Saturday, June 28, 2008

The ongoing saga of the role of speculators in the huge rise in commodities prices

One Reuters article by Russell Blinch entitled "Lawmakers' zeal versus speculators could backfire" strongly insists that the huge rise in commodities prices is solely the result of supply and demand, referring to "the real culprit behind soaring commodity prices -- American consumers' addiction to oil." Meanwhile, a second Reuters article by Matthew Robinson, Robert Campbell, Robert Gibbons, Gene Ramos, Jane Merriman, Fayen Wong and Marguerita Choy entitled "Oil hits record near $143 on rising investor flows" informs us of the reality of investment and trading money flows. The lead paragraph tells us that "a drop in global equities markets sent fresh investors into commodities." The article goes on:

"The renewed attraction of commodities as an investment vehicle is contrasting with the unattractiveness of the stock market," analysts Ritterbusch and Associates said in a research note. "As additional traders abandon the stock market, the appeal of commodities as a trading vehicle is enhanced."

This is the heart and soul of the hige price leap: "attraction of commodities as an investment vehicle" and "appeal of commodities as a trading vehicle." That captures both the players who are bidding up longer-term futures contracts and holding them (or even taking delivery as the contracts expire) and the players who are bidding up short-term futures contracts.

The article goes on:

Additional support has come from a flood of cash from new investors buying up commodities to hedge against inflation and the weak U.S. dollar, which fell further on Friday.

It does not really matter why people are speculating in commodities, but what is so curious is how so many people can act oblivious to the fact that such speculation, as referenced in the Reuters article, is happening on a daily basis and has been for the past couple of years.

The article refers to the great debate over the true role of speculation in rising commodities prices:

Some experts insist supply and demand are behind oil's record rise, while others, including OPEC, say rising flows of speculative cash are behind this year's gains.

"We believe the factors driving oil prices higher are fundamental and not speculative," Deutsche Bank said in a research note.

As far as Deutsche Bank, I would note that they have a conflict of interest and are one of the big players in the commodities markets, collecting transactional fees from clients who are speculators, as well as speculating themselves via their proprietary in-house trading desk.

As far as the overall thrust of the first article that "Lawmakers' zeal ... could backfire", I myself in fact worry that Congress will aim poorly and fail to hit the nail sqaurely on the head and miss yet another golden opportunity to reform more of Wall Street's most egregiously scandalous, but still legal "investment" schemes. The fact that Wall Street is permitted to "market" commodities as an "investment vehicle" is simply indicative of how deep the Wall Street swamp muck really is.

The problem before us is not speculation per se, but speculation which takes on a scale that overwhelms the real markets for real supply and real demand and distorts the traditional hedging strategies used by real producers and real consumers of the commodities. There is also some amount of outright market manipulation by financial speculators who "take delivery" of expiring commodities contracts. They are speculating that the commodities will continue to rise, but they are also restricting actual supply by taking those commodities off the market.

The proper, traditional role for speculators is to "fill the gap" between producers and consumers, but what we are seeing now is that the mind-boggling volume of speculative activity is in fact distorting and worsening the gap bwteeen producers and consumers.

Eventually the current "speculative bubble" in comodities will come to and end and prices will head back down towards earth, but meanwhile there is no telling how much longer speculators will continue to pump vast sums of money into commodities.

-- Jack Krupansky


At 8:58 AM EDT , Anonymous Anonymous said...

Jack, once again, a well-integrated idea that brings together industry sources to reveal an underlying truth. The run-up in commodities is another bubble that will break, but this time there is no "central commodities banker" to bail out loosers. Free markets do not always work when participants are "free" to be a herd. But, even well-intentioned lawmakers are subject to their own herd instincts as they try to fix the problem of excess, one-directional, speculation and no action may be preferable to bad action by them.


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