SANDY HUFFAKER
The growing trend of increased correlation between the price of oil and commodities markets and other assets classes, including currencies, equities and bonds, is well documented.
But two economists have found evidence of a rise in cases of heightened correlation over very brief periods – even as short as one second – pointing to the increased impact of algorithmic trading strategies on commodities.
David Bicchetti and Nicolas Maystre, at the United Nations Conference on Trade and Development, say they have found "striking" correlations between commodities such as oil, corn, soybeans and the U.S. equity market over very short periods, including five-minute, 10-second, and one-second frequencies.
"This is consistent with the idea that recent financial innovations on commodity futures exchanges, in particular the high-frequency trading activities and algorithm strategies have an impact on these correlations," they said.
"Algorithmic" traders are the new breed of speculators: equipped with fast computers, the so-called high-frequency traders go in and out of the market in a fraction of a second, exploiting minute price discrepancies, rather than taking a long-term view. Their role in commodities markets has grown over the past few years.
The paper by Mr. Bicchetti and Mr. Maystre – The synchronized and long-lasting structural change on commodity markets: evidence from high frequency data – provides evidence of a marked change in the presence of HFT in commodities.
"Before 2008, high-frequency co-movements between commodity and equity markets did not usually differ from zero over a long-lasting period at such high frequencies," they said. But "in the course of 2008, these correlations departed from zero and became strongly positive after the collapse of Lehman Brothers.
"We believe a conjunction of factors made that change possible. First, financial technical innovation spurred HFT through the gradual introduction of full electronic trading on exchange platforms since 2005. Second, investors moved away from passive strategies and opted for active ones."
The role of HFT in commodities is controversial, with some market participants criticizing them for distorting prices. Last year the chairman of the World Sugar Committee, the industry body that represents the big traders, said in a strongly worded letter to the ICE Futures U.S. exchange, that their presence "only serves to enrich themselves at the expense of the traditional market users".
Sean Diffley, chairman of the WSC and a hedge fund manager, wrote: "It would appear that the computer-based traders are parasitic, contributing little."
Others, however, have defended HFT, saying they are being scapegoated, playing the role of the bogeyman in current markets.
The argument over whether HFT strategies are good or bad will continue to rage on, but the paper certainly points to them having a greater impact on commodities trading than had been thought. Regulators surely would look into it. A critical question for further analysis is whether the increase in correlation at the five-minute, 10-second, and one-second has a lasting impact that shapes prices and correlations for weeks and months.