Does Herding Behaviour Exist in the Commodity Markets?

In the financial markets, herding behaviour is often exhibited by investors following the crowd and buying or selling assets based on the actions of others, rather than making their own independent decisions. This can lead to market bubbles and crashes as everyone rushes to buy or sell at the same time.

Herding behaviour is often driven by fear, greed, and other emotions, which can lead to irrational decision-making. It can be a difficult behaviour to overcome, but it’s important to remember that everyone else is not always right. Doing your own research and staying calm during times of market volatility can help you avoid making poor investment decisions.

Herding behaviour has been shown to exist in equity markets. Reference [1] examined the herding behaviour in the commodity markets. Its main findings are as follows,

Agricultural and metal-based ETFs are least prone to herding in general, though the former exhibits opposite tendencies in times of market volatility and Covid-19 pandemic. With respect to frequency, in general market conditions herding mostly occurs beyond a half-hour interval. An exception is agricultural ETFs during the Covid-19 pandemic, whereby herding occurs in all frequencies. This is a striking and crucial finding of this study. Elsewhere, broad basket commodities and energy-based ETFs are generally susceptible to herding across most frequencies.

These findings have important implications for the development of trading strategies in the commodity markets. Another important finding is that the correlations between commodity ETFs are rather low and often negative,

Overall, our correlation analysis shows that ETFs are less related to each other over time. Nonetheless, when the frequency of our observations decreases, so does the degree of correlation (except for energy). ETFs, on the other hand, display substantial positive correlations with one another only at 15-minute intervals during COVID-19. When the frequencies are lowered, however, the relationship shifts toward fewer positive and more negative correlations. This analysis could be used by investors as a hedging or diversification strategy.

In short, it’s beneficial to include commodity trading strategies in a portfolio for diversification and hedging purposes.

References

[1] Ah Mand, Abdollah and Sifat, Imtiaz and Ang, Wei Kee and Choo, Jian Jing, Herding Behaviour in Commodity Markets. https://ssrn.com/abstract=4157440

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