Commodity speculators in line of fire

By John Dizard

Published: May 25 2008 19:25 | Last updated: May 26 2008 16:19

As is well known, speculators are clearly responsible for high commodities prices. All of them are using the high profits from their market manipulation to buy yet more gold chains and magnums of champagne, though not for their long-divorced, betrayed spouses.

Fortunately, the tribunes of the people are out to stop them. Of course neither the public’s representatives nor we are attacking the innocent hedgers, who, unlike the speculators, are only seeking to protect themselves against volatility and risk of loss. They have done no wrong.

Senator Joe Lieberman, the Connecticut Democrat, last week expressed public sentiment after hearings on commodities speculation when he said he and his colleagues were “very impressed with testimony that speculation, particularly so-called index speculators, and institutional investors are having a very significant effect on dramatic increases in commodities prices . . . creating a lot of stress among average families and terrible suffering among people who are poorer”.

Well. That is a powerful statement of conviction. So powerful that it apparently cannot be affected by the US government’s own economic studies of the market effects of commodities index investors, hedgers, and speculators. The political reaction to high prices is likely to lead to legislated changes in commodities markets regulation in the US and elsewhere. I am fairly certain the changes will take effect after the coming decline in commodities prices.

I say decline because there always is one, and the late-stage political reaction suggests it is coming soon. But let’s deconstruct the premises of that political reaction.

The US Commodity Futures Trading Commission regulates public US futures exchanges, and also has some ability to examine the activities of non-exchange commodities traders, such as swaps dealers. Two weeks ago, its Office of the Chief Economist provided Congress an extensive study of the effect of commodities index funds and speculators on prices. In the oil market, specifically, the CFTC stated: “Our studies consistently find that when new information comes to the market and prices respond, it is the commercial traders [such as oil companies, utilities, airlines] that react first by adjusting their futures positions. When these commercial traders adjust their futures positions, it is speculators who are most often on the other side of the trade. Price changes that prompt hedgers to alter their futures positions attract speculators who change their positions in response.

“Simply stated, there is no evidence that position changes by speculators precede price changes for crude oil futures contracts . . . Commercial trader group positions are those found to significantly precede crude oil futures price changes.”

Furthermore, the commission’s staff found: “The recent crude oil price increases have occurred with no significant change in net speculative positions.”

This is not to say, in my view, and in the view of others I respect, that today’s oil prices reflect the economics of marginal supply and demand. There are people out there who have bought physical oil and stored it so as to sell it in the future. But the real commodities buying frenzy has been defensive buying by consumers, government stockpilers, and processors trying to protect themselves from the adverse effects of future price increases.

Eugen Weinberg, a commodities specialist with Commerzbank, who does think we are in the late stages of a bubble, says: “At the moment we have big inventories worldwide, about 3.5bn barrels in the OECD countries, which does not include China. That is enough so that if Saudi Arabia stopped exporting, the world could run at its present level of demand for a year and a half with no increases in production from other countries.”

You don’t have to buy the evil-specs-caused all this argument to believe there are problems with the way parts of the commodities markets work. As Mr Weinberg points out: “The West Texas Intermediate oil contract, based on delivery in Cushing, Oklahoma, is good for 300,000-400,000 barrels per day. The storage capacity in Cushing is about 20.5m barrels. The trading volume on which that is based is between 500m and 600m barrels per day. If you are going to manipulate the price, you would think about doing that in Cushing.”

That’s why some passive, or indexed commodities investors are diversifying the markets they use; eg using the Brent contract for North Sea oil as well as the funnel in Cushing.

What about those index longs? While they are thrown in with speculators, they don’t actively bet on short-term price moves. Nevertheless, one of the proposed components of American commodities markets reform bills are restrictions on pension funds’ holdings of commodities positions.

So are index funds taking the bread out of the mouths of Darfurian children, or, as Mr Lieberman says, “average families”? The CFTC study says: “Increased index fund positions do not lead to price increases [in agricultural products]”. Being researchers they believe more research is needed, which I think is a good idea.

johndizard@hotmail.com

Copyright The Financial Times Limited 2008

Some of them are much more good than the others, because they speculate on gold and silver which are more volatile and visible