Commodities in International Markets: A Global Perspective
Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010
Commodities Do Not Care About Borders
When you trade commodity futures on an exchange in Chicago or New York, the effects ripple across the world. That is the big idea behind Chapter 19, written by Kamal Smimou of the University of Ontario Institute of Technology. Commodities are global. And the way they move has real consequences for economies thousands of miles away from the trading floor.
This chapter is a dense, data-heavy look at how U.S.-listed commodity futures affect emerging markets. It covers everything from GDP growth to equity returns to bond markets across 22 countries. We are going to break it into three parts because there is a lot to unpack.
Why International Commodity Markets Matter
Trading costs have dropped across all markets over the past few decades. That means more liquidity, more depth, and more alternative investments flowing into commodity markets. Researchers like Gorton and Rouwenhorst (2006) and Erb and Harvey (2006) showed strong evidence that adding commodity futures to a stock portfolio lowers overall risk. And here is something interesting: commodity futures are not really correlated with each other. Oil does not move like corn. Gold does not move like sugar. So treating them as individual assets rather than one big “commodity” bucket makes more sense.
Studies going back to Errunza and Rosenberg (1982) have stressed how important it is to include securities from less developed countries in international portfolios. But the link between global commodity futures and emerging market fundamentals has not been fully explored. That is the gap this chapter tries to fill.
Two Big Questions
Smimou frames the chapter around two research questions:
- What is the impact of U.S.-listed global commodity futures on the business cycle and financial markets (equity and bond) of emerging markets?
- What happens when you account for the movement of the U.S. dollar index futures?
The dollar question matters a lot. Commodities are priced in dollars. When the dollar goes up, commodity prices tend to fall, and vice versa. So any study looking at commodity impacts on other economies needs to control for dollar movements. Otherwise you might confuse a dollar effect with a commodity effect.
The Data Setup
The study uses the most liquid commodity trades at the Intercontinental Exchange (ICE) and the Chicago Mercantile Exchange (CME). The data runs from January 2000 to December 2016 and covers three commodity groups:
- Energy: WTI crude oil and natural gas
- Metals: gold, silver, platinum, and copper
- Agricultural: corn, soybeans, rice, cotton, coffee, sugar, and cocoa
Three equally weighted portfolios (indices) were created from these groups. This approach, following Gorton and Rouwenhorst (2006), mitigates the effect of having some commodities more heavily traded than others.
The 22 countries studied are divided into four groups based on economic and political similarities:
- MENA (Middle East and North Africa): Saudi Arabia, Kuwait, Qatar, Oman, Egypt, UAE, Iraq, Iran, Algeria, Morocco
- Latin American: Brazil, Argentina, Venezuela, Bolivia, Mexico
- African: South Africa, Kenya, Nigeria
- Special Emerging: Russia, India, China, Turkey
All data for GDP, equity indices, and bond indices are valued in U.S. dollars. The study uses MSCI equity indices for the emerging markets, which provides standardized construction across countries and a longer time span.
What the Literature Says
Before getting into his own findings, Smimou walks through the existing research. And there are some useful takeaways.
On the commodities and growth connection: countries like India and China are in the commodity-intensive stage of development. They have been consuming enormous amounts of raw materials to build infrastructure and industry. When commodity prices surged, it reflected real demand from these nations. When prices crashed during the 2007-2008 financial crisis, it mirrored a sharp fall in global growth. So the links between commodity prices and economic growth in emerging nations make intuitive sense.
Macroeconomic announcements also move commodity prices. Employment reports, GDP data, CPI numbers, and personal income announcements have the biggest impact in the U.S. Metal futures act as a hedge against inflation and play a role as a monetary intermediary during times of crisis.
On the commodities and equities front: Batten, Szilagyi, and Wagner (2015) highlight that the diversification benefits of commodities are time-varying. Using spot market data, they found that Asian investors get positive risk-adjusted returns in gold and rice markets but not in other commodities when combined with traditional stock and bond portfolios. That is a pretty narrow window of benefit.
The agricultural commodity market provides good portfolio diversification during calm periods. But when a financial crisis hits, those diversification benefits vanish. The financial crisis of 2007-2008 strongly affected the relationship between precious metals and stock market indices.
Descriptive Statistics
Among the futures contracts studied, gold had the highest average weekly return (0.16 percent), followed by silver, sugar, and copper. Coffee and cotton had the lowest returns between 2000 and 2016.
Energies showed higher correlation with GDP growth in MENA countries, Russia, Brazil, Argentina, and Mexico. This makes sense given their dependence on crude oil production. But there was no statistically significant correlation between energies and economic growth in the African group.
Metals had the broadest impact. 19 out of 22 countries showed a positive correlation between metals and economic growth.
My Take
Here is what I find most interesting about this section. The fact that different commodity groups have such different relationships with different regions is not just an academic point. It has real implications for investors.
If you are building a global portfolio and you want commodity exposure, you cannot just buy a broad commodity index and call it a day. The energy component will benefit some economies while barely registering in others. Metals might be the better diversifier for a portfolio heavy on African equities. Agricultural commodities might matter more for Latin American exposure.
The chapter is pushing back against the idea that commodities are one monolithic asset class. They are not. And treating them as individual building blocks, each with their own relationship to different parts of the world economy, is a smarter approach.
In the next part, we will look at what this means for emerging markets specifically, including the fascinating case of gold reserves.
This is Part 1 of a three-part series on Chapter 19. Continue to Part 2: Commodities in Emerging Markets.
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