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Our recent study into Changes in Commodity Markets - Impacts on Traders and Software" suggests that the financial traders (banks, funds and so forth) are having an impact on price formation in commodity markets. Indeed, "Understanding the Factors Behind Price Formation" ranked in the top 5 critical business issues identified by traders in the study.

What probably needs to be recognized and factored into price forecasting by physical traders is the impact that financial investors have had and continue to have in today’s markets where commodities are viewed as an asset class. Despite the recent pull back on the part of financially troubled banks and investors in hedge and other investment funds and indexes, the amount of capital deployed remains substantial and commodities will continue to be seen as an attractive investment area (the view is that once economies begin to recover and growth resumes, all natural resources will return quickly to supply/demand tightness). Whether physical traders call this ‘speculation’ or, as CommodityPoint has termed it – “market sentiment”, it has had and will continue to have an impact on price formation.

As demonstrated in the results of the study, non-traditional traders utilize trading styles and strategies that can be based on factors unrelated to the specific fundamentals of a particular energy commodity. They may take trading actions that appear counter intuitive as a result or because they are liquidating or taking commodity positions to balance or manage a multi-asset class portfolio and, perhaps more so in the future, they may be utilizing algorithmic trading methods. When combined with the ready access to essentially long biased indexes, exchange traded funds and other such instruments, physical traders must now be prepared for continuing price movements that appear to be unsupported by traditional factors.

This latter factor, along with the findings of the study in relation to the types of risk analytics employed by the various types of traders that participated, implies that physical trading firms ought to be more widely using portfolio sensitivity analysis and stress testing tools and methods. As one trader remarked during an interview, "the idea that what is considered to be a 100-year frequency risk event can happen multiple times in one single year convincingly shows that stress testing is absolutely essential today."