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$50Bn of Commodity Investment at Risk?
A tax lawyer I know sent me a link to an article about a tax ruling. I’m thinking “Boring”, who cares about that? Then I read the article. A few lines jumped out:
Commodity prices could come under severe pressure if the U.S. Internal Revenue Service (IRS) decides to revoke previous rulings.
Without the tax exemption, mutual funds would have to restructure or liquidate their holdings.
The resulting liquidation would put tremendous pressure on commodity prices and reverse much of the build up of speculative money in commodity markets over the past decade.
An enormous industry has built up on a very thin legal foundation, and now it's starting to sway dangerously in the wind.
I’m no tax lawyer, so I recommend that readers draw their own conclusions about this screwy story. Link. My take:
Mutual Funds (MFs) are restricted as to their investments in commodities by a law that was established in 1936 and revised in 1954. The rules are straightforward. No mutual fund registered in the USA is allowed to own more that 10% of total assets in commodities. (There are negative tax consequences to the MFs if they exceed the limit.)
The law hurt the MFs, so they sought a way around the laws. One after another the MFs requested an exception from the Internal Revenue Service (IRS). The rulings allowed the clever MFs to set up commodity investments using derivatives. To meet the guidelines for the special tax treatment, the funds set up “sham” companies in the Cayman Islands. From the article:
These offshore shell corporations, established by mutual funds, are in every case wholly owned Cayman Island corporations. They are shells. There are no physical offices, no employees of their own, no independent operations. The mutual fund's U.S. employees run their commodities portfolios from their U.S. offices.
After 2006, the IRS issued a total of 72 Private Letter Rulings to MFs that gave the go-ahead for the MFs to investment 100% in commodities via derivatives and offshore shell companies. The IRS stopped issuing these PLRs in 2011. As of today, there are 28 requests for similar PLRs. The IRS has left these in an inbox for over a year now.
Behind this standstill at the IRS is the guiding hand of Administration. What are its objectives?
Many Democrats, including Obama, have pointed at the “evil speculators” who push up commodity prices. Any regulatory/tax changes that discouraged the speculation would, therefore, be a “positive” outcome.
Individuals who invest in commodities via mutual funds do pay taxes on any of the gains that are realized. But those gains are often deferred for years; therefore the timing of the tax receipts is also deferred. This is a disadvantageous position for a government that is running trillion dollar annual deficits.
Some thoughts on this:
-This is nuts! $50Bn of small investor money is tied up in commodity derivatives booked with offshore corporate shells to skirt existing regulations and to avoid current US taxes? And its happening with "side deals"?
-Something has to give. 72 mutual funds have permission to avoid the law (the PLRs). These entities have a “green light”, but no one else is allowed to play in this lucrative sandbox? There can’t be a carve-out for a select few. Either this is legal (confirmed by Congress), or it’s not.
-A very powerful Senator, Carl Levin, (D-Mi) is behind the effort to eliminate the mutual fund exemption (reverse the existing PLRS) for commodity investment. His words on the topic; clearly he is no fan:
"The controlled foreign corporations are corporate fictions, offshore shams, paper exercises whose sole purpose is to make an end run around the legal restrictions on commodity investments by mutual funds."
-Nothing will happen on this until well after the election. If there are no changes at the White House, and the composition of Congress remains about the same, then this issue will come up in Q1 2013.
-If Congress did vote on this, and they concluded (as per Senator Levin) that MFs should not be allowed to avoid current law via PLRs, then it could result in a fairly large hiccup in the commodity markets. A significant portion of the $50Bn now invested by MFs would have to be unwound.
-On the other hand, Congress could go in the other direction and confirm what the IRS has said in the PLRs. It could amend existing law to resolve the uncertainty. This would also create a hiccup as new money moved into the playground.
-The outcome of this has hiccup potential, but the lasting consequences would be minimal (either way). In the end, global supply and demand sets prices for commodities, not tax and regulatory issues in the US.
-If you were looking for an example of just how screwed up the system is, this might be it. We rely on 80-year old laws (that have been patched with private deals for a select few) to govern the way individuals invest. The cobbled-up system is broken; hiccups will be the result.
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Senator Levin always reminded me of the Penguin as played by Danny Devito.
http://www.glass-frog.com/wp-content/uploads/2012/05/devito-penguin_6161.jpg
If a library of Tax Code volumes were pulled from the shelves, to eradicate the cockroach loopholes, inequities, and profitable narrow exemptions.... the infestation falling from the books would completely cover the country.
All anybody would hear is crunching noises as they walked.
BK thanks again for the information/education.
we hear of all this talk on ZH of "socialist" central bank plays. It is a travesty of the english language when applied to the current power construct.
When Kings and Oligarchs use the state apparatus to rob their subjects, its not socialism, its feudalism and despotic autocracy. That central power be the instrument of tyranny is the means to an end.
When a socialist, statist government does it, it is not to concentrate the profits for a few but to spread it around for the many. It may not be an efficient system, it may morph into elitist concentration, undoubtedly, under entropy effect; but at inception, it is a different animal to Oligarchy conception...However, as time and history prove again and again; all power corrupts and statist whirlpool of Charybdis and Oligarchy rock of Scylla lead us eventually to the same result.
Being successful as Ulysses, free willed entrepreneur, man of liberty, is not easy and never has been. Its a recurrent dream that requires extreme assiduity and self effacement, to achieve the common goal of collective survival; called civilization. Only in balance of collective values and individual liberties do we find such voyage possible.
We are finding that out! The wheel of civilization brings us back to square one. Only the outer shell of material living is different, inside, the human will is still the same, warts and all.
"When a socialist, statist government does it, it is not to concentrate the profits for a few but to spread it around for the many."
I disagree. The socialist uses the coercive power of the state to take from one group and give to another. The groups can be defined in any way they see fit. The definition of the groups can change, daily, in some cases. It depends on who has bought the lawmakers that week. Through rose-tinted glasses it can appear a 'fair' system but only when you are a member of the receiving group.
"it may morph into elitist concentration, undoubtedly, under entropy effect; "
With human nature as it is, there is no 'may' about it. There is a cast iron guarantee that will happen. Someone famous said "Democracy always fails when the hordes realise they can vote themselves largesse at someon else's expense"
"but at inception, it is a different animal to Oligarchy"
Giving you the benefit of the doubt, what is the time period between inception and the reality above? If it short then does it matter, other than in ideological terms?
just look at the french revolution; I won't take you to soviet russia; that was autocracy from start.
Then we've have FDR to JFK in the USA, and there are many versions of it in Europe since WW2.
They beat the current US system any day of the week.
You decide when the system went belly up in, say Sweden or Norway. France has been downhill since 1975, slowly but surely. Like the US of A.
And, if you have an elected government, what you called "coercion" is decision by elected government; not perfect but then human beings aren't perfect. Some types of coercion are more coercion than others.
The greatest failure of these systems is that people don't participate anymore and impose accountablity by constant pressure on the elected. You know that.
And...taking from one to give to the others is making the playing field more level for coming generations so that the climb up the ladder remains accessible for all. Being a nation does require some thinking for the less fortunate; thats compassion and solidarity. Without that no nation; just self centered individuals. You know the american dream...requires that we don't treat some like they were Geronimo's sons; parked on reservations...
falak,
Thanks for your reply. However I will have to bow out of this now since I have no training or knowledge in this area and I'm too far out of my depth to form a cohesive argument.
Fund managers get paid win lose or draw so they will play dumb with the poor bastards mutual fund money knowing full well that they will be taken by the cleaners. The big boys will know far in advance what the decision will be and when it is announced the fundies will feign shock when shit plummet, fundies remove their positions at a loss and then take the opposite position in time for the big swinging pricks to drive them to the moon again. Full on ass raping will continue until moral improves.
Hahaha, when thieves of crony capitalism fall out; the government now has to get rid of all those tax perks.
In the USA and in France we see this crazy game now accelerate, as the fiscal cliff is looming and if growth disappears the fiscal pump cavitates big time.
Time to reign in all those tax perks, and if the house of cards of private sector starts "swaying in the wind", like the towering inferno, thats just too bad. Its every man for himself and may the devil...
LAnd of Caymanista dopium, oligarchy shangrila.
wtf isn't manipulated anymore. cobb fucking cobbled law structure favoring select groups.
thanks for the heads up; hope we all remember this come unwind time or non-event!
but surely this is the tip of iceberg when it comes to the wall of worry about true market value;
(of any given commodity anymore). iud's everywhere - fuckin eh...
still i'm thinkin a blow job doesn't have a gub hand involved-could be wrong...
All laws were set up for the rich. I left my last employer in 2008. I had some stock options, worth about 15K that I couldn't exercise because the stock traded on the pink sheets at the time. I asked if I could buy the shares at my strike price. I was told that the LAW said that only sophistocated investors could do this. In order to qualify, I had to have at least one million in tangible assets, which I came up short on. Not knowing when the company would finally become publicly traded again, I decided to walk away and give up the options. Turns out that about a year or so later, the company was able to relist on the stock exchange. The stock split, went up and this year sold and was taken private. I'm sure the officers who all walked away with tens of millions ended up with my lousy 25 or 30k. Choke on it you bastards!
If its a problem for the financial sector they will change the law unless it means more money to them the way it is.
Nice...So start a fire sale so that China can buy at fire sale prices. #Winning!
Bruce,
Another great article, and this is the stuff we know about...I'm willing to wager $50B is chump change compared to all the "approved" shadow banking at extreme high risk.
the picture... Obama with Danny Devito?
Doesn't that short fella have a purty mouth.
Bruce,
I know 50B seems like alot of money. Can you do a writeup on the massive "Loss Carry Forwards" that the corporations and CEO's have amassed on their K-1's over the past 5 years and what the effect on future tax revenues from their profits might be. ?
I would think that would be "many" multiples of the 50B you reference above.
Thanks in advance for your consideration !
Best scenario, those bastards in Congress say, "Fuck it. Let them invest in whatever the hell they feel like."
But this won't happen, because they want to keep their currency meaning something.
Maybe we can just say "Gold and silver are money and not commodities."
Also, what if they say no more investing in commodities, and someone sets up a numismatic mutual fund??? Not commdities any more, but instead an investment in real, collectible, shiny stuff.
Let me see if I understood that well - this is written from a Gold/Silver buyer's perspective:
1) IRS and/or Congress changes the rules and US$50bn+ exit the commodity market. Bad for commodities in the short run: prices go down as "investors" are forced to liquidate their positions or face the wrath of the IRS.
2) IRS and/or Congress keeps the rules "as-is". Good for commodities in the short and long run as "investors" keep on keeping on.
Case number 1 would be very good indeed as it would provide a buying opportunity (PMs especially) in the short run, for people located outside of the USA. Long run, I expect commodities to go back up and up and up... So, buying really quickly *after* the IRS decision would be a bargain...
Case number 2 would be business as usual, with commodities (*cough* Gold *cough*) marching upward.
Did I understood this well, or could someone enlighten me?
I would love a "hiccup" in commodity prices! bring it on! The more derivitves that get liquidated the better. Its all unbacked paper anyway. This is all Obama's fault!
not his fault at inception; his fault for not stopping it in 2009, to pull in all the derivative scams from then on.
But if he had done that it would have caved in the whole shooting match, and he didn't have the guts to take on the WS mob; especially after Paulson TArp made them full to the aces and the government boat empty to the last dime.
Whence QE and Bernanke print...the rest is history. Crony capitalism, you don't take on the FED and the PD's when you get elected in december 2008...and they exist since...1913!!!
$50B in small in small investor money...
I'll bet John Corzine needs some clean skivvies after reading that.
"In the end, global supply and demand sets prices for commodities"
Are you fucking kidding???
Bruce, I greatly respect you and generally agree with your views, but this has to be the dumbest thing you have ever written. Commodity prices are set in the derivatives casino, in order to make supply and demand levels unknown and irrelevant. Witness the Chinese re-hypothicated steel story from earlier today.
Supply and demand. How quaint. Gold, bitchez.
MFers indeed...
Potentially dumb question: What was the rationale behind the original 1936 law banning mutual funds from investing more than 10% in commodities? Neither this story nor the original Reuters piece discusses this...
Purchasing commodities is speculation. It is not investment.
Remember, the era back then understood the scary world of speculation (since they were living-the-crash). In theory, enabling demand in commodity speculation would "increase" commodity price, resulting in lower society productivity (since commodities are the basis of production).
IIRC there was a time when the only players allowed in the game were entities who could actually take possesion of the commodities. If you bought a contract you had to have the ability to take delivery.
Checking on opening a shell corp in the Caymans now..
Vanuatu
Mutual Fund investers are sheep anyway so who cares if they lose their souls?
The government wants lower commodity prices? Since when? They go ape shit when prices fall out of bed ala the natural gas space as "how else to pay for everything?" the last thing the Government wants right now is for people to actually be paying there taxes...safe havens in the Carib? The IRS will be waiting a long time for the political judgment on that one...
when commodities begin to really begin to catch fire following QE to infinity, this would be a nice way to slam them back down.
"There can’t be a carve-out for a select few. Either this is legal (confirmed by Congress), or it’s not."
Bruce, you're applying logic to government and the law. That does not work. Of course there can be laws that benefit selected individuals, companies or industries. That is the whole reason there are lobbyists. Do you doubt that if Jon Corzine was a Republican bundler he would be under indictment right now?
Maybe they'll tell Oracle they can't book tens of billions of US Sales in Luxembourg any more...LOL
+1
The only reason "large-cap" earns more than the other categories is *exactly* this protection: They get legislation that protect them from competitors.
As anyone employed by a "large-company" knows: The dis-economies of scale are fantastic. The waste. The stupidity. It's insane.
The metrics are very clear: The ROI on purchasing politicians is outstanding, actual product-and-service-development, not so much.
If I were an evildoer looking for a controlled-collapse scenario to profit from, this one looks pretty sweet.
Even without pulling the trigger, it makes for a nice political "Sword of Damocles."