On The Comovement of Commodity Prices

Agricultural & Applied Economics Association
On the Comovement of Commodity Prices

Author(s): Chunrong Ai, Arjun Chatrath and Frank Song
Source: American Journal of Agricultural Economics, Vol. 88, No. 3 (Aug., 2006), pp. 574-588
Published by: Oxford University Press on behalf of the Agricultural & Applied Economics
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ON THE COMOVEMENT OF COMMODITY PRICES
CHUNRONG
AI,
ARJUN CHATRATH,
AND FRANK SONG
We
present strong
evidence
against
the excess-comovement hypothesis-that
the
prices
of commodi-
ties move together beyond
what can be
explained by
fundamentals. Prior studies employ
broad macro-
economic indicators to
explain
common
price movements, and
potentially
correlated fundamentals
are not controlled for. We use
inventory
and harvest data to fit a
partial equilibrium
model that more
effectively captures the variation in individual
prices.
The model
explains
the
majority
of the comove-
ments
among commodities with
high price correlation, and all of the comovements among
those with
marginal price
correlation. Common movements in
supply
factors appear
to
play
an important
role in
the observed comovements in
commodity prices.
Key
words:
commodity prices, comovement, herding.
Pindyck
and
Rotemberg (1990)
find that
prices
of
seemingly
unrelated commodities move to-
gether,
even after
controlling
for macroeco-
nomic indicators such as inflation, industrial
production (IP),
and interest rates. The au-
thors
regress
the
price changes
of
seemingly
unrelated commodities
(wheat, cotton, copper,
gold, crude, lumber, and
cocoa)
on some im-
portant
macroeconomic indicators and find the
regression
residuals to be
highly
correlated.
Their
finding, subsequently
well known as the
"excess comovement
hypothesis" (henceforth
ECH),
calls into
question
the
rationality
of
commodity
markets and flies in the face of the
competitive
model of
price
formation. For in-
stance, Pindyck
and
Rotemberg (1990) (PR)
suggest
that the excess comovements
may
be due to
herding-where
traders
alternately
buy
or sell different commodities at the same
time, with little economic
justification.
The ex-
cess comovement of
prices
could
impede
the
decision-making
abilities of
hedgers
and fore-
casters, who base their decisions on fundamen-
tals, and could
imply
that countries
exporting
a
portfolio
of
seemingly
enjoy only
limited diversification of revenues.
Since PR, several researchers have revis-
ited the ECH
employing
a
variety
of data
and test
procedures. Notably, Deb, Trivedi,
and
Varangis (1996)
document that the PR
results are sensitive to the
neglected
structural
changes
in
prices (in
the
1970s),
and to the con-
trols for conditional
heteroskedasticity
in the
price
data. The authors
suggest
that the
inap-
propriate assumption
of
normality
in the PR
regression
residuals cause the false
appearance
of excess comovements. Other researchers
have also shown the PR evidence to be sen-
sitive to methods. Palaskas and
Varagis (1991)
employ cointegration analysis
to show that ex-
cess comovements are the
exception
rather
than the rule in
twenty-one pairs
of
monthly
and annual
prices.
Malliaris and Urritia
(1996)
employ cointegration analysis
to
reject
the
long-term independence
of six
commodity
fu-
tures
price
series. Cashin, McDermott, and
Scott
(1999) employ
a
nonparametric
mea-
sure of comovement, concordance, suggested
by Pagan (1999)
and find little evidence of
syn-
chronocity
in the
turning points
in
prices
of
seven commodities over the PR
sample period.
Taken
together
these studies seem to
suggest
that ECH is the artifact of econometric model-
ing,
and if the
right
econometric model could
be discovered, the evidence of excess comove-
ments would
disappear. Thus, the research
on ECH has focused more on the nature
of the comovements, rather than the causes
themselves.1
For
example,
none of the stud-
ies
explain
the
poor explanatory powers
of
the macroeconomic indicators or
explore
the
Chunrong Ai is associate professor, Department
of Economics,
University of Florida and School of Economics, Hvazhang Univer-
sity of Science and Technology, China. Arjun Chatrath is associate
professor, School of Business, University
of Portland. Frank Song
is associate
professor, School of Economics and Finance, Hong
Kong University.
The authors wish to thank the two
anonymous
reviewers for
their useful comments and suggestions. Remaining errors are our
own.
1
For instance, Deb, Trevedi,
and
Varangis (1996) provide
results
from GARCH models and note that only upon "controlling"
for
the covariance process of price changes
does the covariance in stan-
dardized residuals tend to dissipate. Arguably,
such a specification
captures
the symptoms of the underlying covariance in prices,
and
not the fundamental causes themselves.
Amer. J.
Agr.
Econ.
88(3) (August 2006):
574-588
Copyright
2006 American Agricultural
Economics Association
Ai, Chatrath, and
Song
Comovement
of Commodity Prices 575
possibility
that observed comovements are
caused
by
fundamentals
beyond
these indica-
tors.
Intuitively,
it is unreasonable to
expect
that broad economic indicators
employed
in
PR will
capture
or reflect all or even the ma-
jority
of the
supply
or demand conditions in
individual commodities. Moreover, it is
likely
that such indicators will reflect demand condi-
tions better for some commodities than others.
For instance, IP
may
be more
closely
re-
lated to the
consumption
demand for lumber
or
copper
than for oats or
barley.2
In fact,
there is much evidence that macroindicators
explain very
little of the variation in com-
modity prices.
Studies on the macroeconomic
risk-premiums
in
commodity prices, including
Park, Wei, and Frecka
(1988),
Bessembinder
and Chan
(1992), Bailey
and Chan
(1993),
and
Bjornson
and Carter
(1997)
find PR-like
models to
perform very poorly.
For instance,
the
largest adjusted R-squared
statistic in
Bjornson
and Carter
(1997)
is
only
3.3%. In
contrast, there is evidence that fundamental
factors such as the weather have a
relatively
large impact
on individual
commodity price
behavior
(for instance, Roll 1984; Brunner
1998; Deaton and
Laroque 2003).
It is worth
noting
that PR's inference that
price
comovements
may
be driven
by specu-
lative herders can also be
challenged by
the
literature. Given that
commodity price
co-
movements
appear
to
persist during periods
of booms and busts, their inference would
seem to
imply
that
speculators play
a ma-
jor
role in the behavior of
commodity prices.
While there is some indication that
specula-
tive behavior, particularly
in futures markets,
may
result in increased
volatility,
the
weight
of the evidence is that
speculation
has either
an
ambiguous-
or
dampening impact
on the
variation in
commodity prices (for instance,
see Chari and
Jagannathan 1990; Netz 1995;
Zulauf and Irwin 1998; Carter 1999; Chatrath
and
Song 1999;
Irwin and Holt
2004).
In sum-
mary,
PR
may
be
premature
in
concluding
that
their
findings
of
persisting
comovements are
"excessive," and
implying
that
herding may
be the
prominent
cause for the comovements.
Consequently,
further
empirical
work in this
small literature on the relatedness of commod-
ity prices
is warranted.
The
primary objective
of this article is to ex-
amine the extent to which the observed co-
movements in the
prices
of commodities can
be
explained by
the relatedness of their funda-
mentals.
Specifically,
we reexamine the ECH
employing commodity-specific
data such as
production
and inventories, in
conjunction
of
the traditional macroeconomic indicators, to
more
completely
control for the relatedness
in the demand and
supply
of the commodi-
ties. The main focus of our
investigation
is
on five commodities-wheat, corn, oats, soy-
beans, and
barley,
for which
fairly
detailed
commodity-fundamental
information is avail-
able. With the
exception
of wheat, these com-
modities are different from those studied in
PR. However, as demonstrated
shortly,
these
seemingly
unrelated commodities exhibit sim-
ilar
amplitude
of comovement, that is, they
have "excess comovement," as defined in PR.
The
commodity specific (market-level)
data
that are
employed
in this
study
allow us to
make
improvements
on the tests for
price
comovements in two
ways. First, the market-
level variables allow us to test for excess co-
movements while
maintaining
a low reliance
on
presumptions
vis-d-vis the relatedness of
the commodities. In contrast, PR
presuppose
the fundamentals for commodities such as
wheat, cotton, and cocoa are unrelated
beyond
the
general
economic
cycles.3 Second, the data
allow us to
develop relatively
direct
proxies
of
demand/supply
conditions as are
required
for
effective
testing
of excess comovements. These
data also allow us to make inferences on the
relative roles of
supply
and demand factors in
the observed correlations in
commodity prices.
The relative contributions of
supply
and de-
mand have been studied with
respect
to indi-
vidual
commodity price
behavior
(for instance,
Myers
and
Runge 1985),
but not in the context
of
commodity
comovements.
The
findings
in this article are summarized
as follows.
(i)
The correlation of
commodity
prices
remained
high
for the latter half of the
twentieth
century. (ii)
The macro indicators
such as IP and
gross
domestic
product (GDP)
fail to
explain
these correlations, consistent
with PR.
(iii)
The market-level indicators such
as
inventory
and harvest size, in
conjunction
with the macro indicators, explain
a
strikingly
2
For instance, in PR, the macro indicators and their lagged val-
ues explain less than 10% of the variation in four of the
eight
commodity prices studied. The indicators were most successful in
explaining
the variation in
gold
and crude
price changes (adjusted-
R2 of 0.24 and 0.21), and least successful for cotton and wheat (0.05
and 0.06).
3 Similarly, the filter
employed for unrelated commodities in
Deb, Trivedi, and Varangis (1996) is that they are
neither jointly
produced
nor jointly
consumed. By their metric, sugar
is unre-
lated to coffee or cocoa, and lumber and oil are unrelated to each
other and to nine other commodities, including, wheat, copper,
and
cotton.
576
August
2006
Amer. J. Agr.
Econ.
large portion
of
price movements, and ex-
plain
the
majority
of correlations in commod-
ity prices. (iv) Supply
factors
appear
to
play
a
relatively large
role in the observed correla-
tions, at least for
commodity pairings
such as
wheat and oats, and
soybeans
and corn.
In the next section we
develop
a
partial equi-
librium model
(Equilibrium Model),
which
will accommodate the market-level and macro
data. The Data section describes the
price
and
fundamentals data
employed
in the
study.
The
Empirical
Results section
begins by presenting
correlation results for
prices
and fundamental
factors. The main results are then
presented
to
compare
the "Macro Model" similar to PR,
and our
"Equilibrium Model," one that ac-
commodates the market-level data. The com-
parison
of these two frameworks is broadened
to
twenty
other commodities, agricultural,
and
otherwise.
Finally,
an examination into the rel-
ative role of
supply
factors in the observed
comovements is undertaken. The final section
summarizes the
findings.
Empirical Implementation
Let
pi
and
p1 represent
the
log price
histories
of two commodities, i and
j,
and X a matrix of
macroeconomic indicators such as GDP and
interest rates. The PR method of
testing
for
pair-wise
excess-comovements is based on the
residuals
(ut)
from the
regressions
(1)
pi,t
=
biXt
+
ui,
Pj,t
=
bjXt
+
Uj,t
where b is a vector of sensitivities and u, is
the
regression
error term.
Typically,
first differ-
enced
prices
and economic indicators are em-
ployed.
In the interest of
exposition,
we deal
in the level series for now. In PR, the ECH
is
supported
if
p {uit, ui, t}
>
0.4
It is clear that
commodity-specific factors, such as inventories
or
production
are not considered in
(1), mainly
because commodities i and
j
are
presumed
en-
tirely
unrelated in their fundamentals. We refer
to
(1)
as the Macro model.
Now consider a framework where individual
prices
are determined in
equilibrium.
Because
total
supply
for a nontraded
commodity
with
a
single
harvest season is inelastic at t, the de-
mand function can
always
be estimated from
data. Let the inverse demand function be
given
by
(2) pt
=
f(D,,
Xt)
+
Et
where
Dt
is the
consumption
at t, and
Et
is the
unexplained portion
of the current
price,
and
f
is the function to be estimated. Prices are influ-
enced
by quantity
demanded and the
general
economic conditions. Thus the macro variables
(X,)
are modeled as demand shifters.
Let
zt represent
the harvest size and It the
inventories for a
commodity
at time t. The mar-
ket clears at
Dt
+ I,
=
total
supply, st
=
zt
+
(1
-
8)It-1,
where
8
is the
per period
deterio-
ration rate of inventories. From
(2)
we have
(3) pt = f(st-It,
Xt)
+
Et-.
Equation (3)
is a
partial equilibrium
formula-
tion that considers the effects of both current
and
expected
demand and
supply
conditions.5
Note that the variable
(st
-
It)
generally repre-
sents the
commodity specific
variables
missing
in
(1).
In the
theory
of
commodity prices,
inven-
tories are
endogenous (for instance, Williams
and
Wright 1991; Deaton and
Laroque 1992;
Chambers and
Bailey 1996),
and the above
demand function alone cannot
explain price
behavior unless
inventory
is
explained.
How-
ever, the
objective
of this article is not to model
inventory per
se. Our
objective
is to estimate
the demand function
employing
the observed
supply
and inventories, and
analyze
the extent
to which these variables
explain
the common
movements in
commodity prices.
The advan-
tage
of not
modeling
inventories is that we do
not have to deal with the econometric issue
relating
to the
nonnegativity
constraint for in-
ventories. In this
respect,
note that
equation
(3)
holds whether or not the
nonnegativity
con-
straint is
binding.
The
disadvantage
of course
is that we cannot
explain
common movements
in
inventories (if any)
across commodities. Be-
cause
inventory
is not
explicitly modeled, our
4 Note
that zero correlation between the error term in (1) will
not represent absolute evidence of a lack of excess comovement
as long as all factors have not been controlled for. It is possible
that further controls will reveal an
underlying relationship that is
not evident in the residuals in (2). Naturally, the more
compre-
hensive the controls, the less the chance of
reaching
an erroneous
conclusion.
5
Large commodity price
movements have been associated with
both demand and supply
shocks. For instance, Gilbert (1989)
ar-
gues
that the dollar's appreciation in the early 1980s magnified
the
debt obligations
of developing countries and induced an increase
in the supply of commodities, which resulted in the decline in real
dollar prices (also see Deaton and Miller 1996). Dornbusch (1985)
argues
that an appreciation
of the dollar reduces the demand in
the rest of the world, and results in a decline in the commodity's
real
market-clearing price
in U.S. dollars.
Ai, Chatrath, and
Song
Comovement of Commodity
Prices 577
study may
be considered a
partial equilibrium
analysis.
To estimate
equation (3),
we must:
(i)
model
the functional form
off(.),
and
(ii)
address the
endogeneity
of the
inventory
variable. Since
our
objective
is to
identify
the sources and not
the manner of comovement, we do not want
our
analysis
to be
impacted by
the
misspeci-
fication of the functional form. To avoid mis-
specification error, we
adopt
the flexible model
(4)
Pt =
to
+
ai,1(st
-
It)
+
'
-
+
al,n(st
-
I,)m
+
O2,1(St
-
It)Xt
+
"- "
+
Z2,n(St
-
t)kXt
+
-3Xo
+
X
where the orders of m and k are determined
by
the data
through
a cross-validation
approach
that is common in the
nonparametric
litera-
ture
(e.g.,
Ai and Chen
2003).
The
endogene-
ity
of the
inventory
variable will be addressed
by
an instrumental variable
approach
with 1,
St,
s$,...S"+l,
stXt,
s2Xt,...sk+ltX
as instru-
ments. As with
equation (1), equation (4) may
be estimated with the variables in their levels
or in their first differenced forms. For
expo-
sition, (4)
will be referred as the
Equilibrium
model. A
comparison
of the
explanatory pow-
ers of the
Equilibrium
model and the tradi-
tional Macro model will indicate the
degree
to which
prior
studies on excess comovements
suffer from biases
resulting
from
missing
vari-
ables. Similar indications
may
be
gleaned
from
a
comparison
of the
pair-wise
correlation of the
residuals from the alternate models.
Data and
Empirical
Results
Data
The
majority
of the
empirical
tests in this
study
are conducted on
quarterly
data for five
commodities-wheat
(all), barley (all),
corn
(for grain), oats, and
soybeans,
from
January
1957 to
September
2002. The
study spans
beyond
the
sample
intervals in PR
(1960-
85),
and Deb, Trevidi, and
Varangis (1960-85
and
1974-92).
Our attention is
mainly
on the
five commodities since detailed and
lengthy
market-specific
data are unavailable for other
important commodities, such as cotton or lum-
ber.
Quarterly sampling
of
prices
is
employed
since
commodity-specific
data
(production,
in-
ventories, etc.)
are
sparse
for finer intervals.
It
may
be
argued
that the
quarterly sampling
makes the
rejection
of excess comovements
more
stringent:
it is well documented that the
correlations in
price changes
tend to be smaller
in
higher frequency
data
(for instance, see
PR).
The data on U.S.
prices,
inventories
(on-
farm, off-farm, total),
harvest size, yield per
acre, and
planted
acres for the five commodi-
ties are obtained from the U.S.
Department
of
Agriculture.6
These commodities have well
known sources of
supply, namely
carried-over
inventories and harvest. We do not
directly
control for
government stockholdings.
How-
ever, we do
indirectly
assess the extent to
which such
stockholdings
have altered the
nature of
commodity
comovements
by
com-
paring
our results from the full
sample
with
that of the
post-1972 sample,
over which
gov-
ernment
stockholdings
of commodities are
known to have become
pervasive (for instance,
Westcott, and Hoffman 1999; Goodwin,
Schnepf,
and Dohlman
2005).
With the ex-
ception
of oats, there are no
(or very minor)
U.S.
imports
of these commodities. We do not
differentiate between net
exports
and domes-
tic
disappearance.
The macroeconomic indica-
tors
employed
in the
paper
are IP, the
(GDP),
consumer
price
index
(CPI),
three-month sec-
ondary
market
Treasury
bill
yield (r),
and the
broad dollar index
(FXR).
These data are ob-
tained from the Federal Reserve Bank data
files.
Pindyck
and
Rotemberg (1990)
also em-
ploy
the S&P 500 Stock index but do not find
a
significant impact
on
commodity prices.
Finally,
our
study
also
employs price
histo-
ries of
twenty
other commodities. These data
are obtained from the files of the International
Monetary
Fund and are detailed in the
Ap-
pendix.
While
good
fundamental data are not
available for these commodities, their
price
histories allow us to comment on the
gener-
ality
of our main
findings.
In that
respect,
it is
noteworthy
that the
twenty-five
commodities
in this
study
include four commodities studied
in
Pindyck
and
Rotemberg (1990)-namely
wheat, cotton, copper,
and cocoa.
Quarterly
prices (beginning
for March, June, September,
and
December)
for the
twenty
five commodi-
ties are obtained
by averaging
over
monthly
prices.7
Commodity
Correlations
We
begin
our
empirical analysis by
examin-
ing
correlation
patterns
across five
agricultural
6
For
oats, inventory
data are
incomplete
between 1986 and 1989.
All tests for oats (including bivariate correlations) are conducted
with this
gap
in data.
7
Similar results are obtained when employing prices
rather than
average prices.
578
August 2006 Amer.
J. Agr. Econ.
Table 1. Correlation in Production Variables
Wheat
Barley
Corn Oats
Soybeans
A.
Changes
in
yield
Wheat 1 0.535 0.227 0.521 0.201
Barley 0.537 1 0.431 0.541 0.224
Corn 0.227 0.430 1 0.589 0.828
Oats 0.522 0.543 0.589 1 0.539
Soybeans 0.197 0.218 0.827 0.536 1
B.
Changes
in
planted
acres
Wheat 1 -0.174 0.412 -0.401 -0.055
Barley -0.178 1 0.226 0.253 0.142
Corn 0.407 0.225 1 -0.649 0.179
Oats -0.425 0.225 -0.633 1 -0.260
Soybeans -0.034 0.137 0.178 -0.277 1
Note: Pearsonian correlation coefficients are
reported
for
changes
in
yield per
acre and
planted
acres
sampled annually
for five commodities
from 1957
through
2002. Coefficients above the
diagonal
relate to the de-trended
changes.
commodities. Our discussion of
significance
levels for a bivariate correlation coefficient r
is based on the statistic t =
r/n
-
2//1 -
which is
asymptotically
t-distributed with
n - 2
degrees
of freedom, where n is the sam-
ple
size. For the full
sample,
this
implies
that
absolute correlation coefficients of about 0.12
and 0.19 are
significant
at the 10% and 1%
levels, respectively.
For
price changes
and their
regression residuals, we also
compute Spear-
man Rank correlations.
Commodity prices
are
characterized
by frequent price jumps
so that
the
price changes
are
typically
fat tailed. The
Spearman
correlations
employ
the difference
in the
ranking
of a variable, so that
they
are
relatively
immune to extreme outliers.
Table 1
reports
the
cross-commodity
cor-
relations of some
production
related funda-
mentals. It is
apparent
that the
yield per
acre is
closely
related with correlation
ranging
from about 0.20 for
wheat-soybean
to 0.83 for
soybeans-corn.
One can
expect yield changes
to be
positively
related because trends in
pro-
duction
technologies
are often related across
commodities.
However, other factors
(such
as
the
weather)
seem to be at
play. Specifically,
the correlations remain
high
for detrended
changes
in
yield (coefficients presented
above
the
diagonal).
On the other hand, the correla-
tion coefficient for
planted
acres
ranges
from
a
very negative
-0.63
(corn, oats)
to a
highly
positive
0.41
(wheat, corn).8
These
patterns
continue to be
supported
for the detrended
data.
Table 2
(Panel A) reports
the correlation co-
efficients for the actual
supply
of the commod-
ity.
The coefficients for
changes
in
supply
are
strikingly high
for some of the
pairings,
close
to 0.90 or above for
wheat-barley, oats-barley,
and
soybeans-corn. Very negative
coefficients
are noted for the other
pairings.
These
pat-
terns
persist
for the detrended data.
Similarly
wide-ranging
correlations are seen for
changes
in inventories
(Panel B).
The coefficients for
changes
in
disappearance
are
relatively
mod-
est, with the
exception
of
pairings
of wheat,
oats, and
barley, possibly reflecting
their com-
plementarities (Panel C).9
We find the corre-
lations in table 1 and 2 are
little-changed
when
the data are restricted to the
post-1972 period
(these
results are not
reported
in the interest
of
brevity).
Table 3
reports
the correlation of
quarterly
log price changes
for the five commodities over
the PR
sample
and the full
sample.
As the cor-
relation coefficients are
fairly
similar across
these
samples (as
well as the
post-1972
sam-
ple),
we limit our discussion to the results over
the
longer
interval. The
relationship
between
the
commodity prices ranges
from the
very
high
to the
comparatively
low. The
pair-wise
correlation of
price changes
is between 0.20
(wheat-soybeans)
and 0.64
(wheat-barley).
All correlation coefficients are
significant
at
the 1% level. The
highest
coefficients are seen
for the
pairings involving
corn and the small-
est for those with
soybeans.
Rank correlations,
discussed
shortly, provide
similar indications.
8 It should be noted that the relationship between prices and
planted
acres is
likely influenced
by government programs such as
acreage control.
9 We assume the deterioration rate (8) to be minor and drop it
from our framework.
Ai, Chatrath, and
Song Comovement of Commodity
Prices 579
Table 2. Relatedness in
Supply, Disappearance,
and Inventories
Wheat
Barley
Corn Oats
Soybeans
A.
Changes
in
supply
Wheat 1 0.946 -0.460 0.733 -0.440
Barley
0.946 1 -0.426 0.887 -0.396
Corn -0.459 -0.426 1 -0.306 0.976
Oats 0.732 0.887 -0.306 1 -0.265
Soybeans -0.440 -0.400 0.977 -0.265 1
B.
Changes
in Inventories
Wheat 1 0.912 -0.285 0.717 -0.246
Barley
0.913 1 -0.250 0.887 -0.205
Corn -0.286 -0.250 1 -0.147 0.941
Oats 0.717 0.888 -0.146 1 -0.100
Soybeans -0.246 -0.202 0.940 -0.095 1
C.
Changes
in
disappearance
Wheat 1 0.723 0.119 0.535 -0.055
Barley
0.723 1 0.165 0.741 -0.078
Corn 0.119 0.165 1 -0.059 0.438
Oats 0.535 0.740 -0.050 1 -0.137
Soybeans -0.055 -0.078 0.437 -0.137 1
reported
for
changes
in
quarterly supply, disappearance,
and inventories for five commodities
from Q1/1957 through Q4/2002.
Coefficients above the diagonal relate to the de-trended changes.
Table 3. Correlation of
Changes
in Prices
Wheat
Barley
Corn Oats
Soybeans
A. PR
sample
1960-1985
Wheat 1 0.697 0.474 0.514 0.151
Barley
0.705 1 0.646 0.793 0.389
Corn 0.490 0.660 1 0.557 0.588
Oats 0.527 0.800 0.573 1 0.389
Soybeans 0.163 0.398 0.595 0.400 1
B. Full
sample
1957-2002
Wheat 1 0.638 0.462 0.543 0.198
Barley
0.640 1 0.522 0.581 0.370
Corn 0.470 0.533 1 0.532 0.583
Oats 0.544 0.582 0.536 1 0.377
Soybeans 0.201 0.375 0.589 0.378 1
reported
for
changes
in
log prices
below the
diagonal,
and
changes
in
log
real
prices
above the
diagonal.
Figure
1 traces the
CPI-deflated prices
of
the five commodities and demonstrates the
relatively
weaker
relationship
for the
price
of
soybeans (the uppermost series),
which tends
to be more volatile. As is borne out
by
all
the series, the interval 1972-74 witnessed a
sharp
rise in
prices,
followed
by
a
compara-
bly sharp
fall between 1975 and 1977. The co-
movements in the
price
series are
especially
high
over 1972-77. Deb, Trivedi, and
Varangis
(1996)
also note the structural
instability
of
commodities in the
early
1970s.
High degrees
of relatedness across the five commodities
per-
sist
through
the 1970s and 1980s, when
govern-
ment
stockholdings
started to become more
pervasive,
and
beyond
the end of the PR
sample (1985),
even as
commodity prices
and
price-volatility appear
to settle down.
Performance of
the Macro
and
Equilibrium
Models
Table 4
reports
the results from the Macro
model, where differenced
log CPI-deflated
prices
are
regressed
on
contemporaneous
and
lagged
values of three macro indicators and
two sets of
{1, 0}
dummies aimed at
controlling
for the oil-crisis
period.
The macro variables
are: the differenced real GDP, differenced dol-
lar index, and
(as
in
PR)
level interest rate.
580
August
2006
Amer.
J.
Agr.
Econ.
6
4
0
i L i ii
i
i !
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002
---
Wheat
-
Barley
- -
Corn
- -
Oats
. Soybeans
Figure
1.
Quarterly
real
prices
of five commodities
Q1/1957-
Q3/2002
Table 4. OLS Results of Model with Macro Indicators
Wheat
Barley
Corn Oats
Soybeans
GDP 0.001
(0.21)
-0.001
(-0.33)
0.001
(0.69)
-0.001
(-0.35)
0.002
(1.01)
GDP(-1)
-0.001
(-0.07)
-0.001
(-0.35)
-0.002
(-1.31)
-0.002
(-0.79)
-0.001
(-0.69)
R 0.054
(0.80)
0.042
(0.81)
0.113
(1.63)
0.033
(0.48)
0.129
(1.74)
R(-1)
-0.058
(-0.83)
-0.056
(-1.05)
-0.128
(-1.80)
-0.044
(-0.62)
-0.180
(-2.36)
F 0.042
(0.68)
0.006
(0.13)
0.054
(0.85)
0.068
(1.07)
-0.051
(-0.76)
F(-1)
-0.115
(-1.83)
-0.069
(-1.41)
-0.035
(-0.54)
-0.029
(-0.45)
0.030
(0.44)
D71-74 0.630
(3.28)
0.650
(4.38)
0.522
(2.66)
0.504
(2.55)
0.520
(2.48)
D75-77 -0.644
(-3.16)
-0.571
(-3.63)
-0.493
(-2.38)
-0.443
(-2.12)
-0.338
(-1.52)
Adj.
R2 0.069 0.108 0.053 0.016 0.055
DW 1.950 1.957 1.829 1.925 1.787
Note: The
dependent
variable is the
change
in the
log
of real
prices.
GDP is
changes
in real GDP, R is level
one-year
interest
rates,
F is the
change
in the dollar
index. D71-74 takes the value of 1 if the
quarter
falls between 1971 and 1974, and zero otherwise. D75-77 takes the value of 1 if the
quarter
falls between 1975
and 1977. Coefficients
displayed
are x 10.
Figures
in
parenthesis
are t-statistics. The
sample
covers
Q1/1957-Q4/2002.
The macro indicators
explain relatively
little
of the variance of the
price changes.
The ad-
justed R-squared ranges
from less than 0.02
for oats to 0.11 for
barley. Moreover, only
the
two dummies
(for
the 1972-74 and 1975-77
intervals)
stand out as
statistically significant.
As in the PR
study,
none of the macro indica-
tors is
consistently important,
at least in this
specification.
Other variables, such as
lagged
values of the
dependent variable, IP, alternate
interest rates, and narrower
foreign exchange
indexes, failed to
improve
the
performance
of
the model.
Prior to the estimation of
(4),
the vari-
ables
Dt
=
(st
-
It)
and
st
are de-
seasoned
by regressing
them on a constant and
three
quarterly
dummies
(Q2,
Q3, Q4).10
To estimate the
Equilibrium
model
(4),
we
must first determine the order of m and
k. Once the order of m and k are deter-
mined, we then estimate the model
using
two
stage
least
squares (2SLS)
estimation
since
inventory
is
endogenous.
The 2SLS es-
timation uses 1, s,, s
,...,s
s,
X,, sX,,...,
sfX, as instrumental variables for D,,..., D,
DXt,..., DXt.
The order of m and k are de-
termined
through
a trade-off between overfit-
ting
the model and
obtaining improvements
to its
explanatory power.
We
employ
a cross-
validation
approach
that involves
selecting
the order of m and k that minimize a cri-
terion akin to the sum of
square
errors
between the fitted and refitted
dependent
vari-
able
(see
Ai and Chen
2003). Specifically,
10 An alternate estimation that does not
employ,
the seasonal
filters produced only slightly higher adjusted R statistics. By
conducting these alternate regressions we assess that the role of
seasonality per se in commodity comovements is relatively
modest.
Ai, Chatrath, and Song Comovement of Commodity
Prices 581
Table 5. Predictive Powers of Macro-indicators and Fundamentals
Wheat
Barley
Corn Oats
Soybeans
A.
Change log
real
prices
1. Macro model 0.069 0.108 0.053 0.016 0.055
2.
Equil
model 0.437 0.416 0.542 0.440 0.308
B. Level real
prices
1. Macro model 0.580 0.719 0.656 0.661 0.598
2.
Equil
model 0.895 0.912 0.903 0.873 0.864
Note: The figures are adjusted R2 from the estimation of two specifications. The first is the
OLS estimation of the Macro model (1); the second is the
2SLS
estimation of the
Equilibrium
model
(4).
The
sample
covers
Q1/1957-Q4/2002.
we
regress
Pt,
Dt,
.
.
, D,
DXt
. .
, DX,
re-
spectively
on the instruments 1,
st,
s2,...,s
,
X,,
stXt, ...
,stXt
to obtain the fitted val-
ues
t,
Dt
...,
DB, DtXt
... ,kXt.
We then
apply ordinary least squares (OLS) to
P,
=
"lo
+
Ollb
+
? ? ?
+
-m
bm
+
21b)Xt
+ ... 2kbkX
+
X'3
+
ut
with the first observation deleted. Then com-
pute the fitted value for observation 1 as
p
=
&10
+
&11Dib +...
+
&mDB
+&21BX1 +-
..
&2k kX1
+
X0f3.
Similarly, apply
OLS with the ith
(i
=
2,...
, N)
observation deleted and then com-
pute
fi.
The
optimal m, k are those that mini-
mize the criterion
s(m, k)
=
z1
(p,
- )2
Employing
the
approach
on the differenced
model, we find this criterion to decline in the
order to at least m =
8, k = 8 for
wheat, oats,
barley,
and
soybeans,
and
up
to m =
6, k = 8
for corn. The criterion
provides slightly
lower
orders for the level series. Thus, our selection
of m =
k=
6
represents
a conservative order of
polynomial.
As before,
Xt
contains the three
current and
lagged
macro indicators and the
two calendar dummies. The Macro and
Equi-
librium models were estimated for the full sam-
ple,
for the
PR-sample,
and for the
post-1972
period.
The results are similar so that we
only
report
those for the
longer
interval.
Table 5
reports
the
R-squared
coefficients
from the
Equilibrium
and Macro models em-
ploying, alternately,
level- and first-differenced
variables. It is
readily apparent
that the
Equi-
librium model far
outperforms
the
Macro
model in
explaining price
behavior. For the
first differenced
specifications (Panel A),
the
R-squared
from the
Equilibrium
model is be-
tween 0.30 and 0.50
larger
than from the
Macro
model, representing
between a fourfold and
a
twenty-sevenfold
increase in
explanatory
power.
For the
specifications involving
vari-
ables in their levels
(Panel B),
the
R-squared
from the Macro model
ranges
from 0.58
(wheat)
to 0.72
(barley),
while that from the
Equilibrium
model
ranges
from 0.86
(soy-
beans)
to 0.91
(barley).
Figures
2 and 3
provide
a
graphic compari-
son of the
performance
of the Macro and
Equi-
librium models for the two commodities for
which the
Equilibrium
model
performed
best
(worst),
that is, corn
(soybeans).11
It is evi-
dent that the
predicted
values from the Macro
model
captures
little more than the
general
trend in real
prices:
in not one of the com-
modities do the
predicted
values trace the turn-
ing points.
On the other hand, the
predicted
values from the
Equilibrium
model trace the
peaks
and
valleys remarkably
well for corn,
and
reasonably
so for
soybeans.
To summarize,
the Macro model is almost
entirely
ineffec-
tive in
explaining commodity price
behavior
while the
Equilibrium
model
explains
a sub-
stantial amount of
price
variation. As both em-
ploy only
"fundamental" variables, it is clear
that the latter will
provide
a much better
op-
portunity
to
investigate
the existence of excess
comovements.
Residual Correlations
The residuals from the Macro and the
Equi-
librium models
generally
do not
appear
to be
normal, with
probability plots
that indicate
clustering
at the tails.12
While a
high frequency
of outliers will not
negate
the correlation re-
sults
per se, it becomes
important
to
get
a
sense of their influence on the results. Thus,
n
The graphic fit of wheat, barley, and oats appears closer to
corn than
soybeans.
These figures are not
reported
in the interest
of brevity.
12 While the nonnormality appears stronger in the residuals from
the Macro model, the Jarque-Berra chi-square tests reject normal-
ity in the residuals from both models.
582
August 2006
Amer. J. Agr.
Econ.
(a)
0.4:;-\/>
o.6
:
i.
0'A.A )\
..
0.2 .
0
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002
(b)
3
2.5
2
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002
P(Actual)
- - -
P(Macro) P(Equil)
1.5
I1
Figure
2.
(a) Real corn
prices:
actual versus
predicted
and (b)
real
soybeans prices:
actual versus
predicted
we
augment
the Pearsonian correlations with
Rank correlations.
Table 6
reports
the correlation coefficients
for the
change
in
log
real
prices (Panel A),
for
the residuals from the Macro model
(Panel B)
and for the
Equilibrium
Model
(Panel C).
The Pearsonian coefficients for the Macro-
model residuals
range
from 0.13 to 0.58 and
the Rank correlations
range
from 0.22 to
0.65. The
comparison
of the correlation ma-
trices in Panels A and B indicate that the
macrovariables
explain only
a
minority
of the
correlation-even
among
the
comparatively
(for instance, wheat
and
soybeans).
On the other
hand, the corre-
lation coefficients for the residuals from the
Equilibrium
model
presented
in Panel C are
relatively
small-even for the
highly
related
wheat and
barley,
and wheat and oats
pairings.
The Pearsonian coefficients
range
from -0.02
(barley-soybeans)
to 0.165
(wheat-oats),
sub-
stantially
smaller than those in Panels A or
B. Similar
range
coefficients are observed for
the Rank correlations, from -0.04
(barley-
soybeans)
to 0.15
(wheat-oats).
In
summary,
the
Equilibrium
model
appears
to
capture
the
fundamental
relationships
well
enough
to ex-
plain
the
majority
of the correlation in ob-
viously
related commodities. For less related
commodities, for instance the
wheat-soybeans
pairing,
there
appears
to be no residual corre-
lation, in other words, no excess comovements.
To
perform
a wider test on excess comove-
ments we examine the correlations between
the five
agricultural
commodities studied thus
far, and a wider
group
of commodities
repre-
senting
both
agriculture
and
manufacturing.
Table 7
reports
the Pearsonian correlations
Ai, Chatrath, and
Song Comovement of Commodity
Prices 583
(a)
0.3
-00l"
1
%
...
...
-0.3
-0.5
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002
(b)
0.6
0.4
SI
-0.2
-0.4
-0.6
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002
S
Actual - - - Macro
Equil
Figure
3.
(a) Change
in
log
real corn
prices:
actual versus
predicted
and
(b) changes
in
log
real
soybeans prices:
actual versus
predicted
between residuals from the Macro and
Equi-
librium models for the five commodities and
the residuals from the Macro model for
the
twenty
other commodities. The Rank
correlations are
fairly similar, and are not re-
ported.
The
log
real
price changes (reported
in
the first
column)
for wheat, barley, corn, oats,
and
soybeans
are correlated most
positively
to the
following
commodities: raw material in-
dex
(range 0.15-0.24),
cotton
(0.16-0.28),
co-
conut
(0.07-0.21), sugar-US (0.09-0.19),
and
sugar-I (0.07-0.22).
The correlation coeffi-
cients of the residuals from the Macro model
(reported
in the second column for each com-
modity)
are not
substantially
reduced.
They
range
from raw material index
(0.15-0.23),
cotton
(0.14-0.26),
coconut
(0.04-0.19), sugar-
US
(0.05-0.13),
and
sugar-I (0.04-0.16).
On
the other hand, the correlation coefficients
from the
Equilibrium
model
(third
column
for each of the five
commodities)
are sub-
stantially
smaller for these commodities.
They
range
from raw material
(-0.03
to
0.06),
cotton
(0.01-0.08),
coconut
(-0.00
to
0.06), sugar-US
(-0.00
to
0.05),
and
sugar-I (-0.01
to
0.06).
Importantly,
the
relationship
between wheat
and cotton, that is found to
persist
in
Pindyck
and
Rotemberg (1990), disappears
when em-
ploying
the
Equilibrium
model. Once more,
the
Equilibrium
model
appears
to
explain
the
comovements that the Macro model does not
A Test
of Confirmation
and a Note
on the Role
of Supply
The correlations of the residuals from the
Macro and
Equilibrium
models that have been
presented
thus far
suggest
that the
supply
and
584
August
2006 Amer. J.
Agr.
Econ.
Table 6. Correlation of Residuals from Macro and
Equilibrium
Models
Wheat
Barley
Corn Oats
Soybeans
A.
Changes
in
log
real
prices
Wheat 1 0.561 0.384 0.569 0.258
Barley
0.638 1 0.471 0.534 0.340
Corn 0.462 0.522 1 0.469 0.652
Oats 0.543 0.581 0.532 1 0.309
Soybeans
0.198 0.370 0.583 0.377 1
B. Residuals from macro model
Wheat 1 0.532 0.321 0.541 0.219
Barley
0.584 1 0.429 0.507 0.321
Corn 0.408 0.463 1 0.452 0.650
Oats 0.496 0.545 0.506 1 0.336
Soybeans
0.132 0.301 0.558 0.329 1
C. Residuals from
equilibrium
model
Wheat 1 0.133 0.144 0.152 0.044
Barley
0.156 1 0.010 0.066 -0.039
Corn 0.118 0.052 1 0.043 0.100
Oats 0.165 0.097 0.012 1 0.127
Soybeans
0.031 -0.019 0.079 0.096 1
Note: Statistics below and above the
diagonal are, respectively,
Pearsonian coefficients and
Spearman
Rank coefficients. The
sample
covers
Q1/1957-Q4/2002.
inventory
variables
(along
with the macro indi-
cators) explain
the
majority
of common move-
ments in
commodity prices.
Two
important
questions
remain to be reconciled: First, to
what extent does the difference in the esti-
mation
techniques play
a role in the results?
As described above, the Macro model is es-
timated with a linear
specification
while the
Equilibrium
model is
implemented using
2SLS
and a sixth order
polynomial. Second, to what
degree
are the
commodity
comovements a re-
sult of
supply
factors? Economists have
gained
an
increasing appreciation
for the
importance
of
supply
shocks as sources of fluctuations in
aggregate
economic
performance
in
general,
and the distribution of
price changes
in
parti-
cular
(for instance, see
Myers
and
Runge 1985;
Balke and
Wynne 1996).
The relative role of
supply
factors in
commodity price
comove-
ments remains to be addressed.
We address the first
question
on the role of
estimation
technique
via a more careful com-
parison
of the
empirical
results from the Macro
and
Equilibrium
frameworks. We do this
by
respecifying
the
empirical
framework of the
Macro model to more
closely
match that of the
Equilibrium
model. We estimate the model
(5)
pt
=
o
+
oX1t
+
. . .
+
anXt
+ Et
using OLS, with a sixth-order
polynomial
on
the
contemporaneous
and
lagged
macroeco-
nomic indicators. We examine the extent to
which this
specification improves
the
explana-
tory power
over the more traditional
specifica-
tion Macro model, and the extent to which this
specification
affects residual correlations. We
find that the
explanatory power
of the Macro
model is little
changed
for corn, oats, and
soybeans
with
R-square
coefficients of 0.023,
0.025, and 0.005 for the differenced series. For
wheat and
barley,
the
polynomial
model
per-
formed better, with
R-squared
coefficients of
0.172 and 0.161, respectively,
which
represent
improvements
of 0.10 and 0.05 over the linear
model
(from
table
4). However, the
polyno-
mial fit for the Macro model did not
provide
a
noteworthy change
in residual correlations
for
any
of the
pairings using
either Pearsonian
or Rank correlations. Thus, it
appears
that it
is
mainly
the
inputs
of the two models, rather
than their econometric
implementation
that
cause the
disparity
in the results of residual
correlations.
We address the second
question-on
the relative role of
supply
in
commodity
comovements
by integrating
out the
inventory,
a demand variable. Note that we can
always
write
(6) pt =
E{f (st
-
It, Xt)
I
st, Xt}+ u
=
g(s,, X,)
+
ut
where
ut
=
Et +
(f(Dt, Xt)
-
g(st,
Xt).
Thus, the
relative role of
supply
can be assessed
by
com-
paring
the fit of
equation (6)
with that of the
Table 7.
Relatively
Unrelated Commodities: Correlation of Residuals from the Macro and
Equilibrium
Models
Wheat
Barley
Corn Oats
Soybeans
AP
c(Macro) e(Equil)
AP
e(Macro)
e(Equil)
AP
?(Macro) c(Equil)
AP
?(Macro) ?(Equil)
AP
?(Macro) ?(Equil)
Materials
Nickel 0.002 -0.012 0.008 -0.057 -0.082 0.042 0.055 0.037 -0.057 -0.060 -0.086 -0.073 0.006 0.008 -0.017
Copper
-0.018 -0.062 -0.138 0.050 0.014 -0.056 -0.015 -0.062 -0.104 0.031 0.038 -0.091 0.051 -0.030 -0.080
TSP 0.150 0.015 -0.049 0.136 -0.046 -0.002 0.133 0.028 -0.001 0.088 -0.014 -0.039 0.047 -0.058 -0.049
Rubber 0.158 0.177 -0.070 0.084 0.094 0.046 0.092 0.101 0.091 0.100 0.152 0.031 0.090 0.019 0.072
Raw-material 0.177 0.182 -0.032 0.151 0.154 0.024 0.186 0.209 0.052 0.178 0.227 0.054 0.240 0.204 0.062
Beverages/sugar
Sugar (I)
0.160 0.113 0.038 0.217 0.164 -0.007 0.073 0.036 0.032 0.137 0.120 0.057 0.121 0.069 0.022
Sugar (US)
0.124 0.072 0.046 0.192 0.133 -0.004 0.087 0.049 0.040 0.155 0.128 0.020 0.112 0.072 0.053
Coffee
(0)
-0.018 0.027 -0.038 -0.124 -0.087 -0.035 -0.042 -0.005 -0.026 0.036 0.080 0.003 0.102 0.107 -0.002
Coffee
(R)
-0.017 0.023 -0.001 -0.061 -0.029 -0.065 -0.098 -0.066 -0.016 -0.040 -0.001 -0.040 0.027 0.016 -0.028
Cocoa -0.001 -0.012 0.015 -0.101 -0.127 0.039 0.031 0.015 -0.036 -0.110 -0.129 -0.017 0.045 0.033 -0.013
Edible oils
Palm 0.146 0.122 0.019 0.099 0.062 0.012 0.181 0.146 0.026 0.108 0.081 0.034 0.242 0.212 0.051
Groundnut 0.039 0.012 -0.009 0.028 -0.006 0.024 0.156 0.122 0.029 -0.017 -0.050 -0.035 0.136 0.114 0.032
Coconut 0.160 0.136 -0.002 0.072 0.038 0.041 0.193 0.163 0.020 0.137 0.118 0.037 0.214 0.185 0.065
Meats/hides
Hides -0.033 -0.047 -0.007 0.040 0.048 -0.069 0.110 0.116 0.021 -0.010 0.013 -0.018 0.114 0.073 0.037
Lamb 0.091 0.071 0.036 0.155 0.136 0.091 0.060 0.081 0.116 0.093 0.109 0.022 -0.041 -0.061 0.047
Beef 0.095 0.072 -0.095 0.170 0.168 0.043 0.239 0.214 0.052 0.102 0.105 0.066 0.164 0.112 0.063
Miscellaneous
Rice 0.116 0.071 -0.018 0.018 -0.049 0.032 0.145 0.105 0.045 -0.048 -0.094 -0.036 0.023 -0.016 0.024
Cotton 0.160 0.140 0.022 0.198 0.182 0.026 0.282 0.263 0.052 0.171 0.169 0.013 0.260 0.216 0.083
Banana -0.001 0.004 0.013 0.107 0.127 0.008 0.083 0.102 0.056 0.209 0.232 0.062 0.056 0.058 -0.011
Fishmeal 0.123 0.121 0.061 0.102 0.095 0.058 0.058 0.038 -0.053 -0.010 -0.024 0.024 0.137 0.120 0.046
Note: AP is the
change
in
log
of real
prices, E(Macro)
is the residual from the OLS estimation with controls for Macroeconomic indicators, and
E(Equil)
is the residuals from the 2SLS estimation of the
Equilibrium
model. Coefficients are
Pearsonian correlations. The
sample
covers Q1/1957-04/2002.
0
a
0
586
August 2006 Amer. J.
Agr.
Econ.
Table 8. The Role of
Supply
in
Commodity
Comovements
Wheat
Barley
Corn Oats
Soybeans
A.
Adjusted
R2 0.618 0.427 0.510 0.535 0.348
B. Correlation of residuals
Wheat 1 0.074 0.016 -0.042 0.036
Barley 0.055 1 0.142 0.093 0.016
Corn 0.109 0.151 1 0.091 0.146
Oats -0.022 0.114 0.097 1 0.061
Soybeans 0.048 0.010 0.161 0.085 1
Note: The results are from the OLS estimation of the
supply-model [equation (6)J.
Correlations below the
diagonal
are Pearsonian
correlations and above the
diagonal
are Rank correlations for the OLS residuals. The
sample
covers Q1/1957-Q4/2002.
Macro model, and more
importantly,
the
Equilibrium
model.13 To avoid
possible
misspecification
error in the functional form,
we
adopt
the same functional form for
g(.)
as
was
employed
to
implement
the
Equilibrium
model:
g(st, Xt)
=
o0
+
aOl,lSt
+
-? -
+
atl,nS't
+
O2,1sXt
+-
" "
+
-2,nskXt
+
o3Xt.
Equation (6)
is estimated
employing
OLS with
s,
dea-
sonalized as it was in the estimation of the
Equilibrium
model.
Table 8
reports
the
regression adjusted
R-squareds
from
(6),
our
"Supply"
model. In
the interest of
brevity,
we
present
results
only
for first differenced series over the full sam-
ple,
since results from level series and those for
the PR
sample
and
post-1972 sample produced
comparable
results. While our intention is not
to
compare
the
goodness
of fit across the 2SLS
(Equilibrium)
and OLS
(Supply) estimations,
it is worth
noting
that the
Supply
model
es-
timations
produced adjusted R-squared
coef-
ficients that are
relatively high, ranging
from
0.35 for
soybeans,
to 0.62 for wheat. More
direct evidence of the role of
supply
in the
commodity price
comovements is
provided by
the residual correlations. These
compare
favor-
ably
to the
Equilibrium
model for which the re-
sults were earlier
reported (table 6, Panel
C).
For instance, the correlation coefficients for
pairings involving
wheat are
consistently
lower
in the
Supply model, using
either Pearsonian or
Rank correlations.
Importantly, only
a few cor-
relation coefficients in table 8 are
statistically
significant, suggesting
that
supply-side
funda-
mental factors
(along
with the
macrovariables)
may
be sufficient in
explaining
the
majority
of
the comovements in
commodity prices. Thus,
while the
incomplete
controls for fundamental
factors
(for instance, we
only
consider the U.S.
market)
do not allow us to
comprehensively
distinguish
between the
impact
of demand and
supply
in the observed comovements, the evi-
dence
suggests
that the
supply
factors
play
the
larger
role.
Conclusion
This
study
addresses the
important question
of
whether the observed correlation in the
prices
of commodities is
"excessive,"
as described
by
Pindyck
and
Rotemberg (1990).
Our
findings
suggest
that the comovements are not exces-
sive. We show that much of the comovements
come from common tendencies in demand and
supply
factors. We fit a
partial equilibrium
model that controls for
commodity-factor
cor-
relations
ignored
in
Pindyck
and
Rotemberg
(1990).
This
empirical
model
explains
the ma-
jority
of the comovements
among
commodi-
ties with
high price correlation, and all of the
comovements
among
those that are
marginally
correlated.
How does the evidence in this article
help
our
understanding
of
commodity price
behav-
ior? Foremost, our
findings provide,
in our es-
timation, the most
convincing
evidence
against
the ECH for commodities. Further, the success
of the
empirical
model that
employs
commod-
ity supply
data
suggests
that
commodity
funda-
mentals are related more
closely
than assumed
in
Pindyk
and
Rotemberg.
In
particular,
the
supply
side factors
appear
to
play
a
large
role
in the observed
price
comovements. Our re-
sults also show that the fundamental factors
explain
a
large portion
of the
variability
in in-
dividual
commodity prices
and
price changes,
raising
doubts on the role of
speculation per
se
in
causing
the
large price
movements com-
monly
observed in
commodity
markets. Over-
all, the results reaffirm the notion that
price
s3
A caveat in this
framework is that the X variables may repre-
sent commodity demand, so that we are not fully controlling for
demand effects.
Ai, Chatrath, and
Song
Comovement of Commodity
Prices 587
movements are not a sufficient statistic for un-
derstanding commodity
markets or
developing
a
commodity price
model.
[Received September 2004;
accepted September 2005.]
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Appendix
Prices (in U.S. dollars) from IMF's
International Financial Statistics Database
1. Banana:
Average
of
Chiquita/Del Monte/Dole,
U.S., Gulf
Delivery.
2. Beef: Australian/New Zealand, Frozen, U.S.
import price.
3. Cocoa:
Average
of three nearest active futures
contracts, New York Cocoa
Exchange.
4. Coffee, Other: El Salvador and Guatemala, ex-
dock New York.
5. Coffee, Robusta:
Uganda/Cote d'Ivoire, ex-
dock New York.
6.
Copper:
Grade A London Mercantile Ex-
change, c.i.f., European
Ports.
7. Cotton:
Liverpool A, c.i.f., Liverpool.
8. Coconut oil:
Philippines/Indonesian,
c.i.f.
Rotterdam.
9. Fishmeal: 64/65%, any origin, c.i.f., Rotterdam.
10. Groundnut oil:
Any origin, c.i.f.,
Rotterdam.
Prior to 1974, Nigerian bulk, c.i.f.,
U.K.
11. Hides:
Chicago, f.o.b., shipping point.
12. Lamb, New Zealand, Frozen, London Price.
13. Nickel:
Melting grade, c.i.f., North
Europe.
14. Palm oil:
Malaysian/Indonesian, c.i.f., NW Eu-
ropean
Ports. Prior to 1974, UNCTAD.
15.
Sugar,
International:
Sugar Agreement
Price.
16.
Sugar,
US: Contract #14, c.i.f., U.S.
import
price.
17. Raw Materials
(Agricultural):
Raw material
index.
18. Rubber:
Malaysian, f.o.b., Malaysia/Singapore.
19. Rice: 5% broken, normal
price, f.o.b.,
Bangkok.
20. TSP
(Triple Super-Phosphate): bulk, Gulf of
Mexico.

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