free html hit counter Peak Oil Debunked: 340. TIME TO STRANGLE THE SPECULATORS

Saturday, March 15, 2008

340. TIME TO STRANGLE THE SPECULATORS

It's getting clearer by the day that commodities are the next bubble -- the successor of the NASDAQ and housing bubbles. All the signs are there: vertical takeoff of all commodities simultaneously, massive piling on by hedge funds and J6Ps, talk of a "New Era" where prices will never come down.

As usual, the bubble(s) are being primed with fraud. Here's a couple of enlightening talks by Frank Veneroso on rampant market manipulation and cornering in the base metal markets.

Address to Global Central Bankers at the World Bank(pdf)
PPI summer 2007 roundtable(pdf)

It's not clear what useful social function is being served by hedge funds with massive leverage trampling all over small markets in essential commodities like metals, oil and food -- billionaire investment clubs turning a tidy profit on the backs of the world's poor.
When it comes to oil, Pickens is not often wrong. He has pocketed more than $1 billion (£493m) in each of the past two years by making big bets on rising oil prices, say Wall Street sources.Source
You know who paid Boone that $2 billion? You did, at the pump. And that's just the frost on the tip of the iceberg. You know what Boone did to earn that money? Nothing except sit on his bony ass. It's welfare for billionaire parasites.

Here's a helpful hint on how to strangle the speculators:
Oil prices will continue to rise, insists Verleger, who compares the rise in oil to the accompanying rise in silver prices during the 1980s oil crisis, which is mirrored by the rush to commodities today. CalPERS, the California retirement fund for state employees, is increasing its investment in commodities, notes Verleger, from $450 million to $7.2 billion. This will mean an additional 36,000 crude futures to the fund's portfolio. The push on these futures is also reminiscent of silver, he says.

Silver's rise was ended by government intervention, when Fed chairman Paul Volker asked banks to stop lending to investors buying commodities. "I suspect the continued rise in oil prices will be broken only when the Federal Reserve, CFTC, NYMEX and ICE take similar actions. To be specific, I expect to see prices fall when the central bank orders banks not to lend to hedge funds to purchase commodities."
This sounds like a great idea. And since the banks are over a barrel right now, this would be a great time to "encourage" them to pull the plug on the hot money surging into commodities.

But why stop there? All these commodity markets, from base metals to agriculturals, are small markets, ripe for manipulation by massively leveraged big players. So I think we need a much stronger enforcement presence on the LME, NYMEX, grain exchanges etc. The Feds and the CFTC need to be crawling all over the exchanges, sticking a periscope up everybody's ass, looking for collusion, cornering, squeezes, squirreling and all the usual species of commodity fraud. The enforcement agencies also need to start taking down names and numbers of every person involved in the futures and ETF markets, in preparation for confiscatory windfall taxes.
by JD

36 Comments:

At Sunday, March 16, 2008 at 3:20:00 AM PDT, Blogger JD said...

anon,
Thanks for the comment. I deleted it because I want to have a serious discussion on this issue, and I don't want to have a bunch of anonymous posters.

EVERYONE: PLEASE SIGN IN WITH A NAME OF SOME SORT. Thanks. JD

 
At Sunday, March 16, 2008 at 5:59:00 AM PDT, Anonymous Europacific said...

The skyrocketing commodity prices have to do with massive infusion of liquidity by the Fed since 2001, particularly - i.e. by the debasing of the dollar by the Federal Reserve. Why? To sustain massive consumption fuelled by cheap credit.

Would commodity prices have not risen without Fed induced inflation? Yes but not by as much.

The Fed is the real problem, not the speculators. To argue that massive markets like those for oil can be manipulated by a bunch of hedge funds is utter poppycock. Oil has risen 11 fold against the dollar but only 2.5 fold against gold. It is the dollar that is the problem. And it will get much much worse.

If commodity prices really were being manipulated, wheat farmers would have raked in a fortune. Instead, they are suffering losses even at these prices. So prices will go even higher.

http://money.cnn.com/video/#/video/news/2008/03/07/news.harlow.minnesota.final.cnnmoney

Read Peter Schiff’s Crash Proof:

http://www.amazon.com/Crash-Proof-Economic-Collapse-Sonberg/dp/0470043601

And if you think this analysis is wrong, also consider that the dollar has plummeted to record lows against the Euro, the Swiss Franc and the Japanese Yen. It is not just falling in relation to oil. The dollar is in free fall - and given the current state of the US banking system, it is highly unlikely that the Fed will raise interest rates.

Hey, if you wish to screw the speculators all you have to do is raise interest rates massively. This is what Volcker did in 1981 and the price of gold went from $870 and ounce to $253 an ounce. So why don't they do it? Because there is so much bad debt on the books of the banks that if they did, a good many US banks would go under - like Bear Stearns.

 
At Sunday, March 16, 2008 at 10:12:00 AM PDT, Anonymous Bob Wallace said...

"Oil has risen 11 fold against the dollar but only 2.5 fold against gold. It is the dollar that is the problem."

I fail to grasp the logic in this statement. Is it not possible that people are paying inordinate prices for gold? Gold speculators, one might call them.

--

"If commodity prices really were being manipulated, wheat farmers would have raked in a fortune. Instead, they are suffering losses even at these prices."

That logic doesn't hold. There's a chain of wheat ownership from the field to your mouth.

Just because wheat farmers are not filling their silos with greenbacks doesn't mean that someone in the chain isn't making a killing.

Might be the trucking companies hauling the grain. Might be the storage silos. Might be the bakeries. One needs to look at where the big bucks are being made along the chain.

My money is on the temporary owners who are buying at reasonable prices in sufficient amounts to jack prices as they sell it along.

I think we could call them speculators.

--

We're highly unlikely to increase interest rates for quite some time.

We need readily available capital in order to get the economy growing again. Right now private money is running scared* and the Fed is going to have to make that money availble via inexpensive loans.

To not do so might through us into a depression as happened in the first half of the 20th century.

(* If you wish to guage the amount of private money fear take a look at the price of gold and commodities. Private money is buying tangibles, not investing in businesses/banks which they feel might fail during these turbulent times.)

 
At Sunday, March 16, 2008 at 11:28:00 AM PDT, Anonymous Europacific said...

Your comment does not explain why the US Dollar is not only tumbling in relation to commodities but also in relation to other currencies. There is probably not a currency on earth that has lost value in relation to the US Dollar in the last five years.

If commodity prices are being manipulated, why is the Dollar also falling against a whole range of currencies? Or is everything being manipulated?

It is interesting that people are willing to clutch on to any straw they can find for high commodity prices: the price of EVERY commodity is being manipulated by sepculators! But hey, while one needs to come up with elaborate explanations of how hundreds of hedge funds can manipulate commodity prices, we do know that the price of the US DOllar is manipulated all the time - by the Federal Reserve.

It has been my fear from the beginning that people will simply fail to grasp the root of the problem and we will end up with "solutions" that are far worse.

"We need readily available capital in order to get the economy growing again. Right now private money is running scared* and the Fed is going to have to make that money availble via inexpensive loans."

You can't have ultra-low interest rates and gigantic amounts of money pumped into the global economy and also have low commodity prices (and then blame the speculators for it). As long as the Fed keeps printing excess money at this rate, commodity prices will keep going up.

Every time the Fed creates a bubble by printing excess money (the tech bubble being an example), and that bubble bursts, they create another bubble - in housing this time. In the end, the Fed's injections of money could end up causing hyperinflation and a run on the dollar. That could trigger a US economic collapse that would take a decade to recover from.

It is a dangerous tactic. They should have allowed the recession in 2001 to run its course. It would have been tough medicine but the economy would have emerged from it stronger. Instead, they artifically created growth by stimulating demand with cheap debt (and this showed up in the GDP figures as "growth"). One day we will end up paying a very heavy price for this. After Bear Stearns, if there was a run on a few more banks, the whole system could collapse, even with all the injections of cheap credit. It won't be pretty to watch.

 
At Sunday, March 16, 2008 at 11:42:00 AM PDT, Anonymous europacific said...

Check this out:

http://www.youtube.com/watch?v=6NvjrfC6i0I

 
At Sunday, March 16, 2008 at 11:59:00 AM PDT, Anonymous europacific said...

Sorry, one last comment - don't want to monopolise comments on the blog.

But this link to the video about the rapidly expanding money supply is educational:

http://www.youtube.com/watch?v=kRCiA-gy4ds

It is a chilling projection of what is to come.

 
At Sunday, March 16, 2008 at 12:19:00 PM PDT, Anonymous Bob Wallace said...

You seem to be focused on the Fed as the sole evil doer in the current situation.

I fail to see how the Fed contributed significantly to the current problem with housing.

The housing problem is largely a result of bad mortgage practices and low mortgage rates.

Financial institutions made risky loans to people who couldn't really afford them. And some engaged in delayed usury. They made loans that people could afford for the first few years and then built in rate adjustments that could not be afforded.

(Should people have read the fine print? Sure. But when one starts dealing with the portion of the population that can barely afford a low rate mortgage, one is not always dealing with the financial astute.)

Low mortgage rates brought a lot of speculators into the market. "Flippers".

Low mortgage rates caused people to choose to upgrade to more expensive houses, taking on more debt with the assumption that equities would continue to rise, thus covering their gamble.

When the big rate adjustments hit the fan the result was lots of abandoned/reclaimed units.

The flippers were left hanging with properties that we're going to return their investment and were going to be cash drains.

Individual home owners were left holding mortgages that were significantly higher than their equity.

Should the Fed (or some other agency) have exercised more control over the developing mortgage problem?

Sure. But isn't hindsight a wonderful thing? Find a way to bottle it and we can prevent future problems where greed gets ahead of common sense.

When we finish the current gold/oil/grain bubble there are going to be people with holes in their pockets.

I know people who got on the silver ride up to $80 an ounce back in the '80s. Sure way to get rich.

Their retirement money went away.

There will be similar losers when gold drops back to historical levels and "smart" money moves to more lucrative investments.

 
At Monday, March 17, 2008 at 3:11:00 AM PDT, Anonymous Mark said...

^^^ LOL


Everybody is a central planner.

 
At Monday, March 17, 2008 at 3:41:00 AM PDT, Blogger JD said...

europacific,
Welcome to POD. You're misreading what I wrote. I did not claim that all commodities markets are being manipulated. Some certainly are, and evidence of that is presented in the articles by Veneroso I linked to.
I am claiming that commodities are now being swamped by a tidal wave of money fleeing stocks, bonds, the dollar etc. This is essentially the same money which swamped the NASDAQ during the dotcom bubble. Commodities as a whole are not being manipulated. They're simply the latest hot investing fad.
The problem is that many of these markets are small, and some deal with absolutely essential products like food. Sure, we can do a "tulip mania" in the wheat market, with hedge funds, pension funds, sovereign wealth funds, ETFs etc. etc. crawling over each other to jack up the price of wheat in a speculative frenzy. This is what I am questioning. Doing a "greater fool" pile-on in the tulip market or dotcom market is fairly harmless, and I don't have problem with that. Doing a "greater fool" pile-on in the food market is obviously not in the best interests of the society at large. What's your take on that issue? Should profiteering through speculation be allowed to the point of starving people? That's the core issue I want to talk about.

 
At Monday, March 17, 2008 at 12:19:00 PM PDT, Blogger bc said...

Firstly, I am not convinced that speculation in "paper" futures markets does in fact affect the value of the underlying commodity. Futures are really akin to betting, you match a trade/bet with someone else, so when you win they lose. Neither of you actually buys or sells the commodity. If Pickens did make billions on oil, then money came from all those people who shorted oil, not people paying at the pump.

Where markets are affected by trading, I am in two minds. On one hand, a lot of obscenely fat cats get fatter, for apparently no work. That just doesn't seem good on any level. On hand #2, speculation does perform a useful function, by adding liquidity to the market.

While current supply and demand set the current price, futures markets bring in future expected supply and demand and factor it into the current price. This should effectively allow future price signals to be brought forward and acted upon earlier.

In the specific case of food, if future shortages are expected, rising prices should encourage producers to plan for increasing supply. This type of negative feedback should bring stability.

I say should, because unfortunately when you combine speculation seems to acquire a herd behavior. Like water sloshing around on the deck of a ship, instead of stabilising the ship, it causes greater swings until the ship is at risk of capsizing.

The economy is one of those systems that even with a few simple rules develops chaotic behavior. You can't really tinker with the edges and hop to fix it. This is what lawmakers and administrators continually try to do, but always fail, because the chaos comes from the interaction of the whole system.

The part that seems to cause a lot of the chaos is the allowance of debt. Making lending illegal would help, but this stifles growth, and hands advantage to competing economies that allow debt.

Intriguingly, in the past many cultures have viewed debt as very negative, and those cultures had much more stable economies, although there are other factors. Taking huge loans as a normal method of business is very modern thing.

There are also human factors involved which always tend to subvert whatever controls are put in place, because of the advantage gained. The people who control the system are inevitably subverted by the system they wish to control.

It may well be that the economy merely reflects the underlying boom and bust tendency of human societies. Either way, I think we have to resign ourselves to the fact that the economy will always be variable.

 
At Monday, March 17, 2008 at 1:39:00 PM PDT, Anonymous europacific said...

JD,

Thanks. I should say I am a big fan of this blog and I confess that I am a speculator myself - although a small player by any measure.

First a disclaimer: I am simply posting as a fan of Peter Schiff. I do not represent Euro Pacific Capital - but their site has a wealth of valuable information.

I see what you are saying but I think we have a chicken or egg problem. The reason there was so much money sloshing around in the NASDAQ and now in commodities is because there is too much money sloshing around generally (i.e. too much liquidity). Excessive liquidity encourages massive speculation.

HOWEVER, leaving excess liquidity aside, speculators are a necessary part of the market for a number of reasons. I am somewhat surprised that speculators are being fingered because when prices of all commodities plummeted in the 1980s, no one was fingering speculators.

Aside from the fact that speculation is a necessary and healthy aspect of capitalism, speculators provide, as bc points out very helpfully, liquidity to the commodity markets. Also, higher prices are a good thing - because they do act as a spur to production. Note that metals like Nickel have plunged nearly 40 percent since last year because the price spikes encouraged greater exploration.

We may dislike higher food prices but without higher prices, farmers will not produce more and if they don't produce more, we will have shortages.

But I don't think the price of food is currently all that high. There is a lot of monetary inflation in the system - this is skewing all prices and making it appear as though prices have gone up in real terms. As I said before, if prices were unjustifiably high, farmers would be making decent margins. However, as things stand, they are not.

If we accept that oil supplies are currently tight and if we accept that food production as it currently stands does depend on oil inputs, higher oil and natural gas prices will lead to higher food prices.

There is something perverse about the Fed writing $30 billion checks to bail out Bear Stearns and Americans paying $4 a gallon for gasoline. And trust me, it isn't because Pickens pocketed $1 billion as a hedge fund manager but because the Fed has pumped trillions of excess liquidity in the system since 2001 that you have $4 gasoline.

Eventually Americans are going to have to question if they can run an economy on such astronomical levels of personal debt, with zero savings and such high levels of consumption not backed by production - because it is this cycle of consumption and debt that causes the Fed to pump cheap money (they have no choice in the matter) into the system. And if they pump easy money into the system, prices rocket upwards.

Lastly, in my own defence, I would say that I work hard and save money for the future and I will not allow the government through direct and indirect taxation (i.e. inflation) to simply eat away my savings so that some high paid morons on Wall Street can go scot free. This is what it boils down to. The Fed will print trillions to save the necks of the Banks because the Banks took massive gambles which they should not have taken (and this was encouraged by the Fed's easy money policies).

The investment in commodities is a way of preserving your wealth. Right now we have a severe inflationary cycle in progress. Why sit and watch while 20 percent of your savings is destroyed by inflation each year? I wont stand for that. So I pick commodities that offer good value (right now that would be things like cotton and sugarcane) and speculate on prices. As things stand, equities are in a severe bear market and will be for many more years to come (except for the stocks of the oil majors - but thats for some other time). Bonds are a joke with inflation running in double digits and interest rates at 3 percent. So where do you put your money and where do you invest it? Letting the central bank and the politicians plunder my savings through force and stealth is not an option for me.

 
At Monday, March 17, 2008 at 1:43:00 PM PDT, Anonymous europacific said...

Check this out:

http://www.moneyweek.com/file/43698/us-rate-cuts-will-push-oil-up-to-120.html

 
At Monday, March 17, 2008 at 1:47:00 PM PDT, Blogger bc said...

Just to clarify, when I say debt/lending is bad, I really mean the system of fractional reserve banking, and other schemes that allow "leveraging" of money. When unchecked these lead to cycles of debt and collapse.

 
At Monday, March 17, 2008 at 2:37:00 PM PDT, Anonymous Europacific said...

Jim Rogers on Fed money printing:

http://video.google.co.uk/videoplay?docid=-1610793020716668352&q=jim+Rogers&pr=goog-sl

 
At Monday, March 17, 2008 at 3:41:00 PM PDT, Anonymous fugeguy said...

Why....is oil so high?

"Ghost Dance
By John Michael Greer

A comment during a discussion of the fossil fuel energy crisis reminded me that we've been missing an important factor in what's going on now, especially among those people who insist there's got to be some source of energy to maintain current levels of consumption as the oil wells run dry. It's a thing that happens fairly often when people get into a situation where strategies that were once successful no longer work.

Case in point: my Lakota ancestors, in the 1860s and 1870s, found themselves in a world where the old rules no longer worked. The Wasi'chu ("greedy ones" is the Lakota name for white Americans) were busily wiping out the buffalo and carving up the open plains into farmland. Lakota culture, however brilliantly suited it was to the pre-contact environment, didn't have the tools to cope with a harsh new reality.

I don't know if there's anything they could have done that would have worked. Political and military unification of the Plains tribes, hardball dealings with the Confederacy and the English in Canada to get arms and equipment during the Civil War, or simply a mass flight across the border into Canadian territory... who knows? As it happened, though, they didn't do any of these.

What they did instead was the Ghost Dance. They convinced themselves, with the help of a Paiute prophet named Wovoka, that if they did certain ritual dances, the buffalo would come back, the Wasi'chu would go away, and everything would be just the way it had been.

It's important not to misunderstand what was going on here. The Lakota were relying on a familiar cultural resource, which (in Wasi'chu language) we might as well call magic. Magic is severely underrated as a technology. It may not do much to the physical world, but it has very powerful, proven effects on how people think, act, and experience the world. Like people in most traditional cultures, the Lakota used it systematically and efficiently to keep their society running smoothly, and they had a lot of experience with it.

The problem was that nothing on Earth -- and certainly not magic -- could make things the way they had been. The buffalo were gone or going, the Wasi'chu were here, and all the dancing in the world wasn't going to alter those facts. So they poured their remaining energy into the Ghost Dance, doing nothing at all to help an increasingly desperate situation, and danced their way straight to Wounded Knee.

This sort of thinking -- using the old strategies to face new challenges, even when the former are hopelessly inadequate for the latter -- is very common. There's a sociological classic titled "When Prophecy Fails", by Leon Festinger et al., that shows how the failure of a model actually makes people cling to the model even harder. It's easier to deny the evidence of your senses, in other words, than it is to admit that you were wrong.

It seems to me that this is the driving force behind the insistence that "there's got to be more oil out there," as well as behind the alternative energy schemes -- renewables, fission, fusion, or what have you -- when these claim to be able to replace oil and permit us to keep on chugging along in business-as-usual mode. These are the modern, technologically up-to-date equivalents of Wovoka's visions. They all insist that things can be exactly the way they once were, if we just use our familiar cultural tools (in this case, our science and technology) in the ritually correct way.

No doubt as the energy crisis worsens, we'll see more concrete manifestations of this sort of Ghost Dancing -- huge, expensive, and much-ballyhooed programs to build new power plants, mine oil shale (even at a net loss of energy), expand research programs into fusion, and so on and so forth. This is the way we've done things in the past, and even though most of these projects will make matters worse rather than better -- if only by using up irreplaceable energy resources -- we'll probably keep doing them all the way to our equivalent of Wounded Knee.

The problem is that all the construction projects in the world can't get away from the fact that infinite growth on a finite (and rather small) planet is a guaranteed recipe for disaster. Unless we deal with that, abandon a growth-based way of life, and rein in our lifestyles to the point that they can be supported on sustainable resources, nothing we do is going to make much difference. Even if nuclear energy proponents are right and we can keep on growing for another hundred years on breeder reactors, that will simply delay the final result ... and possibly not by much. (Energy limits are not the only limits to growth we are facing, after all.)

But people aren't likely to see that. The more the current pro-growth, pro-wasting-energy worldview is disproved by events, the more desperately people will cling to it, and the more effort they'll put into trying to dance the oil wells back. It's tragic and rather stupid, but it's also very human."

-- Ghost Dance Page

 
At Monday, March 17, 2008 at 4:16:00 PM PDT, Anonymous europacific said...

The dollar plummets to 96 against the Yen:

http://www.bloomberg.com/apps/news?pid=20601101&sid=arAw2TUhgslk&refer=japan

 
At Monday, March 17, 2008 at 4:17:00 PM PDT, Anonymous DocDoom said...

The same permabears that argued that housing prices were "obviously" inflated are now arguing that commodities aren't.

The evidence for housing price inflation was generally a parabolic chart showing how prices had gone up 20% annually over a few years, sometimes coupled with an argument that incomes hadn't kept up.

Yet for some reason charts of commodity prices that are parabolic, where in many cases prices are up 20% in a few months, and once again incomes aren't keeping up, are somehow not relevant?

Commodities, even important ones like food and energy, aren't everything the average person consumes. You can't simply use them, or even a basket of them, as a perfect proxy for inflation. Commodities are subject to supply/demand imbalances, and I think it's clear that supplies are tight relative to demand, hence prices have been in a long-term uptrend. This uptrend is/was going to continue so long as the supply/demand situation is unchanged. Is this "inflation" in the monetary sense or just freshman economics at work?

Now, I think a good argument could be made that some component of current energy prices, especially the last $20 or so of the move in oil, are due to a combination of monetary inflation, or more precisely a fear thereof, and speculation. The federal reserve's interest-rate cuts have left investors with the prospect of negative real returns in fixed-income investments, at least in the USA. Arguably, after-tax returns were negative even before the cuts - is it any wonder America's savings rate is below zero? Government tax and inflation policy punishes savings and rewards consumption, and we are getting predictable results.

With negative real returns in fixed-income, and huge negative returns in stocks, hot money has been driven to the one asset class that is still showing an uptrending chart - commodities. If supplies were abundant, the underlying trend would not be there to attract the hot money.

Now, is the fact that hot money has moved to commodities "proof" that fed-created inflation is "responsible"? Oil went up from $85 to $110 in two months - that's an annualized rate of 470%. It's true that the fed's policy is inflating our currency, but 470%?!? I think at most you can say that inflationary fed policy has helped triggered the next asset bubble, this time in stuff the average person buys every day. (Except gold - it has relatively few commerical uses, and fewer still if non-essential items like jewelry are discounted; most of the demand comes from investment.)

It is interesting that bulls choose to look over the 2000s period, and not look at the terrible performance of many commodities such as gold and oil during the 1980s and 1990s. This is a common problem with analyzing price movements, the bias created by selection of a basis year. I would argue that commodities were seriously undervalued in the late 1990s, especially oil at $10/bbl. At least some of the recent move is due to reversion to mean.

As to the windfall profits proposal, that doesn't seem reasonable to me. The ability to opt out of fiat currencies around the world is one of the few protections we citizens have against their confiscation of hard-earned wealth. Commodities markets are very well-regulated. I agree that tightening the margin requirements might take some of the speculation out of these markets. Markets have a way of self-correcting, so the goal should be to prevent a broader financial collapse triggered by an (unlikely IMO) implosion of commodities prices.

 
At Monday, March 17, 2008 at 5:40:00 PM PDT, Blogger dc said...

"It's not clear what useful social function is being served by hedge funds with massive leverage trampling all over small markets in essential."

I agree with you. They've crowded out the individual investor by destroying the concept of efficient markets. A few funds have an enormous sway over many of the markets.

I gave up dabbling in equities and commodities in 06 when investing became akin to reading tea leaves.

 
At Monday, March 17, 2008 at 6:15:00 PM PDT, Blogger JD said...

bc wrote: Firstly, I am not convinced that speculation in "paper" futures markets does in fact affect the value of the underlying commodity. Futures are really akin to betting, you match a trade/bet with someone else, so when you win they lose. Neither of you actually buys or sells the commodity.

bc, I believe you are mistaken. If buying and selling of the actual physical products does not transpire on the exchange, then where does it occur? In 2008, two-thirds of the oil contracts held on the NYMEX are held by commercial traders -- producers or consumers of oil.Source

According to the NYMEX: "A futures contract is a legally binding obligation for the holder of the contract to buy or sell a particular commodity at a specific price and location at a specific date in the future."Source
That doesn't sound like pure paper. The commodity must be transacted for the contract to be fulfilled.

NYMEX also clearly states that the traders on the exchange set the price you pay:
"The prices quoted for transactions on the Exchange (NYMEX) are the basis for the prices that people throughout the United States and in many other countries pay for crude oil, heating oil, gasoline, natural gas, propane, electricity, coal, gold, silver, platinum, palladium, copper, and aluminum. "Source

 
At Tuesday, March 18, 2008 at 5:46:00 AM PDT, Anonymous fugeguy said...

New world phase.

Let's say I bought 1000 shares of Bearn Sterns (henceforth refered to as BS) at 50 dollars a share.

That is $50,000.

Now JP Morgan is buying the shares at $2 a piece or a $48,000 loss for me.

What if I do not want to sell?

If JP will pay $2 for BS then maybe I think it is worth more but apparently my contract as a shareholder has no meaning and those in power get to do what they want. Now that used to be BS but apparently no longer.

There is also talk of rewriting the terms of mortgages. Great if you are a bank or other institution who pawned off bad loans as AAA debt- thus avoiding getting sued into oblivion. Or if you are a homeowner who took on to much debt.

But what if I'm a saver and I hold that paper? More BS.

The world is changing and contract terms, property rights and ownership shall be at the pleasure of the powerful....

-- Get It Ghost Dancers? --

 
At Tuesday, March 18, 2008 at 10:39:00 AM PDT, Anonymous Bob Wallace said...

"Now JP Morgan is buying the shares at $2 a piece or a $48,000 loss for me.

What if I do not want to sell?"

I suppose you (collective owners) could have held on to your stock in a company whose debt exceeded its equity by over 25 times (IIRC).

You could have ridden that pony completely to ground and lost the last $2.

 
At Tuesday, March 18, 2008 at 12:08:00 PM PDT, Blogger bc said...

The "Ghost Dance" story is flawed in many respects, but would require a lengthy reply to go over, and would be somewhat off topic. I'll just say that science is utterly different to spirits.

JD: Ok, I think you have mostly convinced me. Despite what the NYMEX sites says, some futures can be settled for cash and not physical delivery. (wikipedia.
This is how speculators are able to play the market, they buy (or sell) but don't take delivery.

However, the fact that dealers use spot prices for trades means that the exchange price does influence the price in the physical market. I understand that producers like Saudi Arabia use WTI as a guide price, then add discounts as they wish, to account for business conditions.

I'm not sure it's possible or desirable to eliminate speculators completely. The problem comes back to leveraging problem I referred before, which in the futures markets is occurs by people buying on margin. Effectively you borrow money based on the value of the asset. This means a lot of borrowed money is used to influence prices. If you stopped people borrowing money to buy assets, that would largely remove the problem of commodity bubbles, but is that a practical option?

On the oil price, a large part of the current high is weakness of the dollar, which is likely to worsen.

 
At Tuesday, March 18, 2008 at 12:50:00 PM PDT, Anonymous Uf Mcguf said...

Some of the doomers at the PO.com keep pointing to a diesel shortage being the main culprit to rising oil prices. Does anybody here believe this is the case and that it's not so much because of the declining dollar?

 
At Tuesday, March 18, 2008 at 6:22:00 PM PDT, Anonymous fugeguy said...

bc,

Cornucopian coward.

You have no science that says "Y" has any chance to replace oil. This is and has always been the point and is why you choose to not respond.

The only energy source that has a chance to be next big thing is fusion and the French whose actual cowardice amazingly exceeds your intellectual cowardice are in charge of its development. I would not bet the future of mankind on that one.

If Bear is only worth 2 bucks why did it go up so much today? As an investor it is my choice and I will always just my own judgment of the stroke of the bureaucrats pen or the lash of a would be master.

As an encore why don't you tell me why I am too dumb to understand how Kilo v. New London was good for me too?

-- Keep Ghost Dancing –

P.S. Please look up allegory in Wiki before responding.

P.S.S. Entropy up and enthalpy down- deal with it.

 
At Tuesday, March 18, 2008 at 10:32:00 PM PDT, Blogger juan said...

Silver's extreme rise in 1980 was a classic corner the the Hunt Bros. had built up.

What we've been seeing in commodities is not quite the same, not a manipulation as such, but more to do with so-called investors, including very large financial institutions, search for higher returns, which partially explains why the rise began when it did and why there have been rotations within it.

But this sort of thing develops a self-fulfilling quality as momentum builds. All types of justifying stories are found/produced in the effort to perpetuate what became increasingly one-way bets.

Someone mentioned that every buy is also a sale but this is static and fails to take account of the large rise in total quantity and the bidding process within this.

Then there is the common misperception that futures contract prices are set by arms length supply/demand exchange of the physical commodity when it is much more the contrary, with the futures trade setting the price for the physical.

A relatively short clip from Robert Mabro's 2005 paper The International Oil Price Regime Origins, Rationale and Assessment might help:

"On certain occasions the optimistic view that futures markets cannot be squeezed has proved to be wrong. But one has to admit that the incidence of squeezes is much less frequent in futures than physical markets. The optimistic view that futures markets are transparent is only partially true. ...

These are not the main objections however.

The economic price of a commodity, a good or a service is the price that arises from the interaction of the supply of and the demand for this commodity, good or service in a market where sellers and (buyers) offer and (purchase) them. The market may be competitive or more likely suffer from some degree of imperfection. Concentration on the supply side usually restricts the volumes on offer but the price that emerges is still the result of an interaction between these volumes and the demand curve. ...

In oil, the price of a physical barrel in international trade is linked very closely to that of a futures contract. As always this price results from the interaction of supply and demand; but of the supply and demand for the item that is transacted on a futures exchange, which is a futures contract and not a physical barrel of oil.

The determinants of a transaction in the futures market include, of course, expectations about developments in the supply of, and demand for oil. In that sense there is a relationship with the physical oil world, but not to actual conditions at given points in time. It is expectations that matter as would be to some extent, but only to some extent, the case in a physical market. (The point is that in a physical market the buyer purchases a commodity, good or service because it has a place in his/her consumption or investment plans but purchases are sometimes also made or deferred in response to expectations about changes in prices or other supply conditions. In a futures market the trader will buy or sell not because he/she has a physical need for the item but entirely on the basis of expectations about subsequent price movements.)

There are other determinants for transactions on futures markets that are not related to the oil situation. This is because the futures oil contract is a financial instrument held by many economic agents (particularly hedge funds, banks, other financial institutions) in a portfolio of various financial instruments. One aim is to optimise the composition of the portfolio. Funds move in or out of a financial market, be it oil, bonds, foreign exchange etc. etc., depending on relative expectations. ..."

(Mabro, The Journal of Energy Literature, Volume XI, No1, June 2005)

Or from Matt Simmons, January 1998:

Effectively, the changing perceptions of a small handful of speculators now appear to set the price for West Texas Intermediate crude oil...

[...]

For all those that fervently believe price movement always reflects fundamental changes in physical markets, the discussion in this paper bears careful reading. Our work strongly suggests that large swings in the funds’ net position in oil contracts on the NYMEX have driven virtually every significant movement of crude oil since the MG position was unwound in early 1994. The single exception was a brief period in the fall of 1996 when physical tightness in the market itself set the price of oil.

(Simmons, Is Another “MG” At Work? (Or, What is Driving Down the Price of Oil?), 1998)

It would, you know, be interesting to see what would happen if all buyers and sellers had to take and make delivery of the physical. I suspect the price would be very much lower, but this old method would introduce other problems.

 
At Tuesday, March 18, 2008 at 10:44:00 PM PDT, Blogger juan said...

JD,

Contracts can, and generally are, cash settled or rolled. The trade can be physical but in almost all cases is not.

 
At Tuesday, March 18, 2008 at 11:15:00 PM PDT, Blogger JD said...

juan,
Nice comments. Very interesting. You say the contracts can be rolled, but let me ask you a question. Suppose, for example, that I enter a futures contract which gives me the obligation to purchase 1000 barrels of oil in 2010 at $100 a barrel. The counterparty has an obligation to sell on those terms.
Now, 2010 rolls around, and oil is at (say) $200. What's the scenario where that contract does not get exercised (by someone)? If oil is at $200, then a contract allowing you to buy it at $100 is a godsend for an oil consumer. So why wouldn't the party make the counterparty deliver the physical oil at that price?

 
At Tuesday, March 18, 2008 at 11:35:00 PM PDT, Blogger dc said...

I concur with bc. Speculators provide the market with signals. The problem is when they do it from absurdly-leveraged positions.

I think that economists would do well to base regulation on some analogue of risk management, particularly as it applies to catastrophes (i.e. low probability, high pain events).

 
At Wednesday, March 19, 2008 at 2:26:00 AM PDT, Anonymous Anonymous said...

Thank you for deleting my anonymous post. As I suspected you are like most of the other bloggers. When the truth gets too close to home just delete it. It is a revealing act that lowered my estimation of you.

Thanks again for revealing your true character.

 
At Wednesday, March 19, 2008 at 2:42:00 AM PDT, Blogger JD said...

Anonymous,
I had no opinion either way on your comment. In fact, I welcomed it as a constructive contribution to the conversation. I deleted it because we can't have a coherent conversation when there are 15 different people posting with the name anonymous. Please sign in next time. Otherwise I will delete you.
Thanks, JD

 
At Wednesday, March 19, 2008 at 7:02:00 AM PDT, Anonymous Drew said...

Anonymous & JD,

Actually, you don't have to sign in or anything to post a comment. I got sick of my anonymous comments getting mixed with others, so I clicked the "Name/URL" choice and it allowed me to enter a unique name. You can still be anonymous, but identifiable!

 
At Wednesday, March 19, 2008 at 8:10:00 AM PDT, Anonymous DocDoom said...

If oil is at $200, then a contract allowing you to buy it at $100 is a godsend for an oil consumer. So why wouldn't the party make the counterparty deliver the physical oil at that price?

For a percentage of contracts that will actually happen. But most likely the contract will be closed out. If you are the buyer of that contract (say, an airline hedging your fuel costs) you don't actually want the crude. You'll want to sell the contract back at a huge profit and then use the money to buy jet fuel. If you are the seller of that contract (say, an oil producer looking to lock in a price to hedge the cost of a new project), you may still buy the contract back to close it as the date draws nearer since you'll basically get (net of the loss on the contract) the same money selling the physical on the spot market. I'm not sure what percentage of contracts actually result in physical deliveries. I've always thought that physical deliveries took place through specific company-to-company arrangements, e.g. a refiner like Vallero has contracts (the kind that involve lawyers, not the that are traded) with, say, PeMex, for delivery of crude in quantities at regular intervals. Both Vallero and PeMex can then go and hedge themselves in the liquid, publically traded markets. (Note: just a made-up example, I have no idea if Vallero buys oil from PeMex.)

 
At Wednesday, March 19, 2008 at 8:40:00 AM PDT, Blogger Fernando said...

JD

"Suppose, for example, that I enter a futures contract which gives me the obligation to purchase 1000 barrels of oil in 2010 at $100 a barrel. The counterparty has an obligation to sell on those terms."

Because this is just a bet.

I bet that oil is going to be X by t, you bet that is going to be Y by t. Everyday you and I put/remove some money from the pool until we reach t.

This example is for a bilateral negotiation. In general it is multilateral with some organization (i.e. NYSE) working as a middle man that warranties all the transactions.

Futures, options are not "fundamental" but they are negotiable nevertheless.

 
At Wednesday, March 19, 2008 at 1:34:00 PM PDT, Blogger juan said...

JD asks: >So why wouldn't the party make the counterparty deliver the physical oil at that price?<

Simply because, as Mabro noted, it is not about the physical crude but price differentials and these can be/are cash settled in most all cases.

I've tried to explain this in other venues for years and it's amazing how few seem able to grasp the obvious, I guess because most have never been in the oil business or even the paper trade but, instead, go with MSM's mythologies, which has seemed particularly the case for those who insist upon using price rise as proof of scarcity.

The trade can be but need not be physical. To which I'll add that it has increasingly been taking place in Over The Counter markets which are extremely obscure.

All of the above has been known for a long time but folks are persistent in their unfounded beliefs, esp. when these beliefs are part of a larger constellation.

 
At Thursday, March 20, 2008 at 2:01:00 AM PDT, Blogger JD said...

Docdoom, fernando and juan:

Thanks for helping me get up to speed on this topic. :-)

The IMF supports what you say: only 5% of futures contracts are actually delivered as physical product. Source

On the other hand, this would seem to negate much of the distinction between commercial and non-commercial players. If not much physical oil is being sold, then virtually everyone is speculating. The IMF also notes that "Furthermore, the distinction between commercial and non-commercial traders is increasingly blurred as non-commercial traders may enter into swap arrangements in which commercial traders act as their agent." So the hedge funds etc. have another figleaf to cover their operations.

I guess now I've got the opposite question. If 95% of contracts don't result in delivery of the physical, then why are the contracts written as obligations to deliver the physical? It seems superfluous. Why not just run the whole operation on a cash basis, as a casino betting on oil prices?

 
At Thursday, March 20, 2008 at 7:04:00 AM PDT, Anonymous DocDoom said...

Can't answer that last question - possibly there is some legal reason relating to how the transactions are regulated. Indeed some new products for small investors are designed just as you've suggested, as straight-up bets on commodities but which are technically/legally debt instruments.

I don't think you can say that just because most contracts are closed without physical delivery that therefore most of the market is "speculation". As in my examples, commercial actors use the market to "hedge" (a way of insuring against a move in price during a time frame of relevance). This is the reason commodities futures markets originally were created, so that someone "in the business" could transfer some risk to another who presumably was in a better position to bear the risk.

 

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