With all of the recent talk of the futures markets manipulating the price of XYZ commodity, I'd like to better understand the effect that futures markets, specifically the near month contract has on the cash market. For example - the oil market. Certain pundits say that there is a $5-$10-$30 premium to the "real" price in the futures market due to speculative demand. I understand how this might be true in the back months, and is not a very controversial statement to make. However, I also understand that at the time of contract expiration, all speculators will have had to rolled their exposure over to the next month by selling the current month, and buying the next. As all speculators are rolling over to the next contract, the only parties left on the bid will be physical hedgers. If there were to be a premium in the current contract, at expiration one would expect a huge sell off to the true demand/supply equilibrium. However, I am curious, given that all non-physical market participants are bidding up the back month contracts, how does this affect the spot market for the underlying? Is there any evidence that future (inflated) price of the commodity has an effect on the spot market? In other words, does an inflated back month contract exert an upward pressure on the actual spot market for a commodity?
Have you read the 'Amaranth'-report (U.S. Congress)? It focuses on nat gas trading, but it has some interesting sections on the influence between swap/futures/spot trading. Worth a read.
The Role of Market Speculation in Rising Oil and Gas Prices Excessive Speculation in the Natural Gas Market At first glance, these senate reports suggest that mechanisms in place to curb excessive speculation have not kept pace with the growth of speculative activity. IMHO,The idea that non-traditional participants (hedge funds, pension funds, endowment, etc) can manage commodity positions as a new "asset class" is questionable. EIA Oil_Market_Basics The above TOC for the EIA primer paints an basic picture of oil markets and oil trading. Clearly there are many factors which influence spot market prices. There is a web of commercial activity which moves crude oil from well head to final finished product delivery. The entire complex is driven by the relationship between key benchmark prices and futures or forward prices. We are in a situation in which is marked by both high inventory levels and high prices. This suggests we are experiencing market distortion. George Soros has written repeatedly on his "Theory of Reflexivity", which distinguishes processes that take place between "thinking participants" from other natural phenomenon. He contends that conventional economic thinking which is founded on beliefs that markets seek equilibrium is fundamentally flawed. His latest book ("The New Paradigm For Financial Markets: The Credit Crisis of 2008 And What It Means") suggests that financial markets are at the end of a 25 year "super bubble" based on what he calls "market fundamentalism". His track record speaks for itself. These oil markets clearly look like a classic boom bust cycle. I suspect Soros is much more wrong than right on his latest pronouncement of a financial market "super bubble". If the growth in commodity speculation does in fact represent an attempt by non-traditional participants (pension funds / banks / hedge funds) to play commodities as an asset class; Does a crash in commodity prices deliver the death blow to a weak and somewhat out of control global financial system? The OP has raised some valid questions. I suspect that most viewers here are interested in speculative trading. We all need to build approaches which give us advantage. The reports referenced above raise significant questions about the current functioning of oil markets (and other speculative markets as well). The recent downwave in CL is clearly driven by long liquidation based on bearish supply reports as the front month goes into delivery. It's no real surprise that oil has begun to recover from last weeks liquidation. It's interesting that the far dated contracts are no longer trading above nearby months. Traditional commodity texts suggest that backwardization in pricing reflect tight market supply. What inference can we make about underlying market conditions when we arrive at this condition because backdated contracts sell off? The underlying premise for increased back end contract speculation has been the need by non-traditional participants to hedge inflation which is being demand driven by globalization and peak oil. Are markets now anticipating new supply activities? Or are they just beginning to understand that current pricing is beginning to create demand destruction? _________________ BR, FreeMarketRider