Wednesday, April 30, 2008

As promised: More on commodities traders and their alleged role in rising prices

A Washington Post piece today backs up yesterday’s inquiry here into the role of new investors played in the rise of the commodities bubble. For farmers wanting to sell winter wheat, when the market price today is the below the value of the same wheat in the futures markets, Steven Pearlstein argues, something is amiss.

Interesting factoid or smoking gun? One economist claimed that during 2006 and 2007, as much as $100 million in investments per day was entering commodities markets. By February and March of this year that number shot up to $1 billion. More numbers. The value of all derivative contracts traded in the Spring of 2005: $3 trillion. Today: $8 trillion.

From Pearlstein:

Speculators have always played a prominent role in commodities markets, but in the past year, they have literally overwhelmed them, causing a dramatic increase in trading volume, volatility and prices and disrupting many of the normal relationships between producers and end-users.

Many of these were the same hedge funds and hot-money investors who had gorged on sovereign debt of developing countries, tech and telecom stocks, subprime mortgages and commercial real estate and now needed a new thing to focus on. Others -- including, it is said, some sovereign wealth funds -- looked to commodities as a hedge against the falling dollar. But perhaps the biggest push came from pension funds, foundations and university endowments whose managers had all gone to the same conferences and read the same academic papers, suggesting that a basket of commodity futures would provide a good hedge against stock and bond market declines.

To meet the needs of these investors, Wall Street and Chicago's commodities houses came up with all sorts of new vehicles, including exchange traded funds, index funds and structured investment vehicles -- the commodities equivalent of mortgage pools and asset-backed securities.

Of course there’s the small question of what to do about this. The problem remains, as Pearlstein reports, nobody at the Commodities Futures Trading Commission, or its regulators, feel that these traders had much impact on commodities prices. (How responsible are traders for changing diets and tightening food supplies?) Pearlstein fears that if the CFTC says anything about the role of speculation, the U.S. Congress may want to take a look at regulatory reforms, something no trader could live with. It is an election year in the U.S., after all.

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