The Economics of Commodity Markets

As commodity markets have continued their expansion an extensive and complex financial industry has developed to service them. This industry includes hundreds of participating firms, including asset managers, brokers, consultants, verification agencies and a myriad of other institutions. Universities and other training institutions have responded to this rapid expansion of commodity markets as well as their substantial future growth potential by launching specialized courses on the subject.

The Economics of Commodity Markets attempts to bridge the gap between academics and working professionals by way of a textbook that is both theoretically informative and practical. Based in part on the authors' teaching experience of commodity finance at the University Paris Dauphine, the book covers all important commodity markets topics and includes coverage of recent topics such as financial applications and intuitive economic reasoning.

The book is composed of three parts that cover: commodity market dynamics, commodities and the business cycle, and commodities and fundamental value. The key original approach to the subject matter lies in a shift away from the descriptive to the econometric analysis of commodity markets. Information on market trends of commodities is presented in the first part, with a strong emphasis on the quantitative treatment of that information in the remaining two parts of the book. Readers are provided with a clear and succinct exposition of up-to-date financial economic and econometric methods as these apply to commodity markets. In addition a number of useful empirical applications are introduced and discussed.

This book is a self-contained offering, discussing all key methods and insights without descending into superfluous technicalities. All explanations are structured in an accessible manner, permitting any reader with a basic understanding of mathematics and finance to work their way through all parts of the book without having to resort to external sources.

Preface xi
List of Figures xiii
List of Tables xvii
Acronyms xxv
Part I Commodity Market Dynamics 1
1 Individual Dynamics: From Trends to Risks 3
1. 1 Backwardation, Contango and Commodity Risk Premium 9
1. 2 Understanding Commodities' Momenta 13
1. 2. 1 Persistence of Shocks in Commodities 18
1. 2. 2 The Nature of Momentum in Commodity Markets 20
1. 2. 3 Time Series Momentum and the Number and Nature of Regimes 32
1. 3 Volatility to Returns Spillovers and Tail Events in Commodities 43
1. 3. 1 Spillover Effects in Commodity Markets 43
1. 3. 2 Twenty Years of Jumps in Commodity Markets 51
References 61
2 Cross-Asset Linkages 69
2. 1 Common Risk Factors in Commodities 77
2. 1. 1 Literature Review 78
2. 1. 2 PCA and the Estimation of the Number of Common Components 80
2. 1. 3 Empirical Findings 82
2. 2 Volatility Spillovers in Commodity Markets 90
2. 2. 1 The Volatility Spillover Index 96
2. 2. 2 Four Empirical Applications 98
References 110
Part II Commodities and the Business Cycle 115
3 The Reaction of Commodity Markets to Economic News 117
3. 1 Measuring the Impact of Price Discovery on Asset Prices 117
3. 2 Key Insights from the Academic Literature 118
3. 3 Database of News 119
3. 4 An Example: S&P 500, 10Y and USD 121
3. 5 Commodity Indices 122
3. 6 Dependence on the Business Cycle: NBER Recessions/Expansion Phases 123
3. 7 Rolling Analysis 125
3. 8 Preliminary Findings 128
3. 9 Market-by-Market Analysis 129
3. 9. 1 Database for Commodity Prices 129
3. 9. 2 Precious Metals 130
3. 9. 3 Industrial Metals 132
3. 9. 4 Energy 135
3. 9. 5 Agricultural Commodities 138
3. 10 Concluding Remarks 143
References 143
4 Economic Regimes and Commodity Markets as an Asset Class 145
4. 1 Index Performances, the Fed and the NBER Crises 145
4. 2 Measuring the Business Cycle 147
4. 3 To Which Business Cycle are the Commodity Markets Related? 148
4. 4 Commodity Performances Depending on the Nature of Each Economic Regime 155
4. 5 Performance Analysis 160
4. 6 Concluding Remarks 167
References 167
Part III Commodities and Fundamental Value 169
5 Cross-Commodity Linkages 177
5. 1 A Primer on Granger Causality Testing and Cointegration 177
5. 1. 1 Granger Causality Testing 177
5. 1. 2 Cointegration without Structural Breaks 177
5. 1. 3 Cointegration with Structural Breaks 179
5. 2 Dataset and Unit Root Test Results 181
5. 3 Cointegration in Agricultural Markets 183
5. 3. 1 Literature Review 184
5. 3. 2 Results of Granger Causality Tests for Agricultural Products 188
5. 3. 3 Cointegration Analyses for Agricultural Products 189
5. 3. 4 Grains and Soft Commodities 190
5. 3. 5 Agriculture-Energy Linkage 196
5. 4 Cointegration in Industrial Metals Markets 202
5. 4. 1 Literature Review 203
5. 4. 2 Results of Granger Causality Tests for Industrial Metals 204
5. 4. 3 Cointegration Analyses for Industrial Metals 204
5. 5 Cointegration in Precious Metals Markets 208
5. 5. 1 Literature Review 209
5. 5. 2 Results of Granger Causality Tests for Precious Metals 211
5. 5. 3 Cointegration Analyses for Precious Metals 212
5. 6 Cointegration in Energy Markets 219
5. 6. 1 Literature Review 220
5. 6. 2 Results of Granger Causality Tests for Energy Markets 222
5. 6. 3 Cointegration Analyses for Energy Markets 223
5. 6. 4 Petroleum Products 225
5. 6. 5 Oil and Gas Prices 231
5. 7 Concluding Remarks 235
References 236
6 Cointegration with Traditional Asset Markets 241
6. 1 Dataset and Unit Root Test Results 241
6. 2 Cointegration Between the GSCI Sub-Indices, S&P 500 and US 10-Year Rate 241
6. 2. 1 Literature Review 244
6. 2. 2 Results of Granger Causality Tests Between the GSCI Sub-Indices, S&P 500 and US 10-Year Rate 245
6. 2. 3 Cointegration Analyses for the GSCI Sub-Indices, S&P 500 and US 10-Year Rate 246
6. 3 Cointegration Between the GSCI Sub-Indices and Exchange Rates 254
6. 3. 1 Literature Review 254
6. 3. 2 Results of Granger Causality Tests Between the GSCI Sub-Indices and Exchange Rates 256
6. 3. 3 Cointegration Analyses for the GSCI Sub-Indices and Exchange Rates 257
6. 4 Concluding Remarks 266
References 266
7 Cointegration with Industrial Production and Inflation 269
7. 1 Dataset and Unit Root Test Results 269
7. 2 Cointegration Between the GSCI Sub-Indices and Industrial Production 269
7. 2. 1 Literature Review 274
7. 2. 2 Results of Granger Causality Tests Between the GSCI Sub-Indices and Industrial Production 275
7. 2. 3 Cointegration Analyses for Industrial Production and Commodity Prices 276
7. 3 Cointegration Between the GSCI Sub-Indices, Inflation and Monetary Indices 300
7. 3. 1 Literature Review 300
7. 3. 2 Results of Granger Causality Tests Between the GSCI Sub-Indices, Inflation and Monetary Indices 302
7. 3. 3 Cointegration Analyses for Commodities, Inflation and Monetary Indices 306
7. 4 Concluding Remarks 320
References 321
Index 323