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Money: the biggest price fundamental

Money: the biggest price fundamental

Skyrocketing prices in commodities over the last year. Enormous price volatility. Index funds are the real driving force.

Everyone is well aware of the skyrocketing prices in commodities over the last year and the enormous increase in price volatility. What many people are not aware of is that one of the biggest factors is speculative money that has flowed into the markets.

Yes, China, is likely the biggest fundamental change with their increase in buying, but the increase in speculation is a close second in causing the bull markets in the last year.

Traditional managed commodity funds currently have about $261 billion in them. That is up from just a little over $200 billion three years ago.

Index funds, the funds that were started in 2003 and are labeled “long only” funds are the real driving force. At the peak of the market in June 2008 these funds had $338 billion invested. After the crash in 2008 their value dropped to almost $100 billion and now in the last 18 months they have ramped back up to approximately $216 billion.

This is a serious amount of cash! The index fund’s long positions in cotton are equivalent to 50 percent of the U.S. crop. Because soft red winter wheat which is traded on the Chicago Board of Trade is a relatively small portion of the U.S. wheat crop, their position there represents 450 percent of the U.S. crop. In corn it’s nearly 20 percent and in cattle over 80 percent.

There is little question that with positions of this size that the volatility in price movements have been influenced dramatically.

No-limit index funds

As I write this, without going in to a long dissertation on what has transpired since 2003, index funds for practical purposes have no limits on the size of their position. Traditional funds do have limits.

The CFTC has been having hearings and has stated that they will be issuing new regulations on index funds early this year. Whatever their new set of rules will be, it is likely that at least some limit will be set on how large of a position these funds can have in individual commodities.

Some view this as a potential negative for prices. That may not be the case since the change is widely anticipated.

What I believe will happen if the fund position sizes are limited, however, it will take out some of the volatility of price movements and allow some of us to start sleeping again at night.

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