The Truth About Commodities, including Oil - Complete Speculation

Discussion in 'Economics' started by ByLoSellHi, May 21, 2008.

  1. Commodities Prices: Speculation Exposed
    by: Philip Davis posted on: May 21, 2008

    That was a nice dip yesterday!

    We were so well covered that we spent the day in member chat discussing World Hunger as we ho-hummed the sell-off, but we did get a little bullish towards the end of the day and started picking off some callers, looking for at least a bounce in the morning but willing to roll down or add to some of our stronger long positions.

    The most exciting thing that happened Tuesday was the testimony of Michael Masters to the Senate Committee on Homeland Security (who have sweeping powers) as he spilled the beans and gave the Senate a very detailed inside view of exactly how speculators are the primary cause of high commodity prices.

    Don't look for any commentary on this in the WSJ or most media outlets, you would think this entire investigation isn't going on as you watch CNBC wearing their Oil $130 party hats this evening!

    What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.

    With very bold categories in his presentation like "Index Speculator Demand is Driving Prices Higher" Masters lays out a simple and compelling case that illustrates how over $250Bn of speculative money has poured into the commodities markets since 2003, driving the average cost of commodities indexed up 183% WITHOUT ANY SIGNIFICANT INCREASE IN ACTUAL DEMAND.

    It's not just oil, there is a chart on page 4 of his presentation that shows how on Jan 1st 2003 sugar futures stockpiled totaled 2.3Bn pounds. On March 12th of this year, speculators had stockpiled 48Bn pounds of sugar. Soybean oil went from 163M pounds to 4.5Bn pounds, corn from 242M bushels to 2.4Bn bushels, coffee from 195M pounds to 2.4Bn pounds. wheat from 166M bushels to 1.1Bn bushels. Even cattle and hogs have had 10-fold increases in speculation. This is your "demand," 10 month supplies of commodities removed from the markets over 5 years and held by speculators who point to the "demand" as evidence of a tight supply - A TOTAL CROCK!

    Speculators "consumed" as much additional oil as China in the past 5 years (848M barrels) while gasoline stockpiles have risen from 1.1Bn gallons to 3.5Bn gallons and natural gas stored by speculators has gone up from 331M BTUs to an insane 2.3 Billion BTUs. Aluminum - 10x, Nickel - 5x, Zinc - 10x, Copper - 7x, Gold - 10x, Silver - 15x — Madness!

    In fact, Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years.

    Demand for futures contracts can only come from two sources: Physical Commodity Consumers and Speculators. Speculators include the Traditional Speculators who have always existed in the market, as well as Index speculators. Five years ago, Index Speculators were a tiny fraction of the commodities futures markets. Today, in many commodities futures markets, they are the single largest force. The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets.

    I urge you to set aside the time to read this full report, it is an excellent presentation of pretty much everything I've been "ranting" about for 2 years put together by a guy who trades commodities for a living and is, as I am, totally fed up with the destruction of our economy and the suffering that is being caused by this rampant commodity speculation. In order for Goldman Sacks to make $1Bn, every driver on Earth needs to pay another $1 per gallon for gas this year - is that an efficient market? If all 2Bn of us just send GS a check for .50, THAT would be efficient. Unfortunately, as we discussed last week, Goldman's partners in crime who got together and formed the ICE back in 2003 (when all this started) also want their Billions - no matter what it costs you.

    One particularly troubling aspect of Index Speculator demand is that it actually increases the more prices increase. This explains the accelerating rate at which commodity futures prices (and actual commodity prices) are increasing. Rising prices attract more Index Speculators, whose tendency is to increase their allocation as prices rise. So their profit-motivated demand for futures is the inverse of what you would expect from price-sensitive consumer behavior.

    When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets.

    Masters closes with the key issue, that:

    The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.

    The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with a Wall Street bank and then the bank buys $500 million worth of Wheat futures. In the CFTC's classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as "Commercial" rather than "Non-Commercial." The result is a gross distortion in data that effectively hides the full impact of Index Speculation.

    Additionally, the CFTC has recently proposed that Index Speculators be exempt from all position limits, thereby throwing the door open for unlimited Index Speculator "investment." The CFTC has even gone so far as to issue press releases on their website touting studies they commissioned showing that commodities futures make good additions to Institutional Investors' portfolios.

    This is how the current administration, through the "Enron Loophole" and other directives to the CTFC, has perverted an organization that is supposed to be CONTROLLING speculation and turned them into more than an enabler, but an actual cheerleader for the commodity markets. You would think this would be news but the same people who are sucking over $2Tn a year out of our pockets (over and above what we paid for the same commodities 5 years ago) are also the people who control the mainstream media and the very government that is listening to this testimony.

    In order to put a stop to this YOU have to act. YOU have to get mad, YOU have to tell people what is happening because no one else is doing it are they? Feel free to copy this, Email it, print flyers - whatever - this is something that needs to be talked about and what better time than the day oil hits $130 a barrel while you drive less than you did last year, when it was $51.03 in January!
  2. By the way, if anyone can refute or dispute the numbers or information in the article posted above, I'd genuinely love to hear it.
  3. Let's assume that all of the numbers set forth in the article are true. So what? Where's the proof that all this speculation is what is actually behind the increasing prices in oil for example?

    I notice the article left some important information out. For instance, are you aware that the world's largest population is China....1.3 Billion people? And that in 2006 only 1 in 100 people owned a car? In the US, 9 out of 10 people own a car? In 2008, there will be something like 10 million cars sold in China. Most of these are first time purchases...people that rode bicycles. And everyone one of them adds incrementally to the demand for oil and gasoline.

    India has a population of 1.1 Billion people. According to some numbers I've read, car sales in India should triple by 2015. More demand for oil and gasoline.

    As both China and India move more toward industrialized economies, not only is there demand for more gasoline for the car, there's more demand for ALL of the energy that an industrialized country would need.

    Hopefully I don't need to paint the picture farther. There is a huge demand for EVERYTHING related to commodities from countries like China and India. All part of globalization in case you haven't heard.

    Now, where do you suppose that fits with the picture of rising commodity prices?

    I suppose it should be obvious that the US is only a portion of the energy pie. You think the CFTC controls all of that? You think the speculative demand for things like oil ends just because Congress passes a law, or the CFTC does something? Geezuz, get real.

    But just to review, Congress has successfully restricted drilling for oil in places like Anwar, off both coasts, off Florida. Some of these are estimated to be huge fields. But now Congress would like to point their finger at "speculators" instead of themselves. And funny enough, they got a few non-thinkers to go along with them.

    Congress passed another law regarding ethanol. That created additional demand for corn, which went thru the roof. Then when farmers saw what they could get for corn, they stopped growing things like wheat and soybeans. So they went through the roof.

    Yeah.....those nasty speculators eh?

    In fact, no new refineries in decades. Why? Environmental restrictions. No new nuclear plants. Etc etc etc. This is called the chickens come home to roost.

    I suggest some of you guys spend some time educating yourself about the laws of supply and demand.

  4. So, if I understand you correctly, you are adopting a 'let current prices settle around where demand would fix them 20 or 30 years from now' view?

    I always thought supply/demand curves should reside along a track something more akin to real time.

    Maybe I'm just naive. If so, I should rush out and buy that new BMW M3 I've had my eye on because I can get it for about 68k now, and it may cost over 1 million USD in 2026.
  5. This is all I hear about why commodity prices are on a parabolic move. Right, cause we're using twice as much oil as we did just a year ago?

    No one is arguing oil shouldn't be higher than in previous years, but to be up 100% in a year or so? To be up about 50% since February? If that isn't speculation, I don't know what is.

    Same argument in the 70s. This is a bubble inflated with easy money injected into the system across the globe, plain and simple.
  6. My post was just to point out that there's a whole lot more to the current commodity markets than speculation. Anyone who believes that is truly naive.

    My recommendation would be to allow prices to go wherever they're going. Instead of Congress wasting time trying to figure out who they can blame for high oil prices, maybe they ought to get to work repealing some of the restrictions we have in this country that are hampering energy production. During this entire run up, they've done literally nothing.

    Now, perhaps you would like to "end" speculation. That ends the ability of hedgers to protect themselves because they can't lay their risk off on speculators. And, it will do nothing to change the price of energy, because energy is trading around the world, not just in the US. ICE is just one example. ICE currently trades WTI and Brent. Neither are under the auspices of the CFTC. Now, perhaps what you would like is to ban trading in the US. You think that would change prices? It doesn't change Chinese demand, Indian demand, or in general, world wide demand. All it does is destroy yet one more US industry, and transport it overseas. Yeah, that's a great idea.

  7. Daal


    "Global Food Price Inflation to continue in 2008 as US wheat stocks projected to fall to 60-year low; Asia high food demand growth to continue"

    speculators are doing the world a favor by creating incentives to increasing the amount of inventories, plus the price increases now will prevent MASSIVE price increases in the future when the supply and demand get seriously out of whack. I have presented evidence again and again but you dont seem to be interested on that, looks like your trying to stroke your own ego as a the resident warrior rather than get to the facts
  8. Daal


    "In 1989,worldwide arable land was 1.6 billion acres. It’s 1.6 billion acres today. On top of this, inventories for corn, wheat, and soybean are near 40-year lows. Other soft commodities like cotton, sugar and coffee are at historically low inventories too. And thanks to a Congress that doesn’t understand economics, more and more farmland in the U.S. is being devoted to biofuels. This year one third of all U.S. corn production will go towards ethanol."

    I can hear the bears saying that the land is more productive and you dont as much to feed the world, well they are wrong, in order to get that productivity they need more fertilizers, pesticides, etc, all of which the price is soaring. you will blame that price increase on manipulation of oil and natural gas, well turns out that there a tons of people in the oil industry who disagree with you, plus that fact that demand is currently bigger than supply right now should at very least make you question your own views(whether you believe in peak oil or not is irrelanvant) the fact is that the market is tight right now, period(as shown by declining OECD stocks)
  9. buyLowSellHi,
    what do you think is the best way to profit from a decline in oil prices other than futures contracts?

    I am looking at put options on some instruments but I am worried that the implied volatility has become too pumped up.
  10. dont


    BuyLowSellHi asked if anyone could refute the numbers I take it they can't?
    #10     May 22, 2008