Readers of this publication know better than most just how hard it is to be an index investor. It's bad enough putting up with the sneers of active investors who think we're settling for mediocrity, but it's quite another to get shellacked by Congress.

Rep. Bart Stupak (D-Mich.) heads a U.S. House subcommittee looking into the recent run-up in commodity prices, and contends that index investors, among others branded as speculators, are responsible for surging fuel prices.

Backing up Stupak's assertions is the testimony of hedge fund manager Michael Masters (reprinted in this issue of Journal of Indexes; see p. 14) who says "index speculators"—pension funds, endowments, sovereign wealth funds, institutional investors and index funds¹—are crowding the market and bidding up the cost of commodities such as corn and crude oil. Long-only index investors, says Masters, are indiscriminate buyers of commodity futures, snapping up contracts at whatever prices are necessary to put their capital to work.

But is that really so? Do index investors deserve such blame?

It's easy to see why legislators might think so. After all, oil prices accelerated upward at about the same time exchange-traded commodity index funds hit the market.

Funds based upon the S&P GSCI and the Deutsche Bank Liquid Commodity Index (DBLCI) were launched in 2006. Owing to their large weightings in crude oil—now 55 percent and 35 percent, respectively—critics said they were nothing more than oil index funds in disguise. To make matters worse, exchange-traded funds and notes based exclusively on oil futures were also floated in 2006.

For a time, the carpers' fears might have seemed justified. There was a direct link between oil prices and long speculation. Between January 2006 and January 2007, the price of NYMEX spot futures and the size of the net long interest held by large speculators—where index funds would be counted—rose and fell apace. The correlation between price and net long interest, at 78 percent, was, in fact, quite strong.

In 2007, though, the connection between long speculative interest and price fell apart. NYMEX crude advanced to dizzying values while the proportion of open interest controlled by long speculators actually declined. Between January 2007 and mid-July 2008, when crude oil prices peaked and heeled over, the correlation deteriorated to only 42 percent.

Corn Models Oil
Because of the lack of granularity in government-mandated reports, though, we can't tell how much of that net long interest in oil futures actually belongs to index funds. The Commodity Futures Trading Commission (CFTC), however, has operated a pilot program—the Commodity Index Traders (CIT) report—since 2006 that monitors commodity index trading in certain agricultural futures.

The price trajectory of corn fairly well traces the same arc as that of crude oil, as it more than doubled over the past year. Corn is the largest agricultural component of both the S&P GSCI and the DBLCI. If we compare the net long position of index traders in corn between January 2006 and July 2008, we can gain some insight into their influence on the oil market.







Back in 2006, commodity index traders held about a quarter of the total open interest in corn futures and options (see Figures 2 and 3).

If you focus on the absolute size of long corn positions held by index traders, which grew 52 percent in two and a half years, you could easily think, like Rep. Stupak, that you'd found your inflationary culprit. But look how much of the total open interest was actually held by index traders. Their influence, in reality, waned 6 percent. How can one attribute corn's near tripling, then, to index buying? The evidence simply doesn't support that point of view.

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