Index Investment and the Financialization of Commodities
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What they found
After 2004, tens of billions of dollars flowed into commodity index products. The authors show that the prices of commodities included in the major indices (GSCI and DJ-UBS) became much more correlated with each other and with oil than commodities not in the indices, and more correlated with stocks and with emerging-market demand shocks. They argue index investment turned commodities into a financial asset class whose prices increasingly reflect portfolio flows and market-wide risk appetite, not only each commodity's own supply and demand.
What you can use
- Since the mid-2000s, commodities in the big indices move together and with stocks far more than they used to; the diversification benefit shrank.
- A commodity's index membership matters for how it trades: index flows and roll dates are a source of predictable pressure.
- Commodity prices now respond to risk-on and risk-off sentiment, not just fundamentals.
Caveats
Correlations rose in the 2008 crisis for every asset, so separating financialization from crisis effects is difficult. Published 2012; some correlations have since declined. Free NBER version exists.
Tags: commodities, financialization, index-investing, correlation
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.