The CFTC Investigates ETFs: Witch Hunt or Fair Trial?

By Dave Nadig

Yesterday we got news that the CFTC is paying attention to the ETF industry. I suppose we should be flattered, but I'm much more concerned than titillated.

It's not all that infrequent that regulators raise the specter of "speculators" in the headlines, and it's nearly as surefire a paper-seller as "man bites dog." Very few market participants really call themselves speculators, and the word itself has taken on near-evil connotations. If you'd walked into a cocktail party in May of 2008 and told everyone you were an oil speculator, you would likely have had a martini-bath and an early taxi-ride home.

Wednesday's news was that the CFTC is looking into limits on speculative position limits on all "commodities of finite supply"—really, energy commodities. This is virtual handwriting on the wall—there will be position limits, just as there have been in agricultural commodities. It will be difficult to argue that the position limits in place in agriculture have somehow killed the liquidity in corn and soybean contracts, and the best we can hope for is that the position limits on energy commodities are sensible, and structurally similar to those we already have in place elsewhere.

The immediate impact for ETF investors was in the U.S. Natural Gas Fund (UNG)—a product that's received an incredible amount of attention (and asset flows) lately. UNG, like most futures pools, needs to issue new shares on a regular basis, and had simply run out of its initially approved 200 million shares. Normally, getting approval to keep an ETF growing is a rubber stamp from the SEC. Not this time—no more UNG shares are getting minted.

Some people are speculating (pardon the pun) that the move by the CFTC is directly tied to UNG, and I suppose that's possible. Citigroup recently opined that UNG was single-handedly responsible for keeping the price of natural gas artificially high, and it's certainly easy to create the sequence of phone calls that has the CFTC writing the memo.

But let's think what this shutdown of creations means. That means if you want UNG shares, you have only one way to get them—you buy them in the market. If you want to get rid of UNG shares, you still have your options. What that means for investors is simple: If there's demand for UNG, and there certainly has been, those shares will likely trade at a premium on the ask. The bid, however, will likely stay relatively normal. After all, if you don't like the price the market's offering for your big block o' UNG, you can just wait until the end of the day and redeem.

It will be interesting to look back in a few weeks at the spreads and see how that panned out. It's possible that the bad PR on UNG from all of this will dampen investor enthusiasm for the fund enough that a premium doesn't manifest.

Side note: The second half of CFTC Chairman Gensler's statement yesterday was about improving the quality of the Commitments of Traders (COT) report we get every Friday, breaking out various parts of the report that are currently single line items into more detail. That's a kind of transparency I think most ETF investors can get behind.

Comments

[Baboon:]

If they remove all the speculators from the market who will remain?

Jul 09 08:53 AM

[User 422955:]

"Speculation" and "investment" are both terms with a long history. Definitions have changed from time to time. Any search engine will give links to several.

The points which the author seems to miss are simple: (1) There is usually room for ample speculation in regulated markets. (2) The CFTC's job is to investigate and regulate commodity markets.

Don't forget that our current financial panic was caused, primarily, by unregulated speculation. The speculators will now be regulated. The purpose is not to "end speculation," but to limit the risks unbridled, unregulated speculation brings to the wider economy.

Jul 09 08:04 PM

[No Free Cake:]

Hmmm .. "all commodities of finite supply". Uh, if the limit is Earth then all materials are of finite supply. If not just Earth, well, then hard to know. Peculiar phrase.

I'm surprised the gold bugs aren't up in arms that this is a trojan horse to limit their activities.

Jul 09 11:01 PM

[G. L. Turner:]

I am amazed at how many are running to cover based on their 'ideologies' regarding capitalism and NO Gov.

We need to parse the word speculation, necessary for good commodity markets, and 'manipulation', that which exists in these markets over the last 3 years. My contention is simple: I bet if you barred Gov Sachs, JPM, MS and DBk from any activity, on any level in the commodities trades, this includes shutting up their "Analyst Advice", their owning a refinery and pipelines and stroage tanks, thier onwership in exchanges, like ICE, their ability to issue CDSs, their ability to ran a CIF, their ability to charge fees to funds to place them in trades and funds, etc...yo know, all those things they do, other than just be a good ole speculator who actually uses Oil and needs to 'buy it' for production purpsoes, and actually needs to take delivery of oil, then, my money says that teh futres markets, would settle down to mild and gradual price moves, such that Oil Drillers and refineries could plan real investment and production, and we, the America People and Global Community, could get on with our lives, our recovery, our economy and oh, btw, we might have avoided those 100 million people who moved into serious starvation last year, to include a large part of these having died!

Yep, that amount of reg and pos limits would fix the problem!

Jul 09 11:32 PM

[Baboon:]

You shut down some speculators and the new ones will take their place. Maybe the same ones under different names. Unless they are obligated under new regulations to fill out questionnaire before trading commodities to indicate their intent: something like 'Will you trade for purpose of speculation?' or 'other'. So much for a free market.

On Jul 09 11:32 PM G. L. Turner wrote:

> I am amazed at how many are running to cover based on their 'ideologies'
> regarding capitalism and NO Gov.
>
> We need to parse the word speculation, necessary for good commodity
> markets, and 'manipulation', that which exists in these markets over
> the last 3 years. My contention is simple: I bet if you barred Gov
> Sachs, JPM, MS and DBk from any activity, on any level in the commodities
> trades, this includes shutting up their "Analyst Advice", their owning
> a refinery and pipelines and stroage tanks, thier onwership in exchanges,
> like ICE, their ability to issue CDSs, their ability to ran a CIF,
> their ability to charge fees to funds to place them in trades and
> funds, etc...yo know, all those things they do, other than just be
> a good ole speculator who actually uses Oil and needs to 'buy it'
> for production purpsoes, and actually needs to take delivery of oil,
> then, my money says that teh futres markets, would settle down to
> mild and gradual price moves, such that Oil Drillers and refineries
> could plan real investment and production, and we, the America People
> and Global Community, could get on with our lives, our recovery,
> our economy and oh, btw, we might have avoided those 100 million
> people who moved into serious starvation last year, to include a
> large part of these having died!
>
> Yep, that amount of reg and pos limits would fix the problem!

Jul 10 07:22 AM