The Proposal to Limit Commodity Positions Will Hurt Free Markets and Economic Growth 35 comments
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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 (ICE), CME Group Inc. (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
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Your closing sentences are meant to be inflammatory and are not indicative of the truth: "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."
This is not waht the regs are needed for - The Gov. Is not trying to determine the value, not is it trying to steer prices- rather it needs to ensure that the markets are working for the benefit of the producers/users...not the Financial Houses that DO NOT CARE if the economy/markets work properly or not, so long as they make huge profits...these guys are so dollar focused that they have 'lost their way'.
Further, the collaborative efforts of GS, JPM and a few others have been very instrumental in 'moving prices', and then shorting the markets they helped to gin-up, quite well, thank you. (Sheeple investors, beware-)
So, in writing what you have, it is not really based on reality...
That is like the those two Republican Fortune Tellers - Bush & Cheney - telling us that the Un-contested mergers of the former US Big Oil Companies in 2004 (8 consolidating down to 3), followed by their ENRGY ACT of 2005 was going to be good for competition and the American Consumer...
Yeah right - let's see, with the small exception of 3.5 months earlier this year, since mid-2005, gasoline has been almost double to triple what it was prior to the mergers, and will trend to at least 'double and more' going forward, ever since the mergers and EA. (RBOB is now an Index play too along with Oil..)
So, give us a break, Index Funds, "Analyst Reports" broadcasted across the CNBC landscape, and people who confuse properly functioning futures markets with regulated markets, dark markets, etc. - pollute the real functions that the economy needs from the commodity markets...
Not wanting to see the TRUTH doesn't mean it 'ain't so'!
Castigating "speculators" because we don't like the price they pay for commodities (with their own capital) is ridiculous. All investing/hedging is speculation by definition. If you're convinced that the price of oil or anything else is too high due to "speculative" buying -- simply take the other side of the trade. The market will ultimately tell you if you were right or wrong. No one can prop up a market indefinitely!
Similarly, the idea of someone "cornering the market" is not something to be feared or regulated against. The market would ensure that this is a prohibitively costly exercise -- one guaranteed to lose the "cornerer" a lot of money.
The more capital a market attracts -- the more liquid it will be, and the better its price discovery will be. This should not be inhibited by politicians seeking scapegoats in an effort to be seen as "doing something".
A common sense observation is that those who take outsize positions in futures markets are operating at the same advantage as a poker player who has more chips than anybody else at the table: he throws his weight around and eventually cleans everybody else out.
In this case while the high stakes players enjoy their game millions of people are gouged for the gasoline they need to commute to work and go about their daily lives. The excessive price of gasoline caused by these antics pushed many people over the brink into foreclosure and the loss of their homes, exacerbating the housing meltdown.
The excesses of the futures markets are another instance of the corrosive financialism that is destroying our economy and impoverishing ordinary citizens in order to enrich a few over-priviliged speculators, who are propped up by the government when their bets go bad. The whole thing stinks.
What we are finding in the futures markets is that abundant capital which the Fed has poured into the financial system is finding its way into price manipulation rather than into the hands of those who need credit to operate their businesses or buy or refinance homes. I applaud Gensler for trying to do something about it.
Barbarous wrote, "No one can consistently pay "too high" a price for a commodity or other investment and hope to have any capital left to invest tomorrow."
This is false. A speculator who is too big to fail will be propped up by taxpayers's money. Barbarous also wrote, "Anyone willing to risk their capital should be allowed to invest as he sees fit."
I agree. The key phrase is "risk their capital". GS and JPM risked their capital and lost. In a free market they would now be bankrupt and out of business. Meanwhile they are still in business, guaranteed by taxpayers to never lose, and GS makes record trading profits last quarter on its front-running software and other advantages that are illegal for you and me to practice.
None of us here on Seeking Alpha are socialists. We are all capitalists trying to make some money and trying to understand the best ways of doing that. Most of us are happy (though some might be jealous) to see each other making money by understanding the markets and doing smart trades. What we object to is that there is one set of rules when we risk our capital, and an entirely different and more favorable set of rules when the big boys risk their capital.
I think in commodities markets those who are too big to fail should also be too big to play. I agree with author Zachary Scheidt and Barbarous that us ordinary investors cannot corner any markets or individually affect commodity prices. But the new CFTC rules are not designed to constrain us. They are designed to constrain players who can affect the prices we pay for gas and bread, even though they produce no oil and grow no wheat.
These large speculators have enough money to move into a market, manipulate the price of a commodity, suck large amounts of money out of that market, and leave legitimate buyers and sellers of commodities poorer, not better off, for all this additional "liquidity" that has gone in and raped this market.
I agree with a point David Merkel made today: inasmuch as a legitimate hedger requires someone to take the other side of the trade, speculators' liquidity is welcome. But once you get to the point where you have speculators trading with speculators, that has gone beyond serving any economically useful purpose and is rightly recognized as simply gambling at our expense and should not be allowed.
like other nice sounding platitudes there is just enough truth in this one to sound appealing. while this statement might be true in the context of normal supply/demand based trading, it is utter rubbish when you add a significant financial speculation component that is indifferent to supply/demand factors. further, to believe this statement one must also deny the existence of speculative-induced bubbles and collapse, for such events are characterized by exploding trading volumes. last year's oil markets are the modern day poster child for this phenomenon. anyone who doesn't acknowledge that $140 oil was not an efficient price but a bubble.....and there were no shortage of these true believers as it was occurring...are members in or candidates for a doomsday cult.
as for hurting "markets and growth," how ludicrous can you get. the economy functioned just find prior to the advent of futures trading. it sure as hell doesn't need financial speculators in oil and gas futures to do so today.
Since most of the banks and brokers can make a good profit off of volatility alone, this is even worse for the market than them betting on a commodity or not. Essentially, they are paid to destabilize the market and hide real demand. There are tons of funny games savvy brokerages and banks can and probably are doing to benefit themselves. This amounts to manipulation if you consider manipulating profiting off of a position and denying others lack of transparency.
Thus, I think the issue is real transparency. In general, I think if the commodities exchanges were smart and market savvy they would allow some portion of commodities orders be parced or run as a fair, transparent, and legitimate ETF for smaller players to place their orders and increase price discovery. That way we can drain all the funny non-transparent positions out there in the market that can cause real havoc.
The market is your friend. Contracts and side bets that circumvent the market are not. Unfortunately, such mechanisms are very profitable for GS and others who will fight tooth and nail to keep their priveledge over average players and their secret money making schemes.
I hope regulators will realize the crux of the issue is really about price discovery, functional open markets , and transparency. It is not about barring some mysterious Mr. X who wants to bid up commodities prices until we all scream outch. If there was such a market participant it would be called OPEC.
www.allheadlinenews.co...
then we are living in a financial tyranny. You say "it was only natural for energy prices to skyrocket." We'll let the data from last summer speak to that when the CFTC releases it. Can't you see that we won't prosper a nation like this? American citizens were harmed by this with no one to protect them but instead you publish an article against the protectors? No enemies need be, status quo thinking like this will destroy America from within.
In foods, speculative excesses in wheat and corn caused many people in third-world countries to go hungry, even starve.
I have no problem with unlimited speculation in gold, and in major currencies such as the dollar, the euro, the yen, the Swiss franc and the pound. But regulate tightly position sizes everywhere else so no corner or virtual corner is possible. Make illegal the holding of positions outside the US which would make the holder's aggregate position -- total of futures, options and actuals for a given delivery -- exceed the legal limit.
There should be no place in commodities markets for "investor" speculators, who buy and hold -- especially open-ended commodity funds -- who by their actions (indeed, by their very existence) force prices up, then, when the market game of "bigger fool" comes to an end, dump and cause prices to decline 75%, destroying most possible value for genuine hedgers. All such activity does is force up costs for all end users of the actual commodities.
Gensler must succeed, and I wish his proposals were much more aggressive.
You cannot regulate away moral hazard.
On Jul 29 01:01 AM Dave Wrixon wrote:
> The arrogance that the US believes that it can control commodity
> prices just shows that not is Wall Street doomed, so is Chicago!
> Trust me it is only a matter of time before most commodities are
> no longer quoted in such an inherently unstable currency.
Right on. It is already happening and will gather pace. People do not remain fools all the time. Too bad, if you think they will. Speculators/manipulators being who they are would prefer a casino type of environment. We have Las Vegas, now Wall Street and soon every where else! But then, even casino have rules!
The small clique of trading intermediaries kick around the North Sea BFOE complex (which now actually prices crude oil globally directly and indirectly) like their own private football and they both created and control ICE as I set out at length here
seekingalpha.com/artic...-
As Izabella Kaminska put it memorably today
ftalphaville.ft.com/bl.../
there is in fact not so much a London Loophole (ICE Europe's WTI isn't even delieverable) but a "Physical Loophole", which canny operators like GLG are racing to exploit.
None of that detracts from the fact that in the long term the oil market price is a function of supply and demand.
But in the short and medium terms, trading intermediaries are pillaging billions at the expense of producers and consumers alike through the creation of unnecessary volatility exacerbated by the gearing effect of derivatives and borrowing from credit institutions.
The price of oil and gasoline should be based on the demand for those products by those who actually buy and use them, not the demand for their underlying futures contracts.
Does anyone really think that the "real market" for oil pushed it to $140 followed by a $100 drop? Nonsense.
The effect is akin to ETFs loaning money interest free to producers, and producers loaning oil to ETFs.
I would argue that it is the hedge funds and proprietary traders (the ICE owners club) who are the only "speculators" in the market.
And they are brilliant at what they do.
But in the same way that a submarine is a beautiful piece of engineering with a malign purpose (sinking ships) , these cleverest guys in the room operate with the (IMHO malign) purpose of extracting profit by whatever means possible from producers, consumers and genuine investors alike.