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Blame the Fed for commodity speculation
The President of the United States has hit commodity investors. Several
Senators, the Attorney General, the CFTC and most of the other global
exchanges have joined in. I think they are all pointing fingers in the
wrong direction. It's the Federal Reserve that is behind all the
speculation of late. Let me throw out some raw numbers to make a point:
(I) Copper futures on the CME have seen average volume of 50,000
contracts a day this year. Each contract is for 25,000 pounds. Therefore
the average turnover of copper at just the CME is 570,00 tonnes. The
annual global consumption is 20mm tones so Copper futures at the CME
(alone) are equal to 5.7Xs total world consumption (200 day trading
year).
(II) CME corn futures trade at a rate that is 10Xs global consumption of 861 million tones.
(III) CME wheat turns over 5Xs global consumption.
(IV) NYMEX Crude volume is equal to trade at 5Xs total global consumption of 32 billion barrels barrels.
Let
me emphasize that these are all global commodities. There are active
exchanges in many other financial centers. There are also private
transactions. Finally, there are over-the-counter derivatives and ETFs
for all of these commodities. The average traded volume in the US
futures market(s) is an average multiple of 5-8Xs of global consumption.
The total world financial turnover is at least twice and possibly 3Xs
that which is evident from US futures data. (For example consider crude
and London ICE trading. Recent volume in crude trading at ICE is by
itself an additional 6X’s global consumption.) What this means is that a
barrel of oil is traded back and forth (mostly on paper) 15-20 times
before it is consumed. The sum of the global financial ins and outs for
just crude would be ~$60 Trillion.
The fact that commodities are traded 10-20 times their consumption is
confirmed (to me) when looking at FX global volumes. The CLS data
(interbank trading only, no futures or derivatives) shows that FX
trading is $4 T a day. That comes to $800T per year or about 13Xs total
global GDP of $62T.
Does this make sense to you? Is it necessary? Is it desirable? Is it
controllable? What’s causing it? I’ll try to answer these important
questions.
* No, it doesn't make sense. These numbers are far higher than
the historical norm. Consider this chart that shows long-term NYMEX
crude trading volume. Volume is up 200-300% versus what was happening in
2004/05.
* No, it's not necessary.
The volume that a commodity is traded is directly correlated to the
uncertainty of the price dynamics of the underlying commodity. The
higher the uncertainty the greater the volume. There is a
great deal of uncertainty today regarding the future path of commodity
prices, but there has always been uncertainty (and volatility) so I am
not convinced that the sharp increase in the volume of trading is
justified based exclusively on risk factors.
* No, it is not desirable. We have seen in just the past few
months how crude prices have performed. They raced higher, and then they
collapsed. In my opinion a great deal of the volatility was related to
increased trading and not to real changes in the underlying dynamics of
supply and demand. Higher volatility in prices results in (net) higher
prices to end-users. Consumers are paying a pretty penny for the
resulting added on risk-premium.
* Finally we come to the critical question of what's causing this?
I maintain that the increased trading and the resulting volatility in
key global commodities is the Federal Reserve. Zero interest rates (and
QE) have eliminated the cost of owning commodities to near zero. Not
only is their no financial penalty (interest expense) to finance a
physical position there is a financial incentive to participate in the
commodity market. When interest rates are zero, money will seek out a
higher return. This reality is the basis of current Fed policy. The
Fed wants people to take money from their checking and money market fund
and put it to a more useful purpose. The Fed is happy when that “useful purpose” is to buy stocks or junk bonds. The Fed and the rest of world should not be surprise that another “useful purpose” is hard assets like commodities.
Consider this review of longer-term volume in the futures markets. They all show a big jump in volume around 2008. That is ZIRP at work:
The President can yell all he wants. He can sick the Attorney General on
the players. The CFTC (and all the other exchanges) can play around
with margin rules all they like. Those Senators making a fuss are crying
to the moon. None of these steps will make a damn bit of difference.
If the President of the United States truly believes that
volatility/speculation in commodities is a problem that has reached a
critical level and that the situation requires policy response(s) he
should call Ben Bernanke and tell him to raise the Federal Funds rate to
2%. That would solve the problem as far as excess speculation goes. But it will not happen as Bernanke has his foot planted firmly on the ZIRP gas pedal.
ZIRP causes all manner of speculation. It's insane to think that
Bernanke can target this powerful force so that it only has positive
effects like boosting stocks and corporate bonds. With those pluses come some minuses.
If the country wants cheap money and strong equities it also has to have overvalued commodities and high volatility of prices.
You can’t have one, and not the other. Blame the Fed for the speculation, not the speculators who have been drawn to the light that Ben Bernanke is shining.
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LOL!
Good stuff, Bruce. Being that an uncertain number of regulars had written you off, it is great to see your "diametric" point of view. ;-)
Are you saying you want to marry my sister?
Bruce, as usual, awesome perspective!
Thank you
Great article. Those charts are amazingly clear in their indictment of monetary policy as the driver of instability in commodities.
Although, it is like saying that because the sale of alcohol is legal, we can blame the government for drunk driving.
Good analogy.
In a legal sense, one who sells too much alcohol to a drunk driver can be found liable for their actions, if the latter causes harm.
But let's take this one step further.
The Fed is a bartender and has allowed "free drinks" to all the speculators willing to participate-- doesn't matter whether the drink is beer (equity futures), vodka (bond futures) or gin & tonic (fx markets).
By curbing commodity speculators, the Fed is essentially saying no more "free drinks" for the vodka drinkers only. You speculators who drink beer, gin-- and sure-- even tequila (derivatives)-- keep on drinking away. It's just those vodka (commodity) drinkers who are the bad apples.
Just as the Fed would encourage me to get drunk from its free money, they are now encouraging me to switch drinks-- just don't drink vodka. Yet all those other drinks are just as destructive if inbibed in excess (especially the tequila).
What do you think is wrong with this picture?
Huh??? Milestones
I think it is more like saying if the government has an all day/all night drive in party every day where they give away free booze they might be responsible for some car accidents.
The drivers would still be the main party responsible for the accident
You simply have to be a typical, so-called "liberal" --- you invariably focus on and condemn the result, while being too mentally lazy to acknowledge the fundamental cause of that result.
It is the same tired story, over and over throughout history, since at least the time of Diocletian --- financially reckless, irresponsible, and omnigrasping governments blaming the "evil speculators" for economic and monetary disasters of their own design.
+1
It has become so blurred now. The hedge fund world is filled with a lot more pirates like fat Raj.
The govt, large corps, banks, hedge funds, unions and wall street are now one in the same. The Mafia are angels compared to this evil scum.
This is exactly the perspective one takes who wants to absolve what the banker-gangsters and Captains of Capital have done.
The working people who belong to unions did nothing to wreck the economy, nor have they been bailed out, nor have them in any way benefitted from the crisis caused by the banker-gangsters and those they control.
All they get is austerity.
Yet you put them on the same level as the criminals running the con.
Classic.
Banksters like Goldman should have change their logo to Skull & Crossbones.
Ha ha ha! thats like saying the lousy Thracian grain trader was responsible for Roman despotism in their hegemonic grip on the world. Grow up!
I am afraid you are not correct. I have no simpathy for both a corrupt government and a corrupt market.
I blame both the drug lords and their pushers.
the cause is the REAGANOMICS Oligarchy. Simple. Like Caesar's legions. Lets hope we don't inherit a four century of dark ages when the lights go out!
No shit! we all agree Wall St. is responsible for the mess.
But like a party of teenagers where some idiot got behind the wheel and killed all his classmates, the person supplying the alcohol (ZIRP bux) should realize that someone has to take away the car keys, or some teenager(s) will make a poor decision and start driving.
The Fed = The banker-gangsters
Not that hard to understand that the two are one in the same. After all, the organization Krasting blames (after he abstracts it from 'the speculators') are owned by shareholders.
So Central Bank and Wall St. are responsible ... good! ... now, with capital being mobile and trading happening on a global scale, there are plenty of Central Banks and trading Centers to keep the game rigged ... we are screwed!!!
You give way, way too much power to the nerdy little quant gambling with government money on commodities they couldn't identify (rice, wheat, oil).
To suggest that these useless little turds can hold the other 99.9999% of the world's population hostage without ANYONE doing ANYTHING to stop them: well, that's quite frankly absurd.
It reflects what a solipsistic dreamworld the banker-gangsters occupy, to think they - the most useless of all human beings - are irreplaceable and unstoppable.
Meanwhile, they need a servant to make toast.
No. No it isn't at all. The Fed should know what happens when it provides free money to specs, human self interest dictates money will concentrate into certain asset classes as people try to get rich. No one can be blamed for speculating and trying to get rich, it is human nature, an automatic reaction. Commodities this time, housing last time, dotcoms before that, tulips in the 17th century.
It is not human nature to want to get into a car drunk and speed around.
Yeah ... human nature ... that's why we need laws and regulation ...
anyway, the fact remain that prices do not reflect production/demand and are inflated by speculation ... human nature or not.
The world is bigger than America. Your laws and regulation cannot reach beyond America's shores.
Face it, says 'sun tzu': nothing can stop the power of the parasitical banker-gangsters.
These nerdy little gamblers living off the government dole, making leveraged bets with other people's money from behind their computer screens, control everything.
Don't even try to stop them from using a horrible economic system as a pretext to rob, rape, and pillage from people who do REAL WORK for a living.
the american oligarchy calls the tune and has started this mad stampede. They must cool it down or send their country, their country men, to the bottom of the pond. The ball lies firmly in the court of the paradigm creators, they ARE the culprits who don't want to PAY the piper.
I am afraid this post proves the exact opposite of its thesis.
If you say that prices are high because the ZIRP moey has to find a home, you are saying that prices are high because speculators, using ZIRP money, are pushing those prices higher.
I agree with you. That is why speculation should be regulated and margin increases are part of it. ZIRP money should go to help the general economy and not to wealth extraction.
Pushing on a string doesn't work
ZIRP money cannot help the general economy because it necessarily be inflationary by the FED's definition and lead to higher interest rates. Ever since the politicians and bankers "accidentally" broke the CDS, ABCP, and assorted other paper markets- they have been increasing the paper supply and hoping that it will flow to US Government paper market to hide the cost. When it instead flows into other paper markets such as Commodities or PIIGS debt, then they "intentionally" try and break the market to drive the flow to US Government paper.
You say:
ZIRP money should go to help the general economy and not to wealth extraction.
Then you say:
That is why speculation should be regulated.
You can't regulate this. It is global. It is not the CBOT. If you squeeze a portion of the market, it will show up elsewhere. You will have more volatility, not lower prices.
Take all the specs out of the market now and in one month when there is a blowup in Nigeria or Iraq or Iran crude will go up $20 in a day. The big move will be caused by the absence of liquidity, not just the news that triggered.
Kill the source, not the messengers.
now let me get this straight, lack of money causes commodities to rise $20.00 a day ???
here is my stated opinion of speculators as a class, with no apologies. to one of the specs you all idolize. traitor dan, i call him,he refers to himself as trader. he like most of you thinks the world will stop spinning if all the sagacious specs dried up and blew away. get a life.
money is the god of this world, and rothschild is his prophet. quoth benjamin disraeli.
behold a pale horse,doubt it not
dan, i could not disagree with you anymore on the supposed need for speculators. speculators are a plague on civilization and generally an unsavory class of humans. unconscionable casino gamblers and financial cut-throats that love nothing better than to profit off the human misery that is so prevalent in this world. if you are a spec, goldman sachs is your ruling demon power, that's who you have patterned you career model after. slimey,greedy,pin-striped bandits that would sell their momma for a profit.
my hard and fast rule is briefed in the following: no specs could participate in futures or options unless they are directly involved in said commodity and take delivery. no idea-sphere loop holes or work around bankster shell co.
severe punishment and hard time in the slammer for violations. no exceptions or civil penalties.
let these idle rich buy govt and corporate bonds,let them loan money @ interest to cities,states and counties to strengthen america. let them fund new corporations and worthy endeavors that would produce profits and jobs for men to feed their families. let them fund farms and food co-ops, in general be a small benefit to your country.instead of booking a trip to davos to lick some boot over their among the billionaires, and crouch down and kiss the hand that gives you your next piece of inside info.
if not let them haul their filthy donkies off of this hallowed american soil and go worship mammon in some other land. i would suggest they set up shop in some ali akbar state and see how long they can retain their heads among them.
you may have guessed by now that i hold these speculators in the lowest regard and anyone that supports them.
don't attempt to lecture poor lil ol me on the virtues of the so-called free enterprise system until you can first show me where one exists. save your breath.
in closing; SHAME ON YOU FINANCIAL AMERICA !!!
Sorry, Bruce. This is a total non-sequitur. That something is 'global' doesn't mean it is exempt in any way from regulation or taxation.
The parasitical speculators you to whom you refer here as some kind of superhuman life form just aren't that important anywhere ... other than in their own minds, at least. To suggest they are is simply wishful thinking on your part.
Government policy has enabled the parasites, first by allowing them to exist and then by handing them all the free money they need to blow up the economy. And just as the doctor who has applied the leech to someone's skin can remove it, so too can the speculators eliminated by direct action.
Once you legislate against them, what are these little quants going to do? Attack you with a computer program?
HA!
Nah. Bruce is spot-on in his assessments.
In a global market like raw commodities, both speculators and hedgers will gravitate to those markets and currencies that allow them to make their bets at the lowest cost and with the greatest leverage.
Adding layers of selective regulation (which this would be) and/or taxation would make that market incrementally less attractive to the participant.
Global it is ... different people enjoy different aspects of this rigged market (QE, excessive speculation, synthetic instruments) ... regulation on a global scale will only happen after massive global pain ....we are headed in the right direction.
So... regulation will fix all our problems eh?
Are you sure about that?
We had adequate regulation on the mortgage industry heading into this most recent financial crisis-- and a combination of the Fed, Treasury and FDIC all managed to look the other way and went lax on enforcement.
Now you have a 2,000 page behemoth of financial system regulation in the form of Dodd-Frank -- to which the Fed is handed even greater "enforcement" powers.
How do you *really* think that is going to turn out?
The big issue with 'more regulation' is that you have to entrust two parties to make the whole thing work: (1) the legislators that draft the laws; and (2) the parties that are responsible for enforcing the regulations once in place.
I see the first party paid off and owned by the financial oligarchs. I see the second party... hmmm... owned by the very same players.
Ohhhhh yeah... more regulation... will head us in the right direction.
He's saying speculators are a symptom of the underlying problem that is easy money from the Fed, and that going after specs is nothing more than naeve populism on the part of an ignorant political class.
And he of course ignores that the same people who own the Fed are the primary speculators.
Unfortunately, it isn't just an ignorant political class we have to deal with. It's also an ignorant voting class......***sigh***
The charts showing commodity volume with ZIRP tell it all! Thanks Bruce. Do you have a 6 month forecast in mind for gold, oil, the dollar and the S&P?
I'm quite certain that they will all be volatile in price.....
It is a very confusing picture (for me) at the moment. I see forces for a slowdown. I see forces that point to inflation. But those two pictures almost never merge together. For what it is worth:
Gold/oil - higher
Dollar/S&P - lower
Again... another well reasoned post, Bruce. You hardly ever disappoint.
I don't think most people really appreciate the degree and magnitude our goverment has gone into intervening into the financial markets to inluence investor behaviors.
In the most recent financial crisis, it began with curbing all those "dirty speculators" who were shorting the financial stocks in 2008 (for good reason as it turned out). That wasn't enough so...
The Fed got into the act with ZIRP and stealth monetization of the "risk free" markets. In fact, under QE1 and QE2, the Fed was very effective in driving speculators into those riskier asset classes by allowing to borrow at zero costs, and investing in anything with a decent nominal yield.
But now, it seems, that speculation stuff has gone too far becuase way too much speculative money was funneled in the global commodity complex. The governement can't allow that, you know, because it's bad for the inflation picture and all that stuff.
So instead of relying on a market driven solution, or a reversal in the free money activity that got us to this behavior-driven point-- what do we get from our caring government?
Well, of course! We get even more goverment intervention into the markets! BAZINGA!
Even better than that-- we get selective intervention-- and right now, that would be in the commodity markets. Because, as we all know, Obama thinks all those commodity speculators are "bad".
So as long as you're pushing speculative money into the "good speculator" equity markets these day-- all seems to be going well.
Just be sure to avoid shorting too much. Especially the finanicals.
Very well done article Bruce. The predictions I humbly submit are backward.
The dollar is headed north & taking bond prices with it.
Gold, silver & oil get a rest, a "time out" if you will. Sideways is not down. The DJIN will rotate spectacularly north defying Grahm & Dodd and all common sense in sympathy with the rally in the $ & T Bonds.
The inflation / debasement secret is overdone for the summer and the lemmings need to have a taste of Darwin thus supporting your analysis & postulation about overtrading in commodities .
Then the hyperinflation trade goes back to work after the dollar rally exhausts it's self probably after the kids go back to school and you get to show off your tan at a Labor Day picnic.
Thanks Bruce - always appreciate your thoughts. My own guess is the dollar will go up because interest rates will go up with the end of QE2 which will force gold, oil, and the S&P lower which will lead to QE3 (in some fashion). I think the S&P will fare worse than gold and oil though.
Nominal interest rate increases by themselves won't necessarily do squat, as was proven by the rise in the Fed funds rate from 1.0% to 5.25% between 2004 and 2006. Unless and until real interest rates go into positive territory, with the prospect of them staying there for the long term (neither of which is even hypothetically possible under the current, dying financial and monetary regimes), gold, oil, and other commodities will continue to move higher in both nominal and real terms.
Margin calls are a Temporary Fix. But little was done by the CME about raising Oil margins. A favorite of the PDs and the Banksters.
Oil Margins raised by 30%. Silver Margin raised by 230%. Goldman and the Hedge Funds dictate their book again.
Spot on. There is a strong correlation between the rise in the price of gold and negative real interest rates.
Very informative article, Bruce. Thanks.
Agree about the volatility. Also expecting it. THE BOE concurs with your view for a slowdown sees inflation at 5%, GDP at 1.7% so that looks like negative growth of 3.3% and a shrinking economy.
Short the FTSE100 at 6000 and again at 5925. Also have shorted the NAS100 at 2395 with sell orders for the DOW at 12745.
I like cash, or using it to get in and out of positions. Definitely think risk is skewed to the downside for equities and commodity currencies, but not certain about your OIL/Gold call.