Oil and Investment Banks: Wrecking economies with hedge funds

On May 20, the Senate Committee on Homeland Security & Governmental Affairs held a hearing to ask "Are Institutional Investors contributing to food and energy price inflation?" Michael Masters, managing member and portfolio manager of Masters Capital Management, says we're experiencing a "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."

Other points he made include:

* Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years.

* According to the CFTC and spot market participants, commodities futures prices are the benchmark for the prices of actual physical commodities, so when Index Speculators drive futures prices higher, the effects are felt immediately in spot prices and the real economy.

* In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels. Over the same five-year period, Index Speculators demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!

* 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.

* 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. 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.

* 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.

Pension fund managers at the hearing claimed their heavy investing in commodities is only having a minor influence on commodity prices. This flies in the face of reason, logic, and the CFTC claims that "when Index Speculators drive futures prices higher, the effects are felt immediately in spot prices and the real economy."

The CFTC - the government agency charged with regulating these markets - claims that prices of commodities aren't influenced by speculation. That would imply that commodities markets are self-regulating and that the CFTC isn't needed - so why are they being funded from public monies?

In response to suggestions made for increased regulation or increased call margins, the CFTC essentially claimed during this hearing that it's impossible to regulate all commodities trades and that increased regulation will reduce "transparency" in the markets. It must have been surreal to hear the National Farmers Union say in the same meeting: "Another example of the dysfunctional market is what happened in the cotton futures market when the price almost doubled in one day. When producers tried to market their cotton at the higher price, they were told there was no market for the physical commodity and the price collapsed shortly thereafter. We have yet to receive a satisfactory explanation from CFTC officials as to what caused this situation. Obviously it was not based upon market fundamentals and again farmers were precluded from being able to capture the higher prices."

Conclusion

Rising oil prices aren't being caused by dwindling supply, surging demand, or the devalued dollar. The physical supply is meeting the growing physical demand, and physical oil consumption is actually down in the USA due to the economy. The dollar, while losing value, has not lost 80% of it's buying power! I'm convinced the largest driving force behind rising oil - and all commodities for that matter - is speculation.

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