Will Gensler Curb Manipulations in Futures Markets, or Is It Just Smoke and Mirrors?

by: J. S. Kim

Several days ago, various news agencies reported on a plan advocated by Commodity Futures Trading Commission chairman Gary Gensler to significantly curb manipulation schemes executed by big banks in the commodities futures markets through new regulations that will assign and enforce limits on positions held by these firms.

Though decades late, such new regulations, if they pass, will be a monumental victory against the big banks and in favor of free markets. The pertinent points of this plan are as follows:

” ‘Our first hearing will focus on whether federal speculative limits should be set by the CFTC to all commodities of finite supply, in particular energy commodities, such as crude oil, heating oil, natural gas, gasoline, and other energy products,’ Gensler said in the statement. ‘This will include a careful review of the appropriateness of exemptions from these limits for various types of market participants.’ Among the questions the agency will ask is whether it needs additional authority from Congress to apply the limits across all markets, Gensler said. The agency didn’t specify dates when the hearings would take place or who would be asked to speak.”

“Index funds and exchange-traded funds, which mimic an index, can hold oil contracts in excess of available supply. Regulation and oversight of deliverable futures contracts have always been necessary, said Michael Cosgrove, head of North American energy operations for broker GFI Group Inc. in New York. ‘Oversight of contracts that do not affect supply and demand, such as Nymex cash-settled futures and ICE cash-settled swaps, is a misguided waste of taxpayer dollars,’ Cosgrove said today in an e-mailed statement. ‘These contracts affect supply and demand no more than the betting at a race track affects the speed of the horses.’

“The CFTC currently sets and ensures adherence to position limits with respect to certain agriculture products,” Gensler said in the statement. “For energy commodities, futures exchanges set position limits and accountability levels to protect against manipulation and congestion. The exchanges are not required to set and enforce position limits to prevent the burdens of excessive speculation.” Gensler further stated that the CFTC will improve its weekly commitment of traders’ reports by separating out swaps dealers and hedge funds from the larger category of “commercial” traders

Prices Set on the NYMEX and COMEX Futures Markets Are Completely Disconnected From Prices Dictated by Free Market Forces

There are three very illuminating statements in my above summary of the proposed regulatory changes by the CFTC. The first comes from Michael Cosgrove, head of North American energy operations for broker GFI Group Inc. in New York. “Oversight of contracts that do not affect supply and demand, such as Nymex cash-settled futures and ICE cash-settled swaps, is a misguided waste of taxpayer dollars…These contracts affect supply and demand no more than the betting at a race track affects the speed of the horses.”

To begin, the great majority, perhaps 99%, of most futures contracts happen through the purchase of a long contract to cancel out a short contract, or vice versa, and are thus settled in cash and not through the delivery of the underlying commodity. Even when futures contracts can be settled with the delivery of the underlying commodity such as wheat, soybeans, etc, the contracts are still settled with cash 99% of the time. Only when the prices dictated on the futures markets become so out of whack with free market forces, as they have at times with gold and silver, do investors turn to the futures market for delivery of the underlying commodity.

Thus, Cosgrove, in his reference to Nymex cash-settled futures, refers to virtually all futures contracts. Cosgrove, in his eagerness to call oversight of these contracts stupid and misguided, aptly illuminated the fraudulent nature of the futures markets most likely to his dismay. If the price that is determined of various indexes and commodities have no bearing on supply and demand of these indexes and commodities, then Cosgrove is basically stating that there is zero connection with the prices set on futures markets and prices set by free market forces. He is stating, that in fact, the US futures markets are in reality, a huge casino to be gamed by certain players for profits with no connection to the reality of supply and demand, and that in effect, prices set on the futures markets distorts reality and leads to gross inefficiencies in commodities markets that can be exploited by controlling interests or those with inside knowledge.

In fact, this is the exact revelation that I explained nearly nine months ago when I explained the massive disconnect between physical gold prices established by supply and demand and the prices of gold established on the COMEX. In the past, there have been many instances in which gold and silver’s price have plummeted on the futures markets at the same time gold and silver dealers all over the world have announced shortages in supply. Given these circumstances, as Cosgrove stated, though futures contracts set prices of these commodities, “[futures] contracts affect supply and demand no more than the betting at a race track affects the speed of the horses.” In plain English, at times sell-offs of gold and silver and other select commodities are engineered in the futures markets for political reasons, for monetary reasons, or purely just due to the greed of controlling interests on Wall Street.

I have maintained for years now that prices of many commodities have nothing to do with the free market forces of supply and demand but rather to alternate price pumping and price suppression schemes executed by big banks on the NYMEX and COMEX. When crude oil futures contracts rose more than 180% from about $52 a barrel in January, 2007 to more than $147 a barrel just 19 months later; and then promptly crashed 76% to $35 a barrel in the next 5 months, what sane person actually would attribute these huge price swings to free market forces of supply and demand when the percent swings in price far exceeded any rational explanation attributable to the changing levels of supply and demand?

When gold plunged more than 24% from a high of about $924 an ounce on October 8, 2008 to less than $700 an ounce in only 11 trading days on the COMEX, again, what sane person would believe that this plunge was caused by free market supply and demand forces, especially during a period when the inventory of the SPDR shares gold ETF remained essentially steady and no significant fall in demand was reflected in the largest gold investment vehicle in the United States? Yes, I realize that deleveraging was the reason offered by the “experts” for this rapid plunge in price, but I believe there was much more than just deleveraging in play back then.

Precious Metals, Defined by Their Rarity, Are Not Finite Commodities?

CFTC Chairman Gensler stated that the CFTC’s “first hearing will focus on whether federal speculative limits should be set by the CFTC to all commodities of finite supply, in particular energy commodities, such as crude oil, heating oil, natural gas, gasoline, and other energy products.”

Curiously, even though the top gold producers in the world have announced increasingly difficulties in expanding their growth in gold production this past quarter, Gensler didn’t acknowledge gold (nor silver for that matter) as a commodity of finite supply. Furthermore, when compared to other commodities such as copper and zinc, the annual production of gold and silver is minute. That is why they are considered “precious” metals. I wonder if Gensler will classify gold and silver as commodities of finite supply or, as I fear, determine that gold and silver will be excluded from the list of commodities that will receive federal speculative limits?

According to our financial leaders, when large future contract positions exist with energy commodities it is manipulative, but If the same situation materializes with gold and silver, it is not manipulative, but a valid hedge.

In support of Gensler’s arguments that the price of energy commodities have been manipulated in the futures markets in the past, the CFTC cited Amaranth Advisors LLC, a hedge fund that controlled more than half of the open Nymex futures contracts for natural gas before its collapse in 2006, when Amaranth trader Brian Hunter promptly lost about $6 billion in a month’s time.

It is curious to me that the CFTC cites an example of an institution controlling a huge position of the open futures contracts in natural gas as manipulative, and that these allegations will be accepted by other financial executives as manipulative, but when the same situation in gold and silver futures markets is delineated, these claims are sloughed off as ridiculed and conspiracy-laced. For example, consider the response of Tom LaSala, a managing director at CME Group and head of market surveillance for futures markets including gold and silver, to silver analyst Ted Butler’s allegations that silver markets are manipulated due to the majority control of silver short contracts on the COMEX by only 2 or 3 institutions.

LaSala responded by stating that “such a large short position in the futures market would not be manipulative if it was a legitimate hedge.”

LaSala reiterated that he “supports the view of the US futures market regulator, the Commodities Futures Trading Commission [CFTC] and its claim that there is no obvious motive and no evidence of long-term manipulation (regarding silver, and by extension, with gold).” To hammer home his point, LaSala goes on. “His (Butler’s) comments are without merit, they are illogical. He seeks conspiracies and talks about holdings by the large banks. But who owns the significant part of other securities like warrants and stocks? It’s just quite frankly logical that the banks, that are also the warehouses in many regards, have physical length (own gold and silver) and their function in the market place, at least to some extent, is to lay that risk off (sell the gold and silver they own on the futures market and lock in the price).”

So if large control of energy commodities exist in the futures markets, it is acknowledged as manipulative, but if a very similar scenario exists in gold or silver futures markets, then such accusations are illogical conspiracy rants? LaSala’s argument that banks would hold huge short positions against silver (and gold for that matter) in the futures markets because they own the most significant portions of gold and silver stocks and warrants simply holds no water if you apply the same arguments to oil. Certainly these same banks held very significant portions of warrants and stocks for major US oil companies during oil’s tremendously manipulated run higher, yet these banks have never been perpetually short huge oil contracts in the futures markets as they have been with gold and silver. Remember, these banks have been perpetually short gold and silver for decades now.

When oil was soaring from $52 a barrel to $147, why didn’t these same banks assume massive short positions in the oil futures markets the entire time to hedge against their long oil positions as they do with gold and silver? These banks are perpetually short silver and gold even during massive run ups in the price of gold and silver, yet during massive run-ups in oil, they assume long oil positions in the futures markets as well as long oil positions in stocks and warrants. And to quote Butler himself, if Butler’s accusations are without merit and illogical as LaSala claims, then why has the CFTC opened up investigations into manipulation in the silver futures markets based upon Butler’s accusations? Given the deceptive explanations of men like LaSala to allegations of fraud on the futures markets, no wonder the public does not trust any commercial financial and investment industry executive as far as they can throw them.


Why Are Position Limits Enforced With Agricultural Commodities But Not With Energy or Precious Metal Commodities?

In the press release regarding the proposed increased regulations for futures markets, CFTC Chairman Gensler stated,”The CFTC currently sets and ensures adherence to position limits with respect to certain agriculture products…For energy commodities, futures exchanges set position limits and accountability levels to protect against manipulation and congestion. The exchanges are not required to set and enforce position limits to prevent the burdens of excessive speculation.”

In reference to the above, why are there separate rules for agricultural products and energy commodities and precious metals? Though Gensler again glaringly avoids discussing gold and silver, the CFTC currently sets no position limits for gold and silver. I believe that the omissions of position limits for gold and silver were purposeful as the Plunge Protection Team, the Exchange Stabilization Fund, and the US Federal Reserve had the foresight to understand that huge short positions were going to be necessary against gold and silver in the US futures markets to prop up a dangerously unstable US dollar.

In the past, given the SEC’s deference to Wall Street lobbyists, it is hard to believe that the CFTC did not also purposefully grant Wall Street loopholes, due to their lobbying efforts, to speculate in energy and precious metal commodities. Whether these loopholes will be closed under Gensler is highly questionable, as a year ago, with all-time high levels of public outrage on his side, US Senator Joe Lieberman’s attempt to close these loopholes still failed.

Smoke and Mirrors?

Gensler’s move to “improve [the CFTC’s] weekly commitment of traders’ reports by separating out swaps dealers and hedge funds from the larger category of “commercial” traders” is a step in the right direction, but this is only reversing an existing ludicrous circumstance. Commercial traders are defined as companies engaged in primary business activities that necessitate hedging by the use of the futures and options markets. Thus, in agriculture if you are a soybean farmer, then you would be categorized as a commercial trader. If you are a hedge fund speculating in soybean futures for Goldman Sachs, JP Morgan (NYSE:JPM) or Deutsche Bank (NYSE:DB), then you should not be categorized as a commercial trader because it is obvious to anyone with an IQ greater than 20 that your primary business activity is not soybean farming.

In the past, the CFTC has stated that Commission staff may exercise judgment in re-classifying a trader if it has additional information about the trader’s use of the markets. Yet firms that are clearly not “commercial” traders have repeatedly been lumped in the “commercial” traders category for years on end to obfuscate and hide the actions of hedge funds and swap dealers. In fact, the CFTC admitted that they miscategorized the dealings of former oil hedge fund SemGroup’s activities in the futures markets for nearly an entire year. It was SemGroup’s massive shorts against oil (a figure estimated at 20% to 30% of US crude oil inventories at one point) and their short covering activity to try to negate massive losses that was primarily responsible for the last stages of oil’s rapid ascent to $147 a barrel in 2008. Yet, at the time, no one attributed this massive oil spike to speculation because the CFTC miscategorized SemGroup’s position for nearly 12 consecutive months!

So forgive me if I am not impressed by the CFTC’s removal of fraudulent elements from the weekly commitment of traders’ reports that never should have existed from day one. Given the CFTC’s past “blunders” (or cover ups, depending on how you interpret the claimed innocence of their blunders) and their repeated sidings with Wall Street lobbyists, the CFTC has a long way to go to restoring free markets and transparency to the futures markets.

I have grave reservations, given Gensler’s background, about his sincerity in establishing transparency and fairness in the futures markets. To begin, Gensler was a former partner and co-head of finance at Goldman Sachs. That’s a huge red flag in it of itself. Secondly, according to a Forbes Magazine article published just a few months ago on April 13, 2009, “numerous people familiar with [the SemGroup hedge fund failure] insist that Citibank (NYSE:C), Merrill Lynch (MER) and especially Goldman Sachs had knowledge about Semgroup’s trading positions from their vetting of an ill-fated $1.5 billion private placement deal last spring.” Due to their knowledge of SemGroup’s positions, some people familiar with this case state that not only did these firms massively profit from this data, but that perhaps some, particularly Goldman Sachs, deliberately abused this knowledge to force SemGroup into a short squeeze to earn these massive profits. Is it just a coincidence that the CFTC’s miscategorization of SemGroup’s holdings in their commitment of trader reports aptly covered the tracks of what was truly happening back then so that this story never reached the major media?

Thirdly, President Obama’s nomination of Gensler as the Chair of the CFTC was vigorously opposed by US Senator Bernie Sanders for very valid reasons. Sander’s office released a statement explaining his opposition to Gensler: Gensler “had worked with Sen. Phil Gramm and Alan Greenspan to exempt credit default swaps from regulation, which led to the collapse of AIG and has resulted in the largest taxpayer bailout in US history.” Sandler’s office also accused Gensler of working to deregulate electronic energy trading, which led to the downfall of Enron, and supporting the Gramm-Leach-Bliley Act, which allowed American banks to become “too big to fail.” – Not exactly the type of track record you want in a man responsible for reinstituting fairness to fraudulent futures markets, that at present time, act as a legalized casino for big banks to rip off the public.

Furthermore, Gensler said the CFTC is reviewing exemptions from position limits for “bona-fide hedging,” after seeking public comment on whether the exemption should continue to apply to traders who are in the market for financial reasons, rather than those that actually use the commodity. These considered exemptions do not sound promising at all. In fact, I believe this consideration is backwards. If anything, consideration for exemptions from position limits should go to those businesses that produce the commodity as their primary business activity and not to speculators.

Again, to me, it sounds like these “regulations” will end up a big smoke and mirrors game with numerous loopholes that allow massively concentrated futures positions in gold and silver markets and perhaps even in oil markets to be interpreted as “bona-fide hedging”. If you believe in the tooth fairy and Santa Clause, manipulation in US NYMEX and COMEX markets may soon come to an end, but if I were you, I wouldn’t hold my breath. In the meantime, you may write Gary Gensler at Ggensler@cftc.gov to voice your displeasure about the current legalized gaming nature of the US futures markets and to urge him to shut all existing loopholes that allow big banks to manipulate prices of agricultural, energy and precious metal commodities at will.