Commodity Speculation, Monetary Policy and “Temporary Inflation”
I am no particular fan or regular reader of zerohedge.com. I prefer to engage in debate under my own name than to fire off polemics under a pseudonym (especially those referencing the movie “Fight Club,” despite the latter’s status as a modern day cultural icon). And, really, does a blog need its own “manifesto?” But I digress.
Nevertheless, a friend (and fellow economonitor blogger) passed on to me a “Tyler Durden” zerohedge piece on a report that was released by the Commodities Futures Trading Commission (CFTC) yesterday that has resonated with me. I have, for no reason other than offering credit where credit is due, re-posted the zerohedge piece below, in italics, and then added my own thoughts and relevant source links following. Please read on:
Daytraders Account For Over 90% Of Volume, Price Formation In ES, Crude, Gold And Silver Futures
Submitted by Tyler Durden on 07/05/2011 19:49
The CFTC has just released two new reports looking at volume in various commodity futures and confirming what most have already known, namely that under 10% of daily futures volume in the most popular products comes from Large Trader position changes. The balance or well over 90% in most cases, originates from “daytrading” accounts, or said simply, speculators dominate price formation on the margin for the bulk of products, which also means that longer-term equilibrium levels, those determined by supply and demand, are largely washed out when all the daytrading, and thus short-term pricing, mania is factored in. This also explains why moves such as the recent desperate SPR release by the IEA are generally doomed to failure. The CFTC’s Gary Gensler said that “The data shows that, in many cases, less than 20 percent of average daily trading volume results in traders changing their net long or net short all-futures- combined positions.
The balance of trading is due to day trading or trading in calendar spreads.” This is bad news for the hedging departments of commodity firms which deal with actual physical, and thus try to hedge price swings, as long-term price expectations are largely moot when attempting to predict short and medium-term price fluctuations. In fact, bets, even correct ones, may ultimately add to price volatility if caught in a wrong-way position that faces collateral requirements. As to whether this new data will change the administration’s approach to artificially setting prices on key political commodities such as oil and precious metal, all signs point to no [DA Note: The prior sentence is gratuitous and somewhat senseless in context - if the market is dominated by a bunch of speculators, then shaking them out of the market would seem to make all the economic sense in the world - if one ignores the fact that another government policy (QE) may have set the speculation into hyperdrive to begin with!].
This also means that churning HFT parasites, which are part of the non-Large trader universe are likely the most determining marginal price determinants for the bulk of commodities,and yes, that includes ES and interest rate products as well.
Specifically, the CFTC said that Large Trader Net positions account for the following daily futures volume:
• Crude Oil: 5.5%
• Gasoline: 9.9%
• Gold: 11%
• Silver: 7.7%
• Copper: 10.6%
• Platinum: 26.6%
• Palladium: 30.3%
To determine the daytrading impact on price formation for the above, subtract the % above from 1. Again, this should not be a surprise for most. What should, however, is that when it comes to far more critical instruments, such as interest rate futures: 2, 5 and 10 Year Treasury are only 18.5%, 11.5% and 9.5% traded by non-daytraders. And the few remaining non-vacuum tube based organisms who care about stocks, will be happy to note that contracts such as the ES and ED are only traded 8.2% and 10.4% by Large Traders.
Since the foregoing is a completely new data set, further analysis is needed – but the implications seem clear to me at least preliminarily, as follows.
You can only evaluate changes in this over broad periods (as settlement and expiration date issues muddy the waters intra quarter and potentially somewhat even more broadly). But, frankly, consider whether you ever thought the numbers were this skewed? I didn’t. Perhaps I am naïve.
Still, historical comparisons are needed in order to detect changes in Large Trader Net Positions during periods of easy and tigher money. My firm would encourage the CFTC to undertake additional historical analysis.
I don’t think that one can deny, however, that speculative trading in these markets has an impact on physical commodity prices in the short term, particularly in non-agricultural commodities. And since we experienced two of what I have referred to as “bubblettes” in the commodity space (particularly oil) during two periods in which ZIRP and other easing have made tradeable positions in non-income producing investments very cheap to carry, I don’t see how there isn’t a connection between these short term bubblettes and the CFTC data.
Certainly, over the long term, none of this matters as the laws of supply and demand eventually burst bubbles. But as to the impact on the real economy, short term speculation-fueled increases in gas prices, for example, to over 4 bucks, appear to take a toll – an unpleasant consequence of desperately trying to reflate the U.S. economy through extraordinary monetary policy.
I continue to believe, therefore, that there is a pronounced connection between super cheap money, (especially when available in excess to those pledging tradeable positions as collateral or leveraged by the futures markets) and physical commodity prices.
This is data worth spending some time with. It offers a potential rebuke to Ben Bernanke’s statement, in his last press conference, to the effect that speculation does not have a material impact on commodity inflation. This is a debate that has been ongoing for decades, but it certainly seems as though you can’t de-link reflationary monetary policy from commodity prices that cease to reflect long term fundamentals in supply and demand – and then recalibrate when monetary pump slows.
Moreover I suspect that my old friend Gary Gensler, the CFTC Chairman, has an agenda in publishing it for the first time…..he’s in a fierce battle with Congress over the nature of re-regulation of the futures and derivatives markets.
I’ve known this guy for 30 some odd years and he’s one of few completely intellectually-honest leaders in Washington (of the Sheila Bair model, to illustrate by example). Gary recognized years ago that his earlier views on matters he is now responsible for (dating from over a dozen years ago, I might add, during Clinton), together with market abuses and the failure of self-regulation, have placed markets, economies and governments in great danger. How many active government officials in technical areas like this are dispassionate enough to reverse their own earlier biases?
Maybe I myself am biased by where/who this data is coming from, but it bears some serious examination.
The CFTC press release is here
The CFTC report and data link is here
A summary of the data in a two-page pdf is here
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