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It’s a busy day for the Commodity Futures Trading Commission (CFTC) as testimony is heard regarding the controversial proposal to limit position sizes on all finite commodities. The two primary investments affected by this discussion are IntercontinentalExchange (NYSE:ICE), CME Group Inc. (NASDAQ:CME). Earlier this month, ZachStocks discussed how further limits to position sizes could have unintended consequences and actually increase volatility instead of helping to stabilize wildly swinging markets.

Jeff Sprecher, the CEO of IntercontinentalExchange voiced a similar perspective in his remarks to the committee today:

While well intentioned, these measures often fail to achieve their desired objectives or, worse yet, lead to unintended consequences … that would otherwise be discovered in properly operating markets

The primary evidence presented by the pro-regulation side of the argument is the drastic swings in energy prices over the last 18 months. But extreme volatility in energy markets is much more affected by economic concerns (which have been more volatile in recent quarters than any time in the last 70 years) than by manipulative trading practices.

Consider the “peak oil” arguments from just over a year ago. Oil companies were finding it more and more difficult to produce oil and natural gas with the same cost structure. As low hanging fruit (or easy to drill fields) were slowly bled dry, the cost to discover and produce each marginal barrel of oil (or gas equivalent) was rising. Technology advances and alternative energy helped to offset this some, but the evidence pointed to rising costs (and therefore higher prices) for traditional energy sources. It was only natural for energy prices to skyrocket.

Then came the most devastating global economic recession seen in decades. Growth assumptions were severely cut (partly as a function of higher prices of commodities such as energy - and partly because of unsustainable growth assumptions in the first place). As consumption, and by extension the future estimates for consumption, dropped, the price of energy products came crashing back to earth. Fundamental economic laws state that when demand for a product decreases, the price will naturally fall. So once again, the price of traditional energy products declined sharply - but more as an extension of global economic forces than due to “evil speculation.”

Now I’m not claiming that prices are always accurate or that traders had no part in pushing prices higher or lower. But an active market with heavy interest on both the buying and selling side will by definition lead to efficient prices given the information that is available at the time. Traders with keen foresight or better information need only to take the other side of a trade in order to profit from their perception (from both a long-term and a short-term perspective). So if prices really are out of line with reality, then it would behoove a large trader to begin building a large position which will profit when prices move back to sustainable levels.

CFTC Chairman Gary Gensler stated that Congress should move “urgently” to prevent market players from moving to the over-the-counter (OTC) market or to foreign exchanges. Yet, increasing regulations by capping position size will likely create an even greater incentive for participants to create their own “side bets” or off-balance sheet agreements in order to profit from price movements, or hedge financial risk.

The assumption that the government can accurately determine value or steer prices towards a “correct” range is absurd. While it is important to make sure that one player or group of players cannot buy up all of the supply and then hold resources hostage (known as “cornering” a market), the oil and natural gas market is large enough to make this virtually impossible. Instead, regulators appear to be using fear as a tool to argue for heavily regulated markets. The anti-business, anti-capitalistic bent of the current administration is sobering and could cause much more harm to free markets and economic growth.

Disclosure: Author has a long position in ICE in the ZachStocks Growth Model

Source: The Proposal to Limit Commodity Positions Will Hurt Free Markets and Economic Growth