Securitize Commodities, And What Do You Get?

Last week, the CFTC finally had enough and withdrew that no-action letter that allowed Deutsche Bank’s commodity ETF get around position limits by declaring itself as a hedger, instead of a speculator. At the time, I wondered what kind of spillover might occur, and now we’re seeing it, and not just in the foodstuffs.

In an important blog post almost exactly a year and a half ago, I noted that these ETFs made it easy for fixed income investors to switch just a portion of their money devoted to bonds and other investments into the commodity asset class. Because of the dollars involved in the bond market, a minor shift out of bonds would be a tsunami into commodities. I later wrote that the position limit exemptions were not causing commodities to go up, but they were causing the size of the increase to be larger than it would be if there was a limit to the amount of money the ETFs could take.

Now, with these newly imposed position limits, bond investors can’t just flip a switch and shift into commodities anymore. They can still get into commodities. But they will have to use OTC swaps, or actually buy the physical stuff, which might violate their fund objectives. So, although it appears investors can hold what they’ve got, they won’t be able to add to their commodity holdings easily.

What will that mean for liquidity going forward? And if there is a significant withdrawal of money from these ETFs, what will that mean for inflation/deflation, and for producers and consumers?

Finally, I wonder if anyone has put this together. Securitize commodities, and what do you get? Securitize home mortgages, and what do you get? In both instances, you got a bubble. Now I am not saying securitization is bad. It’s just that when you do securitize anything, you create a vehicle that expands the universe of buyers and sellers. In the case of commodities, the sellers can’t “make more” that easily, so the price rose exponentially. In the case of mortgages, they can to a limited degree. In fact, mortgage-makers did what they do best, and made more, and more, and more, which was the liquidity engine that powered the home building and buying frenzy.

Now before anybody thinks I am against securitization, stop now. Because I’m not. The securitization process is what allowed me to buy my first home. There’s nothing inherently wrong with securitization. It’s just that with securitization, especially in assets that aren’t accustomed to the potentially gargantuan money flows that come with securitization, there can be unexpected consequences. Like bubbles, which, theoretically, can be stopped. [On the other hand, if anybody thinks anybody with authority would have ever been able to step in and actaully put the brakes on the housing bubble without getting their head handed to them, you're, well, not from this planet.]

Comments

[Analyste de...:]

The established bond & mutual fund players HATE ETFs. Intense, behind-the-scenes lobbying and planted 'enraged short/leveraged investor' stories are two points of attack - that's not all.

A 2003 study for PIMCO on commodities' role in diversification has shocking implications - a 15-25% commodity wedge for long-term, medium risk, balanced "50/50" portfolios ?? How many investors (retail or instl) got that memo?

Yes, the shift of billion$ has already begun.

Aug 26 03:26 PM

[Analyste de...:]

I believe the USD hegemony has long permitted the US govt & its financial proxies to HOLD DOWN commodities prices. I suspect this unilateral control effectively ended in 3q07, due to Chinese investment policy changes. It IS a question of 'US bonds OR commodities' already - easy to call which will benefit longer term.

Although the Chinese don't want to upset the apple-cart, the US leverage over the commodity mkts may be waning - that encourages the likelihood of a 'less restricted' commodity Bull Mkt & greater exposure to this asset class going forward.

Didn't/don't have commodity exposure, still? GET WITH THE PROGRAM already. It's called "asset allocation" ...

Aug 26 03:43 PM