During 2008, when markets were limit-up one day and limit-down the next, hedge funds and index traders caught the wrath of farmers, elevator grain merchandisers and others who alleged improper activity and illegal market manipulation. So far the regulators have not hauled anyone or any company off to jail for such improprieties. But why?

The market volatility last year was not the result of concerted efforts by traders or illegal activity, says Dave Lehman, director of commodity research and product development for the CMEGroup. Lehman offered an assessment at USDA’s Outlook Conference to those who looked upon the recent performance of the price discovery system with a jaundiced eye.

With research assistance by Informa Economics, eight different contracts on five exchanges were analyzed and matched with data from the Commodity Futures Trading Commission, which regulates exchanges.

The investigation covered commercial hedgers, managed money traders, commodity index traders and non-reportable traders during the period of January 2005 through June 30, 2008, which is about when the bull market peaked.

The Informa researchers found:

  • Index traders had the most consistent trading pattern in the markets studied, getting into a contract 75 days before expiration and exiting 25 days before expiration.
  • Money managers were the most erratic, trying to profit by investing their pool of money.
  • Commercial traders, such as grain processors, would enter the market early and maintain their positions, which were the largest positions.

During the 42 months studied:

  • Liquidity increased for corn, Chicagowheat, natural gas and crude-oil futures.
  • Liquidity decreased for Kansas Cityand Minneapoliswheat and cotton.
  • There was no link to changes in liquidity and any group of traders.

Regarding market volatility:

  • The corn, wheat and cotton market volatility had some correlation between index traders and money manager participation, but no evidence that their participation increased the volatility.
  • There was an indication that the corn, wheat and cotton correlation could be connected to the long positions of index traders and the money managers who follow the
    market trend.

Was there a connection between price and changes in trader positions?

  • Changes in futures positions by any category did not cause a price change.
  • Changes in price caused many categories of traders to change positions.
  • Index trader and money manager activity did not drive price changes, but price changes drove their activity.

What was happening in the final 20 days of a contract’s life?

  • No trade group consistently influenced price levels in the final 20 days of trading.
  • Most of the agricultural futures contracts were more likely to be too cheap rather than too rich.

To corroborate the Informa study of the markets, Lehman pointed to USDA’s Amber Waves magazine which evaluated similar volatile periods in the 1970s and 1990s, as well as a recent study by the Government Accountability Office which found that federal laws do not prohibit the type of commodity trading being used, and a 2006 University of Illinois study on contract performance following changes in speculative limits.

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