We are six weeks from the release of the film Wall St. Money Never Sleeps, yet Gordon Gekko has been alive and well over the last 22 years. Anthony Scaramucci has written a great book about the personality complex of greed and envy in Goodbye Gordon Gekko, based upon his life experiences, from his salad days at Goldman Sachs to his current role of CEO and Founder of SkyBridge Capital.

I always thought that Gekko (and Bud Fox for that matter) was a weak man. He made bad choices, mostly because he had no sense of who he was. He had no confidence in himself outside his dealmaking. If you took away the deal, what did he have spiritually? [FYI - I am also someone who threw Liar's Poker out of a 12-story window the window, not because of the writing, but because I thought the protagonists were a**holes and they were not the least bit interesting as people. There is no room for machismo nor bravado on a trading floor, nor on Wall St.]

Scaramucci is an example of the flip side of Gekko. With great candor, he dissects his own life and the choices he had to make in the balance between being a Capitalist and a moral human being.

Scaramucci on Capitalism:

“This is a fantastic country. We have great core values and we are benevolent country. We believe in free will and the capitalist spirit. If you read Karl Marx, greed will consume itself, ultimately because of the design of capitalism. I think we are smarter than that and I think with the right social programs and the right core values, we can overcome that.”

On Financial Reform:

“We are wired for risk. We are built on speculation. I bet your relatives came to the US poor. Why else would they have left? We need to dial down the envy and the greed – the animal spirits – which ultimately hurt us. Gekko was a great striver…a great believer in class mobility. But the the ability to hurt others like Bud Fox…people do not like it. Some can watch Gekko on screen and they can walk out of the theater enamored and others are repulsed.”

Here is a particularly interesting exchange in the podcast:

Michael Martin: Why doesn’t the US have its own Sovereign Wealth Fund?

Anthony Scaramucci: That’s a good question. This is not a Democratic or Republican response. There has been a crisis in our political leadership. These funds are set up for the beneficiaries of the future generations of our America. The political class in our country has made a decision to absorb treasure from future generations and reward current voters. We are in a society where we are over-consuming and under-producing.

“I challenge the political class to think about what they are doing and how they will be reflected upon 200 years from now. This is an indictment of both parties about where we are as a nation. There has been 9 or 10 generations since the signing of the Declaration of Independence that have passed a higher living standard to the next generation. We are dropping the baton. It’s not clear to me that there will be the class mobility. It’s not clear to me that we will be leaving a higher living standard for the next generation. It’s being driven by the political leadership and it has to be stopped. ”

Hillary Clinton telling Iran that the US is looking for sanctions that bite is like telling them they’re going to be grounded and cannot go outside.

Sanctions don’t work as far as political threats are concerned in the Middle East – at best they are “hit or miss.” And as reported in Daniel Ammann’s new book, The King of Oil, Israel got 60-90% of its oil from Iran at a time that they weren’t officially recognized because it was in everyone’s interest to be business partners although publicly they had to “not save face” and remain bitter enemies.

So all this jawboning about Iran does nothing but keep the War Machine moving forward. More importantly, it keep donors’ wallets open for the Dems who may need all the help and support they can get in November.

Officially, the US wants to stop Iran from developing a uranium enrichment program. Iran is the second largest producer of crude oil in OPEC. They can go buy a nuclear weapon or dozens of them. Pragmatically, I don’t think there’s much the US can do but fight this in the headlines.

Iran needs to keep the oil flowing and they will…to China and India or anyone else who needs it. After crude oil, Iran’s largest exports are, ready for this, Persian carpets, pistachios, and saffron and its main trading partners are Japan and Germany.

Secretary Clinton was quoted in the NYT article as saying “parts of Iran’s government are ”a menace” to the Iranian people and the Middle East.” If I didn’t know any better, that sounds a lot like the United States…parts of our government are a menace to me and you, especially the FRB and the CFTC. We have a lot in common with the Persians from that standpoint.

“Clinton said that if Iran developed a nuclear weapon, it would embolden terrorists and spark an arms race that would destabilize the Middle East.” It might be me, but I think poking a stick in their eye emboldens them more than anything else. My guess is that they have them already, not officially speaking.

Politicians will get behind this because they are elected by their donors, not their constituents, but in the end, Iran will stare down the US and win.

When you look at this very telling chart of Energy Supply and the Individual States from Gregor MacDonald’s Gregor.us Monthly, you see the harmful economic impact the green movement has had on California.

Sound blasphemous? Not really. Victor Sperandeo said effectively the same thing in the video excerpt Observe What Is.

California consumes 3 times as much energy as it produces, and as MacDonald states, “when oil and natural gas prices rise, states like Colorado see a cascade of earnings, revenues, and royalties flow into their state. Whereas states like California see a cascade of capital flow out of state.” This seems emblematic of how LA and California in general are run: the state and local economic policies seem to chase otherwise great businesses out of the state, rather than trying to attract them or get them to stay.

Borrowing from MacDonald, I think California consumes 3 times as much energy as it produces intellectually too: our leaders are economically illiterate but the government workers seem to be doing well, despite not wanting to share in the meltdown.

LA Unified School District pays 160 teachers $10 million a year to do nothing. They spent $2 million in legal and salary costs on a case that dates back to 2002 – to remove one teacher for misconduct.

What I’m also thinking about is the recent layoffs, the layoffs to come, more firms like Northrop Grumman leaving for greener pastures, and a credit-rating downgrade that will cost CA millions more in nominal interest payments when (and if they can) issue more debt.

That Northrop Grumman was allowed to leave Century City without any major elected official stepping in to cut their corporate taxes or persuade them to do otherwise would be like watching former NCG Chairman and CEO Ron Sugar himself walking unscathed through airport security at LAX with a B-2 Spirit Bomber under his arm and not sounding the alarms.

California, and especially Los Angeles, are not business-friendly. And that’s before you have to deal with the USPS…

HD Video Sperandeo: US Depositors Are Taxed At 100%

According to Victor Sperandeo, US Banks can borrow from the Fed below 0.25% and buy 2-year Treasury Notes yielding 0.81% without any reserve requirement. They can lever this investment 100 to 1 (maybe higher) if they want and it’s a riskless trade. If rates go higher, the banks just hold the Notes until they mature.

They also don’t need an underwriting department for this, so they can lay off personnel. Since this is so lucrative, and riskless, and can be done with lower overhead, you can see why banks will be reluctant to lend money to small business owners or anyone without an 850 Fico score.

Depositors are the ones fueling this trade by leaving their funds on deposit at the banks. But they’re effectively taxed at a rate of 100% since they are not getting any yield on their money.

Charles Goyette Dollar Meltdown Video Interview from Michael Martin on Vimeo.

Author and radio show host Charles Goyette speaks with Michael Martin of MartinKronicle and Contributor to the LvMI Economics Blog about the state of the US economy, Bernanke’s re-appointment, and US long-term debt.

The Mises post Goyette refers to early in this interview is called Goyette: We’re Near The Crack-Up Boom.

Goyette will be speaking at the Mises Circle / Phoenix on April 10.

It’s fun times these days to be a commodity trader / blogger. There is no mid-range to the comments. Most of the criticism or descending comments I get on anything I write about the role of commodity traders usually has the undertone of populist anger around TARP. I try to present a balanced argument to the anger that is misplaced on managers of commodity hedge funds and CTAs who get lumped in with the big banks who benefited from the bailout.

Wall St. is divided by partisan lines. But in the United States, Republican and Democrat politicians are Corporatists. The terms Democrat and Republican refer to how individuals are registered to vote, or who takes a certain side of an argument. The recent SCOTUS ruling means that China Investment Corporation can sway elections here in the US. Trends persist.

I do not have a political agenda, unless of course you think that being a proponent of preserving individual liberty and personal sovereignty is an agenda, then I have one. In my paradigm, I am responsible for everything that happens in my life…good and bad. I cannot blame anyone for my failures or the times when I’ve had bad luck. That is so foreign to me anymore, I don’t think blaming others for my failures would even feel good.

When Refco went under, I lost my one and only client at the time. And we were dealing with their Indian subsidiary…we were shot by friendly corporate fire. But, no one held a gun to my head and said “bank on one large client.” That was my doing. I admit to having visions of putting a 38-ounce Louisville Slugger to the forehead of Phillip Bennett, the now imprisoned Refco CEO, but that was just a mask for my fear of losing everything. There was no TARP money for me. There wasn’t an SBA loan either. There were friends and family, and my sense of persistence and determination.

I’m not a fan of any politician on either side of the aisle. For the life of me, I don’t know how anyone can idolize a politician. Nor do I idolize my mentors Ed Seykota, Victor Sperandeo, and Jim Rogers, for example. They continue to be kind and generous with me. I celebrate their mentoring and teaching and I pay it forward by sharing as much of it as I can with the readers on my blog for free.

My debate is not with those who criticize me or the commodity futures industry – I don’t think they fully understand how risk transfer markets work. It is with arrogant members of the academic community and especially those in the self-interest groups who believe in abolishing individual freedom and free markets to exert power or control over others.

Economically speaking, academics think in terms of pay-grades and tenure. I think because of that, it seems, they decree a sense of what is fair and what is not. They have no choice but to accept that there is only so much they can earn for all their teaching skills. Frankly, I believe that teachers, instructors, and professors are underpaid, but they do not stand on a higher moral ground because of the choices they’ve made professionally.

Special-interest groups are myopic at best. Whereas Wall St. benefited handsomely from the Greenspan and Bernanke Puts (Put Options), special interest groups want Legislative and regulatory Call options: they want all the upside, but don’t want to pay for the option.

Professional investors earning huge sums of money each year, while the rest of the country is hurting is not an injustice. It’s progress. And trying to cap one’s income or legislate one’s behavior takes the United States backwards, not forwards. Education is the answer – especially in financial literacy. Education is what will close the gap, and IMHO it’s far better to encourage individuals to progress, than to truncate or retard their growth.

The whiners who blather about “what is fair” have already surrendered their power. They are in the camp that the government or a regulator should decide an individual or a group’s fate. I suggest that they learn to trade to better manage their risk or to enhance their compensation. It might also give them a new found sense of liberty. Fairness is a form of reality.

Americans are hurting now, and I genuinely feel for those who are out of work or have suffered through the real estate crash, have been laid off, or downsized. My father was in a labor union and spent months out of work in the late 70s. It was very painful financially and emotionally. I don’t blame President Carter: he made some very stupid decisions, but so did Presidents Nixon and Ford.

I teach anyone who wants to learn and I love when students argue because I know I’m challenging their set-in stone beliefs. My classes have a wide-array of students from various backgrounds and ability levels. Essentially, I teach Risk Management in the form of commodity trading to all types of traders, investors, and hedgers:

Investors

• CFA Charter holders who want to go beyond their professional studies of their charter
• Equity Mutual Fund managers who want to learn more about the cyclical markets of commodities
• MBAs, CMTs, Ph.D’s, and CFA’s who manage Equity or Fixed Income portfolios who want to manage basis risk
• Forex dealers
• Individuals who want to become CTAs or commodity investors
• Individuals who are looking for a change in career

Hedgers

My classes are very heavily represented by the hedging community.

• Energy companies
• Energy wholesalers
• Agriculture firms
• Electric Utilities
• Airlines
• Refineries
• Firms that use crude oil distillates to produce their products
• Individuals and firms who want to hedge an adverse move in a currency their dealing with

I am no apologist for a trader’s bad behavior on either side of the transaction. If a large trader can dominate the market, it hurts me, so naturally I’m against it.

If a commodity user or producer does not engage in hedging, and the commodity in question is an integral part of the business, then they are at the same time, foolish, gamblers, and irresponsible.

To hear author Daniel Ammann tell the story, Marc Rich was run out of the United States. If his thesis is correct, President Clinton’s pardon of Rich (and Pinkus Green for that matter) should have been just the beginning of an apology the size of which could be immeasurable.

At the heart of Ammann’s book, The King of Oil, is the life of Marc Rich who created what is known as the spot market for crude oil.

Rich began his commodity career working for Philipp Brothers, (now Phibro) – a part of Occidental Petroleum – before launching his own firm in 1974 with Pinkus Green and Alec Hackel. The new firm was to be called Marc Rich + Co AG. Rich is a Randian and was known for making large commodity deals on handshakes.

Most international companies, including the Seven Sisters, had legitimate offshore entities to better manage their tax liability, among other reasons. So that Marc Rich + Co AG had several such entities should not have come as a surprise to any international commodity dealer.

If not for an overzealous US Attorney Rudolph W. Giuliani, Rich undoubtedly would be in the United States. He was indicted for dealing with Iran during the hostage crisis. Yet, according to Ammann, each of the American Seven Sisters – through subsidiaries – were doing business with Iran all the while…obviously a double-standard. President Carter’s nationalist decree, as many government interventions, eventually harmed Americans more than helped. Carter was impotent and for the most part powerless during the whole Iran hostage crisis.

Marc Rich + Co AG admittedly was never part of the establishment. Furthermore, their main office was founded in Zug – not the US. This would allow them to legitimately recognize revenue through channels that would lower their tax liability. There’s not a publicly traded firm on the NYSE that doesn’t have legitimate offshore entities for their foreign dealings.

Rich was ultimately indicted for illegally dealing with Iran during the hostage crisis and tax evasion. He did not flee: he was in Switzerland at the time and never returned to the US.

Giuliani, no stranger to the perp walk, saw an easy target and literally made his case. Giuliani got his political win in that he very publicly seized tens of millions of dollars in frozen assets in the US.

However, he didn’t drop the case as he often did after all the fanfare and press that he got BUT he didn’t bring the case to trial either. Had he taken Rich through the court system and lost, he would have lost much political capital.

You can hear a podcast interview I did with Daniel Ammann on his book, The King of Oil.

Attention airline passengers: Not only do you have to pay extra for your luggage, your meal, and your headphones, you now have a dress code on United Airlines. But that shouldn’t surprise you. The airlines industry in general has been mismanaged for decades, including being overwhelmed with high labor costs and being laden with debt…just like the Big 3.

As far as I can see, the airlines have never been a good investment. Most of the publicly traded equities are under $10 save one or two. They’re cheap for a reason: no one wants them.

On Monday, ABC News ran an article on increasing energy costs and tried to tie it in with guesses of impending CFTC rules and position limits. They quoted a few sources: a family-owned heating oil company executive, the head of an airline, and a spokesman for the ATA.

As a Commodity instructor and trader, I was quoted for my opinion on the reasons for the increase in prices across the board. I gave them 2 pretty good quotes, one they ran, but the most telling one was edited out:

“Stable prices and cheap fuel are not our birthright,” argues the L.A. trader/instructor Martin. “This recent run up has everything to do with U.S. monetary policy and nothing to do with Wall Street speculators” was how the article was to have ended, but it was
edited out. Instead, they went with a syrupy, Michael Moore sob story to pull on your heartstrings.

The weakness of the US dollar can cause crude oil and heating oil prices to rise. Jet Fuel A, heating oil, and gasoline are derived from crude oil. Lower crude production has caused a decrease in supply, as shown in this graphic from Gregor Macdonald.

View image

I’m generally not a conspiracy theorist, but not mentioning that there could be just one other reason why heating oil is going higher, looks like ABC News has an agenda or are pandering to their readership. To worsen the matter, since the article was published, ABC has linked an archived video from July of 2009 that features an equity hedge fund manager who’s testimony was thoroughly refuted by both Jim Rogers and Nobel Economist Paul Krugman, among others.

Heating oil is derived from crude oil through a process known as cracking and producers make sure they have enough supply to sell to consumers for the colder fall and winter weather. As you might expect, the demand for heading oil is higher in the colder weather than warmer and this creates a seasonal tendency.

The chart below is based on 26 years of data and shows that heating oil prices (aka Fuel Oil #2) bottom out in the summer and rise to peak prices in late September and October. (Chart courtesy of Jerry Toepke @ Moore Research Center Inc.)

MM091105.pdf

The fact is, we’ve been spoiled with cheap fuel costs, at least I have, for most of my adult life. America’s policy toward drilling for new oil will guarantee you skyrocketing fuel costs and alternative fuels are, although intriguing, years and years away from being practical and affordable for the majority of Americans.

US Airways Chairman and CEO Doug Parker was quoted as saying, “we believe unchecked speculative trading of oil futures is distorting the normal market dynamics of supply and demand.”

I think what Mr. Parker meant to say was, “we know we can pass higher fuel costs on to Americans if we don’t hedge, and ultimately blame speculators for the higher costs.”

Then David A. Castelveter, a spokesman for the Air Transport Association (ATA), said that “speculators have been causing such volatility in the market that it is hard for airlines or other oil users to make appropriate business decisions.”

Really? Scott Topping over at Southwest had crude locked in at $51 / barrel when oil prices were high by utilizing several hedging techniques.

Effective hedging is an ongoing process and needs to cover many years into the future.

Castelveter attests that “every $1 increase in the price of oil adds about $430 million to airlines’ annual operating costs.” An effective hedging program that will offset EVERY $1 increase in the price of oil will run you but a few percentage points of the $430 million number quoted. (Note to Mssrs. Parker and Castelveter and ATA members: Read all the Nassim Taleb you can get your hands on. He can also help you with some hedging techniques.)

American CEOs, including those in the airline industry and ATA, are focused on one thing: hitting their quarterly earnings number…a chicken shit way to run a company. No one is taking any good risks these days: they’ve lost their balls. They don’t hedge b/c they will pass the costs onto Americans.

I think they don’t hedge fuel costs because it costs money and that affects their quarterly earnings which in turn affects their share prices and the CEOs’ collective net worth.

Tie airline CEO compensation to how effectively they hedge higher fuel costs I say and we might be on the right track to a higher fiduciary standard in that industry…I don’t think we are anywhere near that now. And if they do a good job and ensure we can travel for a reasonable fare while they can be profitable entities, pay them twice what they’re getting now. They will deserve it.

Americans and everyone in the ATA need financial literacy and education, not the blame game and lazy corporate attitudes, nor further regulation. There are already some very stringent position limit rules for commodity futures traders. Any large trader will tell you it’s easy to get into a position, but hard to get out of one.

As commodity expert Barry Siler said, “Being unhedged is the ultimate short position,” he says. “You’re betting every day that the price of fuel won’t go up.”

I think the CEO’s of America’s airline companies are the real gamblers in the energy markets. They’re betting that world is continually stable and there will be no shocks to the global energy markets. This scenario has the potential outcome of leaving (Puma-clad) Americans stranded at the airports around key travel days while absorbing higher costs for less service.

To say that author and radio show host Charles Goyette is bearish on the US dollar would be a gross understatement. In a wide-ranging podcast at MartinKronicle.com that covered many topics in his new book The Dollar Meltdown, Charles Goyette discussed several hard-hit areas of the political economy that according to him will tank the dollar much further.

According to Goyette, the fallacy of “energy independence,” the bumper-crop the Treasury is printing in US dollars, and vote-buying on the Hill are just a few on the list. But it’s the US deficit that is the highest on his list. “The real level of the national debt is over $100 trillion – it’s an amount of money that can never be paid off. The only thing the government can do is print a lot more money.”

Paper money was created as a convenience, a claim-check on the gold, but there’s nothing behind it anymore. “One day, those who are paid in $US will realize that they aren’t worth anything. Look at gold over $1,000. The price of gold today is a referendum on the quality and quantity of the paper money.”

Inflation Then Hyperinflation

A “bumper crop” is one where there is an over-abundance of corn, for example. There is so much corn, that each kernel is worth very little. That’s what’s happening to the value of the US dollar with the amount of them coming off the printing presses at the Treasury. “The paper currency is a declining asset and as that happens people will convert it to something of tangible worth, such as hard assets. Paper money can be printed with no cost to the politicians.” When that happens, prices of raw materials and hard assets will rise in an inflationary environment.

“Sooner or later, everyone is going to realize that the only way we can pay back one bond is to issue another one and you have a situation where you’re using MasterCard to pay your Visa.” That’s when Goyette thinks we’ll see what Mises called the “crack-up boom,” hyperinflation and the demise of the exchange economy.

Higher Crude Prices

Peak oil may be the new norm, not an outlier event. “When Nixon took us off the Gold Standard, the price of Crude Oil quadrupled. Ten years after that it was up 1,000 %.” All because there was nothing backing the dollar. If the dollar continues its slide, you’ll see crude prices going higher, “the current Administration is on a course to tank the dollar.”

According Nobel winning Economist Joe Stiglitz, the cost of the Iraq war was $3 trillion and could go as high as $5 trillion, yet the first foreign nation to strike an oil deal with Iraq was China. “They are acting like Capitalists all over the world,” said Goyette, “and they didn’t spend $2 in Iraq.”

That does not bode well for Americans – even while our summer driving patterns are as predictable as colder weather in the winter. Goyette also does not believe that the concept of energy independence is nothing more than a fantasy. “Every President since Nixon has been ringing that bell. Carter gave us the Department of Energy (DOE) and they’ve managed to spend $50 billion over the years and they not created a single drop of oil.”

The Dollar Meltdown include several chapters on how Americans can preserve their wealth and personal sovereignty by converting their US dollars to hard assets such as various forms of gold, silver, and crude oil investments. But beware something like the Gold Reserve Act of 1934 where the Government made it a felony to possess gold and mandated that Americans turn it in for $20.67 – and then commanded that gold not be worth less than $35.00 – thereby fleecing Americans of $3 billion.

There are several things that the Commodity Futures Trading Commission (CFTC) will be considering as they convene hearings. Hopefully they will hear well-researched, and well-thought out opinions, unlike that of Michael Masters – who’s testimony was slammed equally by the left and the right by the likes of Nobel Laureate Paul Krugman and Commodity trader Jim Rogers. Among the issues that the CFTC is looking at are transparency in the markets and the position reporting limits where they are not currently any Federal guidelines. A third issue is the stratification of the COT — the commitment of traders — which characterizes how the market participants are biased in the marketplace. Ultimately, these make for good talking points, however, regulation in these areas will not stamp out speculation nor insure Americans against high commodity prices.
Position Limits

That commodity futures contracts have position limits is not a new concept. The various exchanges set position limits, except for Agriculture futures which are set (Federally) by the CFTC. Each commodity has its own position limit and they tend to be very specific. NYMEX Crude oil, for example, has the position limit of 10,000 net futures in any one month and 20,000 net futures contracts for all months combined. You are limited to “only” 3,000 contracts in the last 3 days of the spot month, including any concurrent Call or Put Option positions on the same commodity. The question before the CFTC is how to account for the Over the Counter (OTC) market in aggregating position sizes. Also, the Intercontinental Exchange (the ICE), has evolved substantially since trading has become much more electronic. The ICE offers “look-alike” futures which are cash-settled and no physical commodity is ever involved by definition. The position limits for the ICE Crude Oil Futures are exactly the same as those set by the NYMEX on its crude oil contract. These are two different contracts on two different exchanges and their limits should be separate.

If Victor decides to sell 5,000 NYMEX crude oil contracts and Mike is buying 5,000 NYMEX crude oil contracts at the same time, there is no effect on crude oil itself. Neither of us is creating nor producing the physical oil – we are trading against one another. We are not impacting the consumer, unless the consumer happens to be a speculator and is taking part of the position. What we are doing, however, is providing valuable information to the marketplace on the outlook for Crude Oil. We already abide by the reporting levels. Further transparency will not annul volatility in commodity futures trading. Uncertainty causes volatility. Hedgers, real hedgers, are hedged oftentimes to the back of the board and they use several techniques beyond futures contracts.

Commodity investors, also called Indexers, invest in commodities for the long-term to assuage the effect of inflation on their traditional investments and “paper assets,” such as stocks and bonds. Through passive investments such as the US Oil Fund, LP (ticker:USO) discussed below, or through the asset class known as Managed Futures, they seek diversification along their investment frontier to enhance their returns while reducing risk. These indexers, which have billions and billions under management, are the large pensions (and in some cases Endowments) that have Defined Benefit plans that they are legally bound to pay out of to plan beneficiaries – retirees – in the future. It has been alleged that such indexers, due to their sheer size, are driving up the price of commodities. So far, there has been no evidence of fact to this regard. Regulating pensions and endowments out of the market or to the point where their participation would be meaningless, would be a great disservice to them and frankly, discriminatory because of their size. Such regulatory banishment would likely come back to haunt lawmakers and tax payers because if there was a shortfall in corpus that is due to be paid out, it would have to be made up. This would be a drama known as Social Security, Part II.

High prices are the best cure for high prices. Sound like a riddle? It could be. When prices rise to extremes, such as they did during Peak Oil, producers will run at full capacity to sell as much as they can into these high prices. The costs to produce oil is relatively static, so there is great profit potential. At the same time, consumers will consume less and less as prices rise. The confluence of the demand backing away and eventual supply glut drives prices down. There is no speculator or commodity indexer on the planet who can compete with the perfect production knowledge of Saudi Aramco or the National Iranian Oil Company (NIOC), the two largest oil producers in OPEC.

Easy Money

Easy credit, or the ability to borrow money at low interest rates, is a lot harder to regulate. It is the availability of easy money that may have had a greater cause for the volatility in commodity futures prices. Excess credit fuels speculation as we’ve seen in real estate, and for that you can look back to Chairman Greenspan. But speculation has nothing to do with the physical cash prices of commodities or what commuters pay for gasoline at the pump. In fact, if speculators were removed, it’s likely certain that price volatility for commodity futures contract prices would be greater. There has been greater volatility in onion prices, for example, where no futures market exists than in corn or wheat, where there are futures contracts. Onion speculating has been banned since 1958 thanks to a bill by then-Congressman Gerald Ford (R-MI). No futures markets exist for cobalt and molybdenum and they too suffer from drastically wild prices in the cash market. Speculators can help smooth out the price if involved in a centralized meeting place – an exchange – and take on the risk that producers and consumers cannot handle. The London Metal Exchange (LME) is introducing cobalt and molybdenum contracts in the next year. Go figure…

The price action in the cash market leads futures market prices, not the other way around. When we purchase gasoline at the pump, price is determined by the people buying and selling the gasoline – not by the trading of gasoline futures contracts. While it’s true gasoline retailers may be hedging their exposure, purchase and sales of commodity contracts is separate from the purchase and sale of gasoline in the cash or spot market. What occurs at the pump is between those companies that supply gasoline and the demand from those who drive. That is between consumer and your gas retailer. Speculators are not involved.

And about the alleged crude oil hoarding? There are several market players who have access to cheap money and storage, and thus, can earn profits on trading the physical commodity. If a market participant can store or finance the purchase of the physical commodity cheaper than the embedded storage and finance costs represented in the calendar spreads, the participant is encouraged to store the physical. It is not uncommon for Futures Commission Merchants (FCMs) to trade the physical commodity concurrent with their brokerage operations. It also diversifies their business operations. FCMs storing several barges full of crude oil is not hoarding – it is lawful, legal, and profitable in carry-charge (contango) markets. The spreads in carry-charge markets, in fact, dictate what to do: either store it (in barges) or deliver it immediately. They can’t store it for too long though. Unlike crude oil’s derivative products gasoline and heating oil, crude oil does not store particularly well.

Sensational articles tend to name these FCMs as also having received TARP money (which was force-fed so as to protect to protect the really sick banks, such as Citi) and therefore very greedily using taxpayer money to profit from commodities trading. Most, if not all, of these FCMs have been trading cash commodities long before the authors of such articles could spell CDO (Collateralized Debt Obligation), which is neither a commodity nor a derivative. The banks could not refuse the TARP funds. The recent SIGTARP report delineated that out of the 360 institutions receiving support, 31% disclosed that they made investments with some of the TARP funds. It did not list specifically what those investments were, although 26% reported buying Mortgage Backed Securities (MBS). Seeking profits from commodity trading – in either the cash or the futures markets – is not a form of greed, it is in business to seek profits! And, since when is it presumed that all the market participants always win or make money? Usually in tough financial times when it feels good to blame others. FCMs are in the business of making money and the CFTC should remember this while the hearings are on.

Zero Impact

Almost all commodity futures contracts are offset well before they expire. Open Interest is the number of contracts that have been entered into by all speculators and hedgers. As time transpires in the contracts expiration draws nearer, you typically see a steady decrease in open interest, which means contracts that have been entered into are being closed. Purchasers are selling, and those who have sold short are buying them back or “covering.” All this activity is beyond the physical cash market for gasoline and the information is publicly available and readily accessible. Historically, less than 2% of all contracts are delivered against. An exception to this might have been an “unintended consequence” when in the early 1970s President Nixon put a price ceiling on plywood when he tried to curtail inflation. Producers lacked incentive to create more product thereby creating a shortage — a shortage so great that the commodity futures market for plywood became the supplier of last resort.

For every buyer there has to be a seller, so for every large index commodity investor there needs to be a willing person or several of them on the other side of the trade who are willing to sell. We’ve all heard of the “Goldman Roll” and we know when it’s coming. This does not create an imbalance in the commodity futures market.

During the most recent run up in spot Crude Oil prices, the International Energy Agency (IEA) determined that demand for crude oil did decrease, however, production fell at a greater rate thereby causing a rise in prices. The dramatic fall in the US dollar (USD) exacerbated the move. IEA and the CFTC found only “inconclusive evidence” (that means no evidence) that speculators had any effect on the cash prices for energy.

A recent paper by Professor Scott Erwin of the University of Illinois took on the argument that speculators were behind the recent price moves in wheat. Professor Irwin demonstrated that speculators were not the cause of increased prices and weak but the relationship between the cash and the futures prices. His research found that they were there were two causes that led to higher wheat prices: “The first factor is the tendency for spreads in the futures market to reflect a relatively high percent of full carry (contango) since 2006. The second factor is long-term structural deficiencies in the delivery system for CBOT wheat.”

Lastly, not all speculators are in the markets at all times. One of the tools that a speculator has is the right to not participate. A hedger has to be in the marketplace to offset risk – a speculator does not – they can sit on their hands. When markets become very volatile, or choppy, many commodity investors head for the sidelines. Volatile and directionless markets can wreak havoc on a manager’s equity and investors usually enjoy stability more than anything.

Inference

We find that there is a lot of inference in media reports about commodity prices, especially when they are high. We investigated one recent, albeit short, blog post on a large commodity index that originally appeared in Reuters Blog called Commodity Corner:

Exchange traded funds like U.S. Oil Fund LP hold an increasing share of outstanding NYMEX energy contracts. The funds allow retail investors to bet on a rise in crude oil prices, but looming U.S. CFTC regulations aimed at curbing speculation could limit their positions in the future.

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Seemingly, harmless enough, yet with a little digging we found (on Yahoo! Finance) that the price of US Oil Fund LP (ticker: USO) fell from $57.38 to a intra-month low of $22.86 during the acquisition of the July NYMEX Crude Oil contracts.

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During that same time, the price of NYMEX July Crude Oil futures dropped from approximately $76 to a low of $42. USO was buying July Crude in a falling market.

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We also found that USO purchases ICE Crude Oil contracts alongside their NYMEX contracts. In fact, according to Yahoo! Finance, only 50% of the corpus USO manages is invested. About 23% of all corpus is invested in NYMEX contracts and the other 26% is ICE Crude Oil – the one that is cash-settled. “WTI” stands for “West Texas Intermediate” – the type of crude oil that underlies the commodity futures contract.

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We used Yahoo! Finance because it is public and free. You don’t need a 2-year contract and $2,000 per month to get this information like you would if you needed a Bloomberg terminal to get this data for example. This is just one blog post, but you’d be surprised how many of them are written in this manner.

Commitment of Traders

One thing that effects the COT is the physical trading desks of the large oil producers. In our opinion, it would be quite easy for a producer to speculate under their hedging activities. If a producer had production set at some factor X, they could sell X + K futures as a hedge, with K being excess contracts that do not represent the hedge. Currently, all such trading would be considered hedging.

Speculators can also enter into a long-term OTC swap arrangement and “hedge it” using futures. Although they’d be “hedging” a core position, they are in fact still speculating since that is their main business. In this scenario, they have entered into a type of spread trade with futures against an OTC position and would be looking for the spread to narrow or widen.

Indexers, such as USO above, will continue to be included in the Commitment of Traders.

Conclusion

Regulation gives one a false sense of security. One cannot legislate behavior, no more than religion can “legislate” morality. Parties that are invited to testify have agendas and their allegations should be vetted thoroughly. It is important for the CFTC not to over react so as to drive trading to foreign markets. We have already know that the more regulation (and tax) you add to the system, the less the output for a nation. Virtually all securities known as “structured notes” are sold in the UK and Asia due to the too stringent regulations and tax rules on such in the US. Too stringent rules on commodity exchanges, contract position limits, and regulations on participants, and you’re likely to see business heading offshore along with the jobs…and that means taxes – tax revenue that will eventually need to be made-up. One alternative that exists right now, is our ability to trade Crude Oil from our desktops in the US through the Dubai Mercantile Exhange (DME).

US commodity traders on regulated US exchanges do not pose any counter-party risk to one another and there has never been a financial failure in the commodity markets. There is no way to lower volatility in commodity futures prices through regulation because no one can regulate uncertainty. Speculation poses no risk to cash commodity prices for US consumers. Despite the lawmakers’ need to “do something,” the markets will take care of themselves. High prices fix high prices and therefore the CFTC should sit on its hands.

The text of this blog post originally appeared at The Big Picture. It was co-authored by Victor Sperandeo.