Institutional Speculators Disrupt Futures Markets: The Evidence Mounts 23 comments
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The Wall Street Journal finally is catching up on the investigation of the roles of institutional speculators in the cotton, petroleum and grain futures markets, and a careful reading of its page one story Wednesday shows that pension, index and hedge funds have been very disruptive in the markets. The story is here for paid subscribers. I blogged about the institutional speculators and the cotton and corn futures markets here on June 28.
What's clear is that the reason that Wall Street brokers and executives of the futures exchanges have had a tremendous financial incentive to blame soaring commodiities prices on tight supply and demand and to totally dismiss talk that institutional speculators have boosted cotton, corn and oil prices. Most important, as I've blogged here, institutional speculators have made the futures markets almost useless for farmers, grain elevators, exporters and grain and soybeans processors who traditionally use the markets to hedge their risks. Congress and the Commodity Futures Trading Commission are studying the roles of institutional speculators and considering new regulations that will make their activities easy to track and regulate.
So far, pension funds and index funds have been able to work around position limits that apply to individual speculators by employing brokers to hedge their positions on the futures markets. The increasing probability that such regulations will be imposed on institutional speculators has caused them to withdraw from many futures markets, or at least reduce their positions, and this has helped cause the recent declines in oil, corn, soybeans, wheat and other commodities futures prices. Individual speculators have always played major roles in creating liquidity in futures markets. The markets don't function well unless both speculators and commercial hedgers like farmers, refiners and exporters are active traders.
But institutional speculators have poured so much money into the relatively small futures markets that they've over powered all of the other traders, both speculators and commercials. Pension funds have defended their speculative activities with the claim that they're trying to hedge against inflation for their beneficiaries and investors. That doesn't wash, because they've created tremendous inflation and unemployment for those same beneficiaries and and investors as well as for traditional speculators and commercial hedgers. And its becoming even more clear that sovereign wealth funds, which invest surplus dollars for foreign governments, have been buying oil and other commodities futures prices, inflating the oil prices that their governments collect from American consumers.
Yes, they're hedging against a weak dollar, and they're also helping weaken the dollar in the process.
On Aug. 11, the Washington Post finally caught up on the story here, publishing a major report, "Sovereign Funds Become Big Speculators Pools of Foreign Wealth Move Into Commodities." I've blogged on how many business writers have been snowed by the futures industry's propaganda here.
Disclosure: none
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This article has 23 comments:
The money managers of the large pools of money are not engaging in these markets with the purpose of hurting farmers (even if that is what is happening). The are involved because they believe that the intrinsic value of the underlying commodity is worth more(or less) than its current market value.
Perhaps now ,the FED could focus more on the monetarry accomodation to deflect the vestiges of economic questions lingering on the Wall Street .More importantly perhaps the ECB will ease drastically deflecting potential disaster.
Let the CFTC and the relevant exchanges address the speculative issues discussed in the Wall Street Journal.
Agreed. Institutional speculators should not worry about other speculators or hedgers.
Questions:
1. Should pension funds, endowments and mutual funds be speculating in the futures markets, given their tremendous risks?
2. Should exchanges and regulators be concerned that institutional speculators are making it impossible for farmers and other hedgers to hedge their risks in the futures markets?
While the Journal's story reveals nothing "radical," it puts to rest the nonsense that speculators haven't played major roles in inflating and distorting futures markets. This apparently is news for a lot of speculators and business journalists at CNBC, the NYT, WSJ and Barron's.
Whether or not the pension funds, endowments and mutual fund should be speculating in the futures markets (given, you say, their tremendous risks) is entirely their decision, not ours or anyone (like the government) else’s. Just like any other investment opportunity, the investment managers weigh the risk-return characteristics of the investment. If they still see an opportunity then it is their choice to take it. (Just like I’m not going to tell Bill Miller that he’s wrong for being long financials, I’m not going to tell a pension fund manager that his commodity play too risky.)
Your second question is tougher but I’ll begin by stating that I do not believe that market regulation is a good thing. In order for a market to operate entirely efficiently, it must be free. (supply and demand should be able to freely influence price) Farmers and other hedgers trade in futures, forwards (and other derivatives) markets in order to hedge price risk (among others). Why do you assume that the farmers are the only people that have the right to dictate the intrinsic value of the underlying commodity? If someone is willing to pay more for something than someone else then you would be irrational not to sell it to the higher bidder (you’d be throwing away money). Should the regulators be concerned about this? They should not if they want their markets to reflect fair market value.
> jack
I respect (and disagree) with your opinion.
Why should the (you call) few wealthy irresponsible individuals care about the public's interest? What personal liability and obligation do they have to it? Seriously ask yourself that question.
If there is an opportunity to make money you'd be irrational not to take it. If everyone operated with the mentality of doing what was best for the whole instead of themselves (altruism), markets would be inefficient. You are questioning the institution of laissez-faire capitalism (free markets) when asking for regulation to protect certain individuals. Market efficiency is impossible under those (regulated) conditions.
You're still not addressing the issue of price integrity! In order for a price to reflect fair value, it must be able to be driven by both sides of the market (buyers and sellers) freely. If an investment bank goes long oil futures (buying them and sending their price higher) and another investor thinks the price is too high, they are absolutely free to express their dissenting opinion by shorting (and vice versa).
Is there price integrity when a group of institutional speculators only buy and put a floor under the market? Is that like trying to corner the market? Is there price integrity when major players, hedgers and small speculators, are forced to the sidelines because the market is distorted by a few speculators? I don't think so.
I'm not a commodities analyst so I don't know. But I do know that if I personally have a strong conviction that the price of oil will be X dollars in 2015 then I should be able to invest accordingly (whether I'm a farmer or a bank).
I too am a proponent of free markets. They allocate resources in the most efficient manner possible. However, consider this scenario.
There is a 100 dollar market, and any individual market participant controls at most 25 cents worth of the market. A new participant comes along with 5000 dollars and begins participating. Is the market still free? I would argue that the market is now controlled by the participant that controls more resources than the entire market. It does whatever they choose to have it do.
For a real life example, look to the oil market. Sovereign wealth funds of the oil producers could purchase outright over 100 days of production of world oil. With that much control they can set a price they want, and purchase their own contracts until the price is at that level. When the contract comes due, they take delivery of their own oil (just don't pump it). What this amounts to is that they are able to set the price of oil, for the price of the contract fees. When was the last time you saw a squabble among the OPEC members over the price of oil and their production quotas? Demand for oil has fallen more than 10% yet the price of oil, inelastic as it is, is only down $30. Iran's president has said he thinks $115 is a good price for oil. Coincidence? Maybe. OPEC exists to thwart a free market for oil, so why would they hesitate to do this?
Neither of these is a symmetric situation. It is difficult for the market distorter to make money driving price down, they need to drive price up. They are both making money from the buyer, by inflating the price of a resource. They are acting as a monopolist, effectively purchasing all production and selling it at the price they choose. It isn't that they think it is worth more, they *make* it worth more.
So my argument to you is that if there is a player that can dominate a market, it is no longer a free market.
In reference to your statement: "Let the CFTC and the relevant exchanges address the speculative issues discussed in the Wall Street Journal," the CTFC HAS weighed in.
The Commission chaired an Interagency Task Force on Commodity Markets at the behest of Congrfess and delivered its report on July 22 (see "Interagency Task Force Interim Report on Crude Oil," www.cftc.gov/stellent/.../@newsroom/documents/f...
The Task Force found that "...current oil prices and the increase in oil prices between January 2003 and June 2008 are largely due to fundamental supply and demand factors. During this same period, activity on the crude oil futures market – as measured by the number of contracts outstanding, trading activity, and the number of traders – has increased significantly. While these
increases broadly coincided with the run-up in crude oil prices, the Task Force’s preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices."
A graphic analysis of trading activity in the crude oil market over the past couple of years can be found here: "Congress Blames Index Speculators" (www.hardassetsinvestor...).
When I have stated that the CFTC and the relevant exchanges should address the issue ,that is not what I have meant.Allow me to preface my modified response.
The price of the crude has attained a level which is approximately 400% increase of the past 10 years average (approximately 30 dollars per barrel).
Even allowing for Chinese and India's increased demand for the crude ,it is impossible to justify the geometric price increase.
It is quite clear that the hedge funds and other prominent trading desks did have significant impact on the price of the crude irrespective of CFTC findings.
As we know by now ,the trade of the year was long the crude and short financials-fundamental... not a very logical trade and a very dangerous trade from the broader economic perspective.
It assumes (implicitly) that the high energy prices will derail economy and impede functionality of the financial sector.
With some experts expressing an opinion about the 200 dollars crude,in fact you would have contributed to an economic decompression and potentially unprecedented systemic failure that would spread to the rest of the universe.
In its wisdom the FED ,the Administration ,the Treasury and the Congress have addressed the "potential debacle".
The result ...unwinding of the sensless spread driving the oil prices lower and allowing the financial sector to rally .
More importantly ,this rational adjustment will allow for a further stock market consolidation resulting in unprecedented rally.
In addition we have almost neutralized the mass psychosis which will contribute to economic stability leading to a major rebound.
The magnitude of the adjustments in the financial sector and the price of the crude,is indicative of the magnitude of the speculative forces at work-pure logic.
Now let's revert to my statement about the exchanges and the CFTC.
Some 28 years ago as U.S had experienced 17% inflation ,a well known Texan,Bunker Hunt had decided that the silver was a great hedge against inflation and started to buy silver pushing the price of the metal to 50 dollars per oz.-just as recently as some investors /speculators have thought that the price of the crude could attain 200 dollars per barrel.
Back then ,the Comex had decided (CFTC was involved as well) that silver at 50 dollars was indicative of a squeeze and has accused Mr.Hunt of attempting to corner the market.
The solution was to impose 100% margin(the value of the contract).From that day on the silver started to decline all the way to six dollars.
It may be an approach to take in the crude market when it threatens global economic stability.
If the fundamentals are there (I don't think so),the crude prices will be maintained and another solution will have to be found.
If my assumption is correct then the oil prices could implode
allowing the FED further accomodation.
Thank you for paying attention to my comments.
You've made a rather sweeping statement: "It is quite clear that the hedge funds and other prominent trading desks did have significant impact on the price of the crude irrespective of CFTC findings."
HOW is it clear? What definitive evidence can you offer to support this contention?
BTW, it really annoys me when the WSJ and others talk about institutional "investors." No "investors" trade futures. Only speculators and hedgers trade futures.
Also, I have no ax to grind here. I've never been employed by any organization that trades futures and I have never traded futures, but I spent 12 years covering and studying the markets. What has got me interested in this debate are the numerous lies told by the futures industry and reported as truth by leading financial publications. To me, it is clear that the apologists for the institutional speculators are being intellectually dishonest or naive and are trying to mislead the public and politicians. I have no sympathy, btw, with those who are trying to scapegoat all oil speculators, because I believe they play important roles in the markets. I just think the institutions should be required to play by the same rules as everyone else.
If you have a bone to pick on the Task Force report, please provide data to substantiate your argument. The case made by the Task Force report and the the "Congress Blames Index Investors" article were backed up by data.
What can you offer to bolster your argument?
The losses sustained by the oil price implosion were reported in the media.Even Mr.Pickens ,a truly an expert ,had sustained substantial lossees in one of his energy funds.In fact the the CNBC with their pseudo experts had referred to unwinding of the long the crude and short the financial spread.According to a major paper ,seven or eight out of ten hedge funds had sustained major losses.
There is no doubt that some Wall Street prop desks were involved in the trade. One more time ,if you look at the magnitude of the price implosion in the price of oil and magnitute of the spike in the financial sector ,it should be logical to deduct what market forces are at play.
In 1999,I have met with Direttore Menginni(back then portfolio manager for the Vatican- a great strategist and a good listener).
At the time I have warned him about the stock market implosion in the period ahead.How did I know? Objective analysis and"deductive reasoning".
In the current case,I am sure that in the period ahead more light will be shed on the topic.
I do understand your attitude given your responsibilities .
For myself ,my track record is like an open book .
Google my name .I would love to have this discussion face to face as I do not want to minimize the opinions of the others.
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