INFLATION & COMMODITY MARKET

PROJECT DONE BY, BHAVIKA THAKKER PGDBM

OBJECTIVE OF THE PROJECT
 

Testing the market efficiency If the market are efficient than predicting spot prices through futures Establishing relation between inflation & economic indicators like money supply, volume in commodity market, crude oil & historical inflation

Testing The Market Efficiency

VOLUME IS INCREASING


 

RETURNS ARE INCREASING
INFLATION IS RISING GOVERNMENT IS INTERVENING

Volume analysis
volume ananlysis
500000.00 400000.00

volume

300000.00 200000.00 100000.00 0.00

MCX NCDEX

Mar 05

Nov 06

Jan 06

Jun 06

Dec 03

Aug 05

Apr 07

Sep 07

Oct 04

Month

Feb 08

May

Comparing the risk and returns of different asset classes
MEAN (Annual) G-SEC 10 YR BOND MCX GOLD MCX COPPER MCX CRUDE NIFTY SENSEX 7.51% 21.90% 30.74% 31.34% 31.18% 29.62% 21.67% 29.04% 30.81% 31.60% 29.36% 15.94% 30.94% 26.85% 23.47% 24.48% CAGR STD DEV (Annual)

SILVER

30.74%

29.04%

30.94%

45000.00 40000.00 35000.00 30000.00 25000.00 20000.00 15000.00 10000.00 5000.00 0.00
1/31/2005 5/31/2005 9/30/2005 1/31/2006 5/31/2006 9/30/2006 1/31/2007 5/31/2007 9/30/2007 1/31/2008 5/31/2008

copper silver gold crude sensex nifty

WPI

250 200 150 100 50 0
4/30/1994 2/28/1995 12/31/1995 10/31/1996 8/31/1997 6/30/1998 4/30/1999

WPI

2/29/2000 12/31/2000 10/31/2001 8/31/2002 6/30/2003 4/30/2004 2/28/2005 12/31/2005 10/31/2006 8/31/2007

INCREASE IN WPI

TIME

METHOD FOLLWED FOR TESTING MARKET EFFICIENCY

COINTEGRATION

Definition: If there exist a stationary linear combination of non stationary random variables, the variables combined are said to be cointegrated.

DATA COLLECTION
One three month contract of refined soya oil is taken (Apr, 08) from NCDEX database. Three time series of spot and future is been constructed for the analysis. Series 1: First series is made with the seven days lag of future prices by assuming market players know what would be the demand supply scenario after the seven days and can predict spot prices in precise manner. Series 2: Second series is constructed with the fourteen days lag of future prices to check whether market players know what would be the demand supply scenario after the fourteen days and are they able to predict spot prices or no? Series 3 & 4: Similarly third and fourth time series are constructed with the one and two month lag of future prices respectively to check the long term and short term equilibrium between spot and future prices.

Procedure

Determine whether yt and xt are I(1). This is equivalent to determining whether or not they have unit roots

Provided they are both I(1), estimate the parameters of the cointegrating relation
Test to find least squares residual appears to be I(0) If the series is cointegrated we put restriction on vector to see the future prices are unbiased indicator of spot . We check this because high speculation leads to the increase in future prices which may not be the pure or unbiased indicator of spot After checking for restriction if we get the cointegration relationship we fit the model into VECM to get the cointegrating coefficients. Coefficients can be used for forecasting the spot prices in that time horizon.

 

FINDINGS..

For all the three series we got cointegration and after getting the cointegration linear trends were established and cointegrating vectors were measured. Only for first series equilibrium was obtained even after putting the restriction on b coefficients. This can be interpreted as that the future prices are unbiased predictor of spot in seven days horizon i.e. future market player has the idea of what would be the spot price in seven days. When market is in this equilibrium we can predict the spot price seven days in advance

Apr 08 contract: prediction seven days in advance
800.00 700.00 600.00 500.00 400.00 300.00 200.00 100.00 1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 spot prices predicted

Mar 08 Contract: Prediction Seven Days Prior:
800.00 700.00 600.00 500.00 400.00 300.00 200.00 100.00 1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 Series1 Series2

(Series 1 represents actual spot prices and series 2 predicted values)

INFLATION
Inflation is a rise in the general level of prices over time. It may also refer to a rise in the prices of a specific set of goods or services. In either case, it is measured as the percentage rate of change of a price index

Causes of inflation
  

Demand-pull inflation Cost-push inflation Built-in inflation

Causes of current inflation rise:

 

Wage pressure
Commodity prices and expectations Imported Inflation

10

12

14

0

2

4

6

8

1/31/2000 6/30/2000 11/30/200 4/30/2001 9/30/2001 2/28/2002 7/31/2002 12/31/200 5/31/2003 10/31/200 3/31/2004 8/31/2004 1/31/2005 6/30/2005 11/30/200 4/30/2006 9/30/2006 2/28/2007 7/31/2007 12/31/200 5/31/2008

-2

GROWTH IN INFLATION INDEX

US CPI

INDIA WPI

CHINA CPI

JAPAN CPI

FRANCE CPI

10000

12000

14000

2000 wpi gold

4000

6000

8000

0

11/30/2003 3/31/2004 7/31/2004 11/30/2004 3/31/2005 7/31/2005 11/30/2005 3/31/2006 7/31/2006 11/30/2006 3/31/2007 7/31/2007 11/30/2007 3/31/2008

EFFECT OF INFLATION ON GOLD

EFFECT OF INFLATION ON NSE

-200 100 150 200 50
9/30/1998 7/31/1999 5/31/2000 3/31/2001 1/31/2002 11/30/2002 9/30/2003 7/31/2004 5/31/2005 3/31/2006 1/31/2007 11/30/2007

-150 -50 0 1 2 3 4 5 6 7 8 9 10 nse inflation

-100

0

CORELATION MATRIX
WPI(-1) WPI(-1) VOLUME(-1) M3(-1) WTI(-1) 1 0.93094256 0.98165113 0.90283515 VOLUME(-1) 0.93094256 1 0.909206176 0.871265068 M3(-1) 0.98165113 0.90283515 1 0.904038656 WTI(-1) 0.90283515 0.871265068 0.904038656 1

Establishing relation for inflation

Regression testing for the hypothesis that mispricing of commodity futures contracts leads to inflation is performed by multiple regression WPI is regressed on the volumes of trade in leading two futures exchanges in India (NCDEX and MCX), money supply (M3) and oil prices. We took WPI as dependent variable. The independent variables are one lagged WPI, WTI, money supply (M3) and volume. One lag is taken because WPI figures that we get is it self a laggard variable.

Multiple regression results

INFERENCES

 

Futures price contains better information about the supply and demand of the commodity when it gets closer to its maturity or at least in seven days horizon For seven days horizon using the cointegration equation coefficients spot price were forecasted which showed the same trend as of actual values The regression model is significant as suggested by F test. It suggests that the inflation is persistent as it depends on its past values (approx. 76.32%). Rising crude prices showed next higher effect on the inflation. The growth in volume of trade and growth in money supply are not so important determinants of inflation as their coefficients are very small.

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