or qualities that can affect the commoditys
price. For example, lighter grades of crude oil tend to trade at
higher prices per barrel than heavier grades of crude oil.
Forwards are over-the-counter trades in which a buyer and

seller individually come together and agree now to exchange
in the future a given commodity at a prespecified price. With
futures contracts, investors also agree now to buy or sell a
commodity at a future date, but such contracts are traded
on exchanges, are highly specified, and are regulated and
monitored in the United States by the Commodity Futures
Trading Commission (CFTC).
See Opening Statement of Senator Carl Levin (D-MI), Chairman,
Senate Permanent Subcommittee on Investigations, Hearing
on Excessive Speculation and Compliance with the Dodd-Frank
Act, Nov. 3, 2011. Available at http://www.levin.senate.gov/
newsroom/press/release/opening-statement-at-psi-hearingon-excessive-speculation-and-compliance-with-the-doddfrank-act.
The IMF regularly discusses these trends in its biannual World

Economic Outlook. See www.imf.org for details. A recent paper
by IMF staff emphasizes the importance of global growth in
explaining commodity price movements for commodities that
trade in financial markets, like oil, and ones that do not, like
wine. See http://www.imf.org/external/pubs/ft/wp/2011/
wp1101.pdf.
The correlation is highest for the S&P GSCI at 0.62, and is

much lower and statistically insignificant for the Dow JonesUBS Commodity Index at -0.01. This pattern holds even
though the majority of commodity mutual funds, holding
more than 90percent of assets under management in the
category, judge their performance relative to the Dow JonesUBS Commodity Index. This finding suggests caution in using
correlation between asset levels and commodity price levels to
infer any relationship.
As discussed in Understanding the Benefits of Investing in

Commodity Mutual Funds on page 18, many mutual funds
and exchange-traded funds whose investment objectives are
exposure to equities, bonds, or money markets also employ
derivatives (typically financial futures, options, or swaps) to
manage risks or improve returns in a cost-effective manner.
These funds are not intended primarily to provide commodity
exposure for their investors. While these uses of derivatives
have been a focus by some analysts and policymakers, they
are not implicated in the discussion over commodity price
trends and thus are not a topic of this paper.
28
Irwin and Sanders (2010) define open interest as the total

number of futures contracts, long or short, in a delivery month
or market that has been entered into and not yet liquidated
by an offsetting transaction or fulfilled by delivery. See Frenk
and Turbeville (2011) for their claim that the increase in open
interest is a measure of excessive speculation.
A perfect positive correlation is 1.00. A perfect negative

correlation is -1.00.
See graph 2.3 on page 13 of the G20 study group report on

commodities for the emerging market contribution to global
growth and overall commodity demand growth in China and
other emerging markets. Available at http://www.g20.org/
images/stories/canalfinan/gexpert/01reportG20.pdf.
10
See Carter and Smith (2011) for an analysis of how the

interaction of demand and supply factors has influenced boom
and bust cycles in commodities in the past.
11
See box 1.4 in Chapter 1 of the International Monetary Funds

April 2008 World Economic Outlook, available at
http://www.imf.org/external/pubs/ft/weo/2008/01/pdf/c1.pdf.
12
To be sure, the relationship can also work in the opposite

direction: rising commodity prices can depress the value of
the dollar. For instance, a rise in oil prices may put downward
pressure on the U.S. dollar, since the United States is a major
oil importer and rising oil prices worsen the terms of trade for
the United States.
13
See Gorton and Rouwenhorst (2006).
14
Commodity indexes can measure commodity prices or total

returns to commodity markets. For clarity in this paper, this
study uses Dow Jones-UBS Commodity Index to denote
the price index and Dow Jones-UBS Commodity Index
Total Return to denote the total return index. See
http://www.djindexes.com/commodity/. For the Dow JonesUBS Commodity Index, the correlation betweenpercent
changes in the price index and its total return version is higher
than 0.999 in both weekly and monthly regressions. This study
therefore uses the total return index in the regressions.
15
The fundamental regression can explain over 90percent of

the price level if one uses last periods price level and the two
economic fundamentals to forecast the next periods price
level (i.e., a static forecast). To be more rigorous, this study
also uses a dynamic forecast that uses last periods forecast of
the price level, rather than the actual price level. The dynamic
forecasts are shown in Figure 7.
16
Index-based investment strategies are often referred to

as passive investments because they require following
an indexs formula when buying or selling securities or
other assets, as opposed to active strategies that involve
discretionary selection of securities or assets.
17
18
19
20
Existing commodity price indexes (such as the Dow JonesUBS Commodity Index) maintain fixed weights in the
underlying index components (i.e., the individual underlying
commodities) during the year. Commodity mutual funds
that seek to mimic the index, therefore, will be forced to
sell positions in commodities that are rising in price and
buy positions in commodities that are falling, helping to
stabilize commodity prices. For example, suppose that a
commodity mutual fund links to an index composed of only
two commodities, oil and gold, which contribute equally
(i.e., 50percent each) to the index. Suppose that today
the commodity mutual fund is in balance, in the sense
that 50percent of the funds value is exposure to gold and
50percent to oil. Next, suppose that oil prices rise 10percent
tomorrow. In that case, the fund is now out of balance
with the index because it has weights of 55percent in oil
(50percent times 1.10) and 45percent in gold. To rebalance,
the fund must reduce its exposure to oil, potentially helping to
offset that days rise in oil prices.
21
Index weights are usually adjusted annually. For discussion

of the Dow Jones-UBS index weights and a primer, see the
following links: http://press.djindexes.com/index.php/dowjones-indexes-and-ubs-announce-2012-weights-of-dowjones-ubs-commodity-index/ and http://www.djindexes.
com/mdsidx/downloads/brochure_info/Dow_Jones_UBS_
Commodity_Index_Calculation_Primer.pdf.
22
See Gorton and Rouwenhorst (2006).
23
In addition, investors can gain exposure to emerging market

growth indirectly by investing in a diversified commodity
mutual fund, since commodity price returns are highly
correlated with emerging market growth over the last decade.
The ability to gain indirect exposure to emerging markets
also helps overcome capital controls that emerging markets
countries sometimes enforce, which can make it difficult to
invest directly in those countries.
24
For simplicity, this study ignores the expense ratios of both

mutual fund investments and focuses on gross return.
This paper focuses primarily on commodity mutual funds

because they invest in a diversified basket of commodities.
That focus reflects the direction of the debate over
financialization of commodity markets, which is concerned
less with investments directed at individual commodities (e.g.,
commodity ETFs, which are concentrated in precious metals)
and more on massive passivesinvestors and investment
vehicles like commodity mutual funds that seek broad
exposure to commodity prices through commodity indexes.
25
The food and energy component of the Consumer Price Index

is often excluded from measures of inflation because it is
more volatile. However, it also has been one of the key drivers
of overall inflation over the last decade and reflects price
changes for an important part of household consumption.
26
In February 2012, the CFTC amended its Rule 4.5 to limit

sharply an exemption granted in 2003 to mutual funds, ETFs,
and other registered investment companies from registration
and regulation by the CFTC as commodity pool operators. On
April 17, 2012, ICI and the U.S. Chamber of Commerce filed a
legal challenge to that rulemaking, asking the U.S. District
Court for the District of Columbia to set aside the CFTCs
amendments. That action is pending.
27
Mutual funds that pursue a managed futures strategy may

invest partly in commodity futures, either directly or indirectly
via commodity index swaps. This study includes these in
Figure 10 for the sake of comparison only. This study excludes
these managed futures mutual funds in the rest of the analysis
because they do not invest exclusively in commodities
and remain relatively small in terms of assets compared to
commodity ETFs and commodity mutual funds.
28
In statistical terms, the contemporaneous correlation between

net new cash flows to commodity mutual funds and the
monthly percent change in the Dow Jones-UBS Commodity
Index Total Return is 0.30 for monthly data from January 2004
to December 2011.
ICIs definition of commodity mutual funds is consistent

with the Morningstar, Inc. classification titled Commodities
Broad Basket, but this study uses ICI data on assets under
management and flows for this category. Morningstar states
that Commodities Broad Basket portfolios can invest in a
diversified basket of commodity goods including but not
limited to grains, minerals, metals, livestock, cotton, oils,
sugar, coffee, and cocoa. Investment can be made directly in
physical assets or commodity-linked derivative instruments,
such as commodity swap agreements. See http://corporate.
morningstar.com/us/documents/MethodologyDocuments/
MethodologyPapers/MorningstarCategory_Classifications.pdf.
The Dodd-Frank Wall Street Reform and Consumer Protection
Act established a comprehensive new regulatory framework
for swaps and security-based swaps. Among other things,
the Dodd-Frank Act imposed clearing and trade execution
requirements on standardized derivatives products. See
Core Principles and Other Requirements for Swap Execution
Facilities, 76 Fed. Reg. 1214 (Jan. 7, 2011).
29
29
The contemporaneous correlation between net new cash flows

to commodity mutual funds and the weekly percent change
in the Dow Jones-UBS Commodity Index Total Return falls
to 0.167 for weekly data from January 2004 to December
2011. See the regression appendix for the results of weekly
regressions.
30 A
simple regression that regresses the weekly percent change

in the Dow Jones-UBS Commodity Index Total Return against
the contemporaneous net new cash flows to commodity
mutual funds produces an R-squared of 0.0195, confirming
that weekly flows to commodity mutual funds, at best, can
explain less than 2 percent of weekly commodity price
changes, leaving 98 percent of that variation unexplained.
31
This study estimates the implied percentage that commodity

mutual funds invest in various commodity markets by using
the Dow Jones-UBS Commodity Index and S&P GSCI. This
calculation uses the fact that more than 90 percent of assets
under management are tied to the Dow Jones-UBS Commodity
Index, and thus assumes that only 10 percent of assets are tied
to the S&P GSCI to arrive at the estimates.
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ICI RESEARCH PERSPECTIVE

1401 H STREET, NW, SUITE 1200 | WASHINGTON, DC 20005 | 202-326-5800 | WWW.ICI.ORG

Fundamentals Drive Commodity

MAY 2012 | VOL. 18, NO. 3

Commodity Markets and Commodity Mutual Funds

Financialization has not driven commodity prices. Despite concerns raised by

L. Christopher Plantier, Senior Economist in

Investing in commodity mutual funds provides important benefits for investors.

Flows to commodity mutual funds have little or no influence on commodity

global financial crisis hit global growth, commodity prices

Over the past decade, the prices of many commodities

Recent developments in commodity prices have raised

Commodity Prices Rose over the Last Fifteen Years

Price per unit

Gold (left scale), price per ounce

Corn (right scale), price per metric ton

WTIcrude oil (right scale), price per barrel

*Data to December 2011.

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

years, hedge funds, pension funds, university endowments,

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

electronics, the need for raw materials, and worldwide

Number and Assets of Commodity Mutual Funds

Number of funds (right scale)

Assets (left scale)

* Data to December 2011.

This papers chief contribution to the current policy debate

As the paper discusses, commodity mutual funds are a

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

Commodity Mutual Fund Assets and Commodity Price Indexes

S&P GSCI (right scale)

Dow Jones-UBS Commodity Index (right scale)

Commodity fund assets (left scale)

* Data to December 2011.

The paper explores whether new investment to commodity

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

of global commodity markets. By the end of 2011, these

Size and Composition of Global Commodity Markets

Commodity Market Size

Heating oil and gas oil

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

Fundamentals Drive Commodity Prices

According to the International Monetary Fund (IMF), the

Emerging Market Industrial Production Growth and Commodity Price Growth

Percent change year over year

Percent change year over year

Emerging market industrial production growth (left scale)

Dow Jones-UBS Commodity Index (right scale)

* Data to October 2011.

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012

This strong economic growth will remain a key source of

higher prices in the 2000s might only be temporary (which

Commodity Prices and Value of the U.S. Dollar

Commodity price index

S&P GSCI (left scale)

Broad trade-weighted exchange value of U.S. dollar (right scale)

*Data to October 2011.

ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 3 | MAY 2012