cij.inspiriting.com/?p=455
Imagine you are standing in a typical petrol station in 1974 on a typical day (there was an oil shock in 1973). This is what you may see back then: Cars queued for hours to get petrol in 1974 Now, imagine you get sucked into a time warp and time-travelled to today on 2008. This is what you may see: A typical petrol station in 2008 So, let's say a passer-by told you that petrol price had doubled more than 2 times over the past 2 years, would you laugh at the passer-by?
The Problem that can throw us back into the age of horse-drawn carriages, there are good reasons why the oil price rose over the past decade. In fact, this is true for commodities in general (eg base metals, food).
Example of a secular trend- commodities and the upcoming rise of a potential superpower, there are good reasons for this. Already, we are hearing of food riots in the Middle East and Asia. Yet, strangely, these upward price movements seem unreal.
Here, let us zoom into the testimony of Michael Masters, who is the Managing Member and Portfolio Manager, Masters Capital Management, LLC. As our reader Zoo said, "It seems it is the testimony of Michael Masters, a hedge fund manager, which made all the Senators sit up and take notice (sic)." This is Michael Masters' introduction in his testimony: Good morning and thank you, Mr Chairman and Members of the Committee, for the invitation to speak to you today. This is a topic that I care deeply about, and I appreciate the chance to share what I have discovered. I have been successfully managing a long-short equity hedge fund for over 12 years and I have extensive contacts on Wall Street and within the hedge fund community. It's important that you know that I am not currently involved in trading the commodities futures markets. I am not representing any corporate, financial, or lobby organizations. I am speaking with you today as a concerned citizen whose professional background has given me insight into a situation that I believe is negatively affecting the US economy. While some in my profession might be disappointed that I am presenting this testimony to Congress, I feel that it is the right thing to do. You have asked the question "Are Institutional Investors contributing to food and energy price inflation?" Unlike many mainstream financial commentators, Michael Masters did not fluffed around with the "on-the-other-hand" and "having-said-that" types of answer. It is as clear as you can get, backed up by evidence, charts and numbers. So, how do we explain such a spectacular rise in commodity prices without the queues and rationing? Michael Masters answered, What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets Just who is this "new category" of market participants? The rising demand of these two giant nations had been gradually brewing and simmering over the past decade and will continue to the next decade and beyond. Michael Masters pointed the finger at: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant. To give you a sense of scale of their share on the commodities futures contracts, Michael Masters gave an example: According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 188 billion barrels to 28 billion barrels, an increase of 920 million barrels.
demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China! There are a few more examples given by Michael Masters in his testimony. What happened was that these institutional investors hoarded commodities through the futures market, affecting futures price, which in turn affected the spot prices (ie the real world market price). The spot prices are the prices that we all face in our daily life. In additional, these institutional investors (which Michael Masters called "Index Speculators" are a completely different breed from the traditional speculators. The latter were relatively small fries who had limited supply of money, specialised in certain commodities and price conscious (ie they are careful with what price they pay for). They have vast amount of money (fiat money in US dollars) to be distributed among "key commodities futures according to the popular indices" and are not conscious about the price they pay. You can expect such behaviour to have colossal impact on commodity prices. Michael Masters explained, In the early part of this decade, some institutional investors who suffered as a result of the severe equity bear market of 2000-2002, began to look to the commodity futures market as a potential new "asset class" suitable for institutional investment. While the commodities markets have always had some speculators, never before had major investment institutions seriously considered the commodities futures markets as viable for larger scale investment programs. Commodities looked attractive because they have historically been "uncorrelated," meaning they trade inversely to fixed income and equity portfolios. Mainline financial industry consultants, who advised large institutions on portfolio allocations, suggested for the first time that investors could "buy and hold" commodities futures, just like investors previously had done with stocks and bonds. The value of assets devoted to commodities by these Index Speculators grew from just US$13 billion in 2003 to US$260 billion as of March 2008. Over these 5 years, the prices of commodities grew by an average of 183%. In 2003, they were small fries in the commodities futures market. Why is it that no one seems to know about this phenomenon? Michael Masters believes that (emphasis in the original testimony): The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets. To compound the effect of Index Speculators on commodity prices, it must be noted that the commodity futures markets are much smaller than the capital markets. For example, it is 240 times smaller than the global equity market. Thus, every dollar on commodity futures has a much greater impact on prices than the same dollar on equities. To compound the problem even further, it was observed that their demand increases prices, which in turn increases demand even more. Let's say OPEC increases production in an attempt to help bring down the price of oil. You can see that these Index Speculators can easily pour more money into the oil futures sink hole. Sad to say, through a loophole, the US Commodities Futures Trading Commission (CFTC) allows such speculators "unlimited access to the commodities futures markets." As Michael Masters explained, The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with a Wall Street bank and then the bank buys $500 million worth of Wheat futures. In the CFTC's classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as "Commercial" rather than "Non-Commercial." The result is a gross distortion in data that effectively hides the full impact of Index Speculation.
Connecting monetary inflation with speculation, Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments. Is it surprising to see the arrival of the Index Speculators?
May 23rd, 2008 at 10:24 am VERY Interesting and I agree with Pete, an eye opener! This effectively explains what some of the gold bugs been saying. Free money hand out by government in an attempt to pop up the equity market was not working bec...
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