June, 2008:- For some time Marketpredict.com has distanced itself from the crowd and has listened to veteran traders and analysts. They have warned about the dangers of massive speculative flows into the relatively small & illiquid commodity markets.
With oil over $130 a barrel and sky high agricultural prices causing untold misery in the poor global communities, governments, regulators and central bankers are at last beginning to listen.They are starting to open their minds to an effective giant Ponzi scheme. It is drawing pension fund managers and other suckers into the so called commodity asset class.
Our aim is to spread the message that commodity index speculation, hedge fund greed and the blatant stupidity of pension fund and other investor lemmings are further dangers to the global financial system and economy. The commodity bubble will implode. The only questions are when and the extent of the consequences.
Comments on both sides of the debate are welcome. Those who wish to contribute, please email comments of not more than 200 words toneil@marketpredict.com . We reserve the right to edit the copy.
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To start off the blog we suggest that you read the following pieces:-
London Metals Exchange Chief’s bubble justification backfires
Oil manipulation investigations could burst commodity bubble
Raise margins and tighten bank loans to end energy & food inflation
Food, energy and raw materials inflation to deflate
Pension & hedge fund commodity holdings soar
Regulators probe alleged collusion & manipulation in commodities
Peak oil supplies – the contrary view
Historic examples of Crowd Madness
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COMMENTS
Proposed solutions to end the commodities crisis
by Steven Spencer, Traderight (Commodity Trading Advisor)
In the current furore surrounding oil prices and the inflationary spiral that has seen global prices for foodstuffs rise sharply over the past few months, a major point has been missed or dismissed.
All physical commodity prices – that is commodities that are actually shipped for consumption – for which there is a terminal market somewhere in the world, are priced basis the price of that terminal market.
For some months or even years major financial institutions, many of whom have suffered massive losses in the recent credit crunch, have been selling the concept of Exchange Traded Funds and Commodity Indices to unsophisticated and inexperienced retail investors. The asset bubble thus created is reminiscent of the technology stock boom and subsequent bust. These uninformed speculators are buying because the price is rising, and they are buying everything that has a price, from cotton to freight futures. The fact that their activity sets the price of the futures markets and thus directly influences the price of commodities has been deliberately ignored in the funds’ quest for new business.
Solutions to the problem
Central banks need to raise reserve requirements on their cash-strapped banks to avoid a second crisis when the commodity bubble bursts.
Secondly they must persuade commodity markets to raise margins for speculative clients through the brokers that hold their accounts by 5% every day for 20 trading days until the full price of the commodity is paid. That would prevent the unlimited speculation ‘on margin’ that characterised the Great Crash of 1929.
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Editor’s comment
Several veteran traders have been warning about this for sometime. They include Steven Spencer of Traderight (above) & David Threlkeld of Resolved Inc who both issued warnings well ahead of the $3 billion Sumitomo copper fraud in 1996. Simon Hunt Strategic Services on the ground investigations in China and elsewhere have also shown that there are hidden speculative stocks. Hunt, a long time metals analyst & economist, is extremely critical of current consensus analyses of metal markets.
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Those who believe that speculators are not big force in commodities market
Barclays Capital view
Commodity investments at the end of the first quarter 2008 amounted to $225 billion. Paul Horsnell of Barclays contends that this inflow “is very modest”. Commodity index investment has received a thoroughly undeserved focus in the search for scapegoats for higher oil prices, he maintains.
David Wighton, The Times Business Editor
Hedge fund managers are being called to account for their latest crime – high oil prices. Never mind the fact that global oil production is sputtering while demand from the developing world soars. Never mind the fact that official US figures show that speculative bets on rising oil prices actually peaked last July – while oil prices reached their historic high of $135 only last week.
It would be naive to suggest that there is no manipulation. In a market this size, that would be unlikely. Yet it is precisely the size of the market that is the point. The $32 trillion global crude oil market is so big and so liquid that anything more than the most marginal “manipulation” of prices would be beyond even the mightiest hedge fund heavyweights.
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Counter arguments
Steven Spencer, Traderight (Commodity Trading Advisor)
Until journalists and the media in general – never mind politicians and academics – understand two things, the commodity bubble will continue.
First, the position of the US regulators in allowing hedging by banks against their ETF and other OTC speculative commodity swaps to be treated as commercial transactions in CFTC stats.
Second, the fact that ALL commodities for which a terminal market exists, and is used as a reference price, are priced basis that terminal market. It doesn’t matter whether the physical volume is 100, 1000 or a million times bigger than the traded volume on the terminal market.
Marketpredict.com Editor
David Wighton’s analysis is faulty on several counts:
1) The foreign exchange market is far more liquid than oil trade, yet investment and speculative flows drive rates, not foreign trade.
2) Oil and other commodities are open to manipulation because they are relatively illiquid compared with forex and bond markets. Note the following: The open position on WTI crude oil on NYMEX in New York was 2.8 million contracts at the end of May 2008. This is equivalent to 2.8 billion barrels of long and short positions worth $356 billion. The massive size compares with around 780,000 contracts in June 2005.
3) Exchange trading excludes the vast commodity swap dealings of hedge funds and commodity index products on the over-the-counter market (OTC). Banks and commodity brokers issue swaps to “investors” purchasing CRB, GSCI and other index products. According to the Bank For International Settlements, the notional value of OTC commodity swaps and other derivatives was $9 trillion at the end of December 2007. This compares with $1.4 trillion in 2004. The majority of these derivatives relate to oil and other energy products.
4) The latest International Energy Agency report shows that there is no shortage of oil. In March global oil supplies of around 87.3 million barrels a day, were marginally more than physical demand, which fell during the month. Global oil inventories of Organisation For Economic Cooperation & Development (OECD) nations amounted to 4.1 billion barrels of oil, equivalent to 83 days demand. This includes government strategic stockpiles of around 1.5 billion barrels. In terms of an IEA agreement, strategic stocks cannot be used to counter speculation.
5) Yes, there is some justification for price increases. Total world oil demand has risen by 7.5% since 2002. China’s crude oil demand is up from 6.3% of global demand in 2002 to the current 9%. This justifies an increase in oil prices from the depressed $19 a barrel in 2002, but not to the recent peak of $135.
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Here’s a piece, published in the Infovest21 hedge fund newsletter, showing that consultants are at last beginning to worry about the effective speculative takeover of the commodity markets:-
Index speculators and hedge funds fueling energy and agricultural price surge
The entry of new financial or speculative investors into global commodities markets is fueling the dramatic run-up in prices, according to Greenwich Associates.
In particular, long-only index speculators, notably pension funds, hedge funds, banks and individuals have poured multi-billions into commodity swaps. In testifying before the Senate, Michael Masters of Masters Capital Management, a long/short equity hedge fund manager, stated that Congress and the CFTC should tighten rules to curb this speculation. Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008. The prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years, he calculates.
Greenwich reveals that more than one-third of investors in commodities have been active in these markets for less than three years, and more than one in 10 say they started investing in OTC commodity derivatives within the past 12 months. The main participants are pension funds, European banks that are using commodity derivatives to structure retail investment products and hedge funds.
Around the world, “investors” in commodities are most active in index swaps and plain vanilla non-index commodity swaps. Nearly 45% of participating investors say they invest in index swaps and 39% say they use plain vanilla non-index commodity swaps. About one-quarter use OTC commodity options and 21% use structured notes with commodity underlyings. “In general, fund managers and pension funds are more likely to invest in index options, while banks are more likely to use single-commodity swaps and structured notes,” says Greenwich Associates consultant Woody Canaday.
Between 20-30% of the speculators are active in OTC derivatives in oil and natural gas. 15-20% use OTC derivatives in base metals and precious metals, and just under 10% use OTC derivatives in electricity. Goldman Sachs and Morgan Stanley are the most active dealers servicing this trade.