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Speculators blamed for gas and food prices { May 2008 } Original Source Link: (May no longer be active)
http://www.iht.com/articles/2008/06/12/business/speculate.phphttp://www.iht.com/articles/2008/06/12/business/speculate.php
Crackdown urged on speculation in commodities markets
By Diana B. Henriques
Published: June 12, 200
In Washington, financial speculators have a fat target on their backs.
They are being blamed for high gasoline prices, soaring grocery bills and volatile commodity markets, and lawmakers are lashing out at market regulators for not cracking down on them more vigorously.
"You study it, but you don't act against this incredible increase in speculation," Senator Carl Levin complained to a senior official of the Commodity Futures Trading Commission at a recent Senate hearing. "Unless the CFTC is going to act against speculation, we don't have a cop on the beat."
Just this week, Senator Joe Lieberman, the Connecticut independent, said he was working on a proposal to ban large institutional investors from the commodity markets entirely. The same day, the administration of President George W. Bush approved another Senate proposal for the creation of a federal interagency task force to investigate commodity speculation. At least four public hearings have explored the topic in just the past two months, and Lieberman has scheduled another session on June 24.
This escalating rhetoric against speculators is starting to worry people with years of knowledge about how commodity markets work. Because without speculators, they note, these markets simply do not work at all.
Speculators, people willing to risk their capital in search of high profits, are so central to healthy commodity markets, they say, that the broad-brush restrictions now being considered could inadvertently damage a market that is already under pressure from rising global demand for food and fuel.
Even in Washington, there is widespread agreement that no single factor is responsible for rising food and energy prices. The hungry, high-growth economies of India and China are fundamentally affecting worldwide demand, while uncooperative weather, and government policies on trade and ethanol, are among the many factors affecting supply.
And commodities, priced in dollars, tend to rise in price as the dollar weakens, making commodities a haven for investors fearful of future inflation.
But beneath all these external factors is the simple see-saw of the marketplace: For every person trying to buy oil at $130 a barrel, there must be another person willing to sell at that price - and, odds are, one of them will be a speculator, taking a risk in hopes of profiting from the next big price move.
But with tempers rising along with food and fuel prices, some market scholars are concerned that speculation, the legal pursuit of market profits, is becoming a synonym for manipulation - secret and collusive trading activity aimed at deliberately moving prices to produce illegal profits.
Certainly, there have been unusual price spikes in commodity markets, like the short, sharp roller-coaster ride that hit the cotton market in early March and the more recent gyrations in the oil markets, that have alarmed some market participants.
While commodity market regulators regularly scan markets for manipulative behavior, they took the unusual step in recent weeks of publicly confirming that they were conducting investigations looking for illegal activity in both the energy and agricultural markets.
"Concern about manipulation is not misplaced," said Patrick Westhoff, an economist at the Food and Agricultural Policy Research Institute of the University of Missouri. "But speculation doesn't equal manipulation, and I am concerned that there's been a confusion between the two concepts."
The scene of the speculation that is alarming Washington is the commodity futures market, which trades a financial derivative called a futures contract, an agreement for the future delivery of a fixed amount of a commodity at a certain price. The prices at which these futures contracts change hands are the benchmark for pricing commodities around the world.
In essence, speculators are the only voluntary players in the commodity futures markets. They could use their billions to dabble in currency markets or buy distressed real estate or pile up Treasury bonds. But farmers, miners, oil producers and all the other players engaged in commodity production and consumption - the so-called "commercial" players - pretty much have to be there. There just are not many other places they can hedge the price risks that arise in their commodity-based businesses.
So speculators become the ballast in the market, making the contrary trades, taking on the risks the hedgers want to shed, reacting quickly when news jolts the markets and, most importantly, creating liquidity by pouring in enough money to allow everyone to make very large trades quickly without causing wild price swings.
In the past five years, hundreds of billions of dollars have flowed into the commodity futures markets both from traditional institutions - hedge funds, pension funds and investment-bank trading desks, for example - and from the newer commodity-linked index funds and exchange traded funds, which track various commodity market indexes.
Critics - including Michael Masters, a portfolio manager whose testimony last month in Washington strongly influenced Lieberman's views - complain that these new investors are piling in only on the "buy" side, thereby tilting the market toward higher prices.
The actual picture is more complex, said Paul Horsnell, a managing director and head of commodity research at Barclays Capital in London. Many index funds constantly adjust their positions to maintain a fixed percentage of their portfolio in commodities, he explained. Thus, a pension fund that wants to put no more than 2 percent of its assets in commodities would have to sell some of its stake when its value rises above that percentage limit.
"So, as in other markets, index funds are stabilizing forces because when the asset goes up in value, they sell some to put their portfolios back into balance," he said.
But the sheer size of the money flowing into commodity futures has become the most important fact about it.
According to Barclays research, about $200 billion in managed assets were invested in commodities at the end of 2007 - up from barely measurable levels just seven years ago.
He noted that this entire investment stake was dwarfed by the amount of money financial institutions have invested in, say, Exxon. But the commodities markets are much smaller than the equities markets, Masters noted during Senate testimony last month. For these markets, this flood of new capital is a once-in-a-lifetime occurrence.
Senator Carl Levin, a Democrat of Michigan, said lawmakers knew that markets needed speculators, but were using "speculation" simply as shorthand for their real target of concern, which was "excessive speculation."
But while U.S law orders commodity market regulators to prevent "excessive speculation," the law does not define the term - and neither has Congress. "That's what regulators are for," Levin said. "It's up to them to put some flesh on that term."
Lieberman disagreed, saying Congress must clarify the standard for regulators to enforce.
America must not hang a sign on its commodity markets saying "no speculators allowed," he said. "There is a difference between speculation and excessive speculation." But Congress has to "define and legislate that definition better," he added. "We can't just say, as Justice Potter Stewart once said of pornography, that we know it when we see it."
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