The evolution of commodity market financialization: Implications for portfolio diversification

The financialization of commodity markets is a well-documented phenomenon spurred by the massive growth of institutional funds directed into commodity indices from the mid-2000s. More recent research suggests that a subsequent era of de-financialization has coincided with the retreat of institutional investors. This paper uses a latent factor model to examine the dynamic impact of commodity market financialization on spot currency, commodity and equity market linkages, focusing on countries with ‘commodity currencies’. The financialization period is characterized by increased interdependence of non-oil and oil commodity markets with each other and with other asset markets, implying reduced diversification potential. We find that commodity markets have become more highly interconnected with currency and equity markets of the large commodity exporters over the most recent sub-sample. We suggest that apparent de-financialization may be attributable to contagion effects from global crisis events, including the Great Recession and the European Debt Crisis of 2012.