Quantitative Finance, 24 Mar 2015, Libo Yin*, Liyan Han
The broad-based surge in commodity prices in recent years has stimulated increased public attention in the commodities markets. A large number of papers suggest that the rapid growth of China and other emerging economies is a popular explanation for the recent commodity price boom.
However, despite the important effects of emerging economies on commodity prices, a number of market analysts and economists who attribute the boom-and-bust cycle to a matter of elevated financial situations with economic volatility and the financialization of commodities express skepticism about the supply and demand argument, citing logical inconsistencies and contrary facts.
Therefore, in this paper, we aim to contribute to the existing literature by investigating whether macroeconomic factors of China would play a systematic and significant role in determining commodity prices using a Factor-Augmented Vector Auto-regression (FAVAR) model, and comparing their performance with macroeconomic factors of the United States. To further understand the interdependence of commodity returns and changes in macroeconomic factors, we also calculate measures of directional return spillovers from macroeconomic factors to commodity returns using a generalized vector autoregressive framework. If the impacts of macroeconomic variables of the United States outperform the impacts of macroeconomic factors of China, we therefore fail to find systematic evidence of a relationship between strong growth in emerging economy and the level of commodity futures prices statistically or economically. The results prove useful to commodity producers, consumers, and financial investors keen to enhance their understanding of commodity price movements.
Generally, our analysis confirms that macroeconomic factors of China do have significant impact on commodities markets, whereas these effects are less than that from the US macroeconomic factors in terms of the size of coefficients and their level of significance. We therefore fail to find systematic evidence of a relationship between strong growth in emerging economy and the boom in commodity futures prices statistically or economically.
Moreover, the effect of macroeconomic factors on individual commodity futures is commodity specific, which varies widely between different commodities. The effects of Chinese macroeconomic factors on energy commodities are negligible when compared with the effects of the US macroeconomic factors. Similar results can be found in soft, livestock and precious metals commodities. However, as for grains and copper with huge demand in China, China’s contributions are always significant whereas the US’ contributions are rather small. This fundamental difference is likely to persist as long as the rapid growth of China remains to propel the huge demands, and has profound implications for a wide range of issues from hedging and speculating strategies to many countries’ commodity policies.
