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Commodities - November 24, 2011

Commodity prices over the last decade were greatly influenced by the rise of emerging markets - an interview with Blu Putnam

In this month's interview, we talk to Dr Blu Putnam, Chief Economist and Managing Director at CME Group, about EDHEC-Risk Institute's recent research on long-short commodity investing supported by CME Group, the financialisation of commodity futures markets and calls for tighter regulation of those markets, CME Group's goals for Asia, and CME Group's support for EDHEC-Risk Institute's research.

Blu Putnam

The first EDHEC-Risk Institute research study supported by CME Group has just been released. As a practitioner, as a scholar active in academic research, as well as the chief economist of CME Group, what do you think are the study’s key take-aways?

Blu Putnam: There are two main findings from Professor Joëlle Miffre's research. First, there are important diversification benefits relative to traditional equity and bond benchmark indices from trading commodities futures dynamically according to a long-short strategy. Second, her empirical results support the view that there is no basis to the assumption that the inflow of new investors (sometimes seen as speculators) into commodities have contributed to volatility in recent years.

While long-short investment strategies are often lumped into the category of speculation, my own perspective is that these strategies represent carefully constructed portfolios that balance risk and return potential. Moreover, the liquidity provided by long-short traders plays a critical role in absorbing the risk that is not desired by commercial hedgers.

The study confirms the financialisation of commodity futures markets; what is CME Group’s experience of this development, (for example, what has been the impact on volumes and transaction costs)?

Blu Putnam: Commercial hedgers need to manage their risks, and that means finding investors and other market participants to take the other side of the trade. A professional asset manager utilizing long-short strategies plays a critical role in the market, providing liquidity and often taking on the risk that commercial hedgers want to shed. What is important to realize is that the more players that participate in the market with different investment objectives, the better the liquidity and the lower the transactions costs for everyone. A search engine works better when there are more users. An online auction system is improved when the number of users increases. Commodity markets are no different; the price discovery process and orderly functioning of futures markets improves as new participants enter the market.

The rise in commodity prices over the last ten years, which has roughly paralleled the financialisation of markets, and recent volatility episodes have led some politicians and market participants to call for regulation restricting the participation of financial investors in commodity futures markets. What is your view of the causes of the commodity price increases over the last ten years?

Blu Putnam: While many factors are in play, EDHEC’s research findings correspond with my own, that commodity prices over the last decade were greatly influenced by the rise of emerging markets. Emerging market countries grew much more rapidly than the mature industrial world, and because they are also less efficient users of energy, metals, and agriculture, the marginal increase in commodity demand outpaced real GDP growth.

We also have to appreciate that over the last decade, the equity indices of the mature industrial countries did not provide much return. The global investment community, from retail, to pension funds to hedge funds, is driven to seek superior returns adjusted for risk. When one major asset class, such as equities, falls behind, it is only natural for other asset classes with stronger demand fundamentals to see exceptional price appreciation.

The fixation on the role of speculators is mainly a political phenomenon, as politicians play for press coverage and to their local audiences. Indeed, in the US for example, the bio-fuel legislation passed by the US Congress pushed as much as 40% of the corn crop out of the food supply chain. It is a little disingenuous for politicians not to recognize the serious price implications for agriculture and food, but then denial of responsibility is part of the political rhetoric.

While the study has a global focus, it originated from discussions managed by EDHEC-Risk and CME's respective Asian offices – what are CME Group’s objectives in Asia for the next few years?

Blu Putnam: CME Group is committed to growing its business in Asia by offering products and services that address Asian customers’ risk management and investment requirements, and that includes developing new Asia-specific products via our research and product development team in Singapore. We also look to provide access to existing Asian-based products for our existing global customer base. And importantly, we are focusing on growing the proportion of our daily volume that originates in the Asian time zone.

Why did CME Group choose to support EDHEC Risk Institute's research on commodities futures investing?

Blu Putnam: CME Group, as the manager of the world’s leading derivatives marketplaces with the widest range of global benchmark products across all asset classes, sets a high store by innovation in our products and services. For the commodities sector, like any other, good research is essential to giving us the data we need to guide our product development activities. And as we have found, it is also very important in shaping our dialogue with regulators. There is no substitute for hard data, analyzed rigorously and independently, and that is what EDHEC does exceedingly well.

About Blu Putnam

Bluford (Blu) Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. He is responsible for leading economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company's business strategy. He also serves as CME Group's spokesperson on global economic conditions and manages external research initiatives.

Prior to joining CME Group, Putnam gained more than 35 years of experience in the financial services industry with concentrations in central banking, investment research and portfolio management. He most recently served as Managing Partner for Bayesian Edge Technology & Solutions, Ltd., a financial risk management and portfolio advisory service he founded in 2000. He also has served as President of CDC Investment Management Corporation and Managing Director and Chief Investment Officer for Equities and Asset Allocation at the Bankers Trust Company in New York. His background also includes economist positions with Kleinwort Benson, Ltd., Morgan Stanley & Company, Chase Manhattan Bank and the Federal Reserve Bank of New York.

Putnam holds a bachelor's degree in liberal arts from Florida Presbyterian College (later renamed Eckerd College) and a Ph.D.in economics from Tulane University. He has authored five books on international finance, as well as many articles that have been published in academic journals and business publications.