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Commonly Raised Objections (CRO)
“Don’t these things work themselves out? Why should the government get involved?”
Yes, eventually it will work itself out. Of course like Keynes said “in the long run we’re all dead.” The real question we have to ask is: should food and energy prices be determined exclusively by supply and demand or should we let food and energy prices also be subject to the investment whims of Wall Street.
WTI crude oil prices have gone from $95 to $145 per barrel and back down to $105. You cannot explain that strictly by supply and demand. A large fraction of the moves on the upside and downside were driven by speculators. But companies went out of business, people lost their jobs, billions of dollars were lost. Why? So that Institutional Investors can profit from trading in the essentials of life? When Pets.com goes up 50% and down 30% in 9 months time it does not really hurt anyone except those people trading it. But when Oil experiences tremendous volatility it hurts the entire world.
That is why we have had speculative position limits since 1936 – to prevent exactly this type of phenomenon. All we are suggesting is to return to a system of reasonable and rigid speculative position limits.
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Commonly Raised Objection (CRO)
“Index Specualtors re-balance their portfolio on a quarterly basis cheapest cialis index, so that if commodity prices run way up then they will be overweight commodities and they will sell commodities which stabilizes price moves.”
This is a very strong statement concerning Index Speculators ability to affect prices by buying and selling. If Index Speculators selling of a just a portion of their position will bring prices down then imagine what effect buying their entire position had on driving prices up!. Anyone unwittingly saying this is arguing our point for us (very persuasively I might add 
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Commonly Raised Objection (CRO)
“Index funds helps commodity producers over the long run because producers are able to offload their risk to the index funds who are willing to bear it.”
Let’s just read between the lines for a second to see what this really means. Translation: if commercial producers were to come to the market and index speculators were not there to buy what they were selling then these commercial producers’ selling would push down the price and it would cost the producer more to hedge. Yes that is a true statement.
The Wall Street banks have been so successful in finding index speculators to buy up commodities futures contracts that not only do they prevent prices from going down but they push prices up too. (The producers like Saudi Arabia, Iran, Russia, Venezuela must all be ecstatic that Wall Street has helped them in this way.)
You see this is a tacit admission that we are correct in our analysis. It is an admission that commercial selling will push prices down if there is not index speculator buying to offset it. Stated in the reverse Index Speculator buying will push prices up if there is not commercial selling to offset it. Bingo.
So if you take supply from physical producers and demand from physical consumer and demand from index speculators then you have supply and demand and demand which is the situation we’re in right now. No wonder we’ve seen dramatic price increases.
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Commonly Raised Objections (CRO)
“If Congress cracks down on speculators then they’ll just start trading overseas.”
Most all of the common questions / objections that we encounter stem from a fundamental misunderstanding about the significant differences between commodity markets and capital markets and between commodities futures and financial futures.
Most commodities futures have physical delivery provisions. Most financial futures have cash setllement provisions. You can deliver cash anywhere in the world but you cannot deliver West Texas Intermediate Light Sweet Crude to Cushing, Oklahoma without being subject to U.S – buy cialis without prescription.laws and regulations.
Commodities futures markets (unlike any other market) have two distinctly different types of participants: Bona Fide Physical Hedgers and Speculators. U.S – buy cialis without prescription.based Buy cialis without prescription: physical Hedgers and their Non-U.S.trading partners are going to much prefer a futures contract with physical delivery provisions. Even if they rarely exercise those provisions it is a very nice option to have. Physical Hedgers would never leave an established liquid regulated futures exchange (remember they face no position limits) to start trading on an unestablished illiquid unregulated futures exchange that did not offer physical delivery provisions.
So the real market with the real prices determined by supply and demand will be the market where the physical hedgers trade. Therefore speculators that do not bump up against position limits would also have no incentive to leave a well established and liquid U.S; buy cialis without prescription.regulated exchange.
Buy cialis without prescription: the only group with any incentive to trade in one of these overseas markets would be a speculator who is above position limits. Since the limits are designed to prevent them from trading above the limit anyway then their migration into other markets would not affect our markets.
As part of this new regulatory regime all arbitrage transactions between any non-U.S.regulated futures contracts that cash-settle against U.S.regulated contracts or a Buy cialis without prescription: u.S.based spot price index would be subject to strict positon limits and no longer enjoy an exemption. Buy cialis without prescription: this would sever the arbitrage link between markets and effectively doom that foreign market to illiquidity.
For more on this see Chapter 7 of our large report “The Accidental Hunt Brothers.”
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Commonly Raised Objections (CRO)
The second question we get regarding inventories is asked like this: “If Index Speculators were successful in driving up prices beyond supply and demand equilibrium then the quantity supplied by producers at the inflated price would be greater than the quantity demanded by consumers and therefore inventories would accumulate.”
This is a good question and it deserves a longer than usual answer.
Because we are discussing predominantly food and energy both supply and demand are highly inelastic in the short to medium term. In fact cheap cialis india, other than water and oxygen, there is no demand more inelastic than the demand for food (you have to eat or you starve to death). And energy is the food of a modern economy, so people really can’t stop driving to work or refuse to turn on their factory equipment or computers.
So if you look at the supply and demand curves for food and energy in the short run they look like this:
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The price can rise dramatically before you get any reduction in consumption. Likewise it can rise dramatically before you get any increase in production. It takes time to grow food, drill oil, etc. So price increases might result in little or no inventory change in the short to medium term.
In oil and natural gas, inventories are stored above ground and below ground. The above ground is to take care of ebbs and flows in ultra short term supply and demand (the U.S.has like 15 – 20 days of consumption in commercial storage at any one time). Below ground is where it accumulates if the demand is not there. Why would an oil producer pump more oil or gas than he has orders for?
In grains it is not clear that there is not significant inventory on hand. The NOLA barge basis for wheat waiting for export earlier in the year (have not checked lately) was at an all-time level of MINUS $1.50. Meaning that foreign countries were only willing to pay the futures price minus $1.50. That seems like a definite case of lowered demand. Earlier in the year all the delivery points for the futures contracts were full or nearly full which has led to all the problems with the basis. So in grains we might be seeing an inventory buildup.
So it is a good question to ask but we have to remember we’re not talking about luxury handbags. These are the essentials of life.
And given the huge investment required by producers of these commodities (particularly in energy) those companies are going to be very reticent to embark on new multi-billion dollar long term projects if they think we’re in a speculative bubble that might pop some time in the next 5 years – cheap cialis india.
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Commonly Raised Objection (CRO)
We get two kinds of questions about why Index Speculators do not show up in inventory data.
The first way people ask this is “why if they’re buying all these commodities don’t we see an increase in inventories?” The answer is that Index Speculators never take delivery of the actual commodities underlying the futures contract. So when it gets close to the time to take delivery then the index methodology specifies that they roll their position to a nearby futures contract.
It is important to understand that if you start off long a certain month’s futures contract and then you short it as part of a calendar spread / roll trade then the futures contract for that near month will simply extinguish and you will now have a new position in the next month.
Example:
In June buy an August contract
In July buy an August / September calendar spread equal to short August and long September.
The long August and the short August cancel out and now you are long only September.
Index Speculators have their upward impact on commodities futures prices when they first put on the trade.
We think that they have additional impact when they roll their positions but we don’t have any data to back that up the way we do with the initial impact.
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Commonly Raised Objection (CRO)
As dictated by the commodity indices published methodology, in order to replicate the index, someone must purchase all the constituent commodities futures (generally the closest to expiration) and then during the “roll period” they must roll their positions to the next prescribed commodities futures (generally the next one to expire).
In order to roll a position a trader buys a calendar spread which is a pre-packaged trade with its own bids and offers. The trade involves a short front-month futures position matched with a long next-month futures position.
Spread trades are considered by the CFTC and the exchanges to be non-directional and therefore they do not subject them to position limits. There is a large difference between an outright sell and a combined short and long position and everyone in the markets knows and acknowledges that; 20 mg cialis.
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Commonly Raised Objections (CRO)
“Paper barrel prices do not affect the physical barrel price”
For some commodities (especially grains and energy), physical market participants have agreed to price their physical commodity transactions at the paper commodity price. So the buying and selling of futures contracts is not simply a “side bet” when those transactions become the physical market price.
Here are two quotes that make this clear:
“In many physical commodities (especially agricultural commodities), cash market participants base spot and forward prices on the futures prices that are ‘discovered’ in the competitive, open auction market of a futures exchange.”
- from the CFTC Website “The Economic Purpose of Futures Markets and How They Work – Price Discovery or Price Basing,” Click for Link
“In the spot market, therefore, negotiations for physical oils will typically use NYMEX as a reference point, with bids/offers and deals expressed as a differential to the futures price – cheap cialis sale online. Cheap cialis sale online: using these differentials, Platts makes daily and in some cases intra-day assessments of the price for various physical grades of crude oil, which may be referenced in other spot, term or derivatives deals.”
- Platts (a leading pricing service for the energy industry) “Platts Oil Pricing and Market-on-Close Methodology Explained – A Backgrounder,” Platts, A Division of McGraw Hill Companies, July 2007, page 3.Click for PDF (free registration required)
Additionally all commodities with physical delivery provisions have strong arbitrage links that means that the paper barrel price and the physical barrel price have to trade in relationship to one another. To say that the physical price can affect the paper price but not the reverse is like saying that only one blade of a pair of scissors is doing the cutting – cheap cialis sale online.
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“For Every Buyer There Is A Seller”
Yes! but at what price?
For every transaction in history there has been a buyer and a seller but prices move all the time. In early January when WTI crude oil was $95 per barrel there was a seller for every buyer and in July when WTI crude oil was $145 per barrel there was a seller for every buyer.
By necessity every transaction must involve a buyer and a seller but prices are determined by the enthusiasm / motivation of the buyer compared with the enthusiasm / motivation of the seller.
If you list your house for sale and five buyers show up the same day with their checkbooks in hand you will get a higher price for your house than if your house sits on the market for six months before you see a single offer. Still one seller (you) and one buyer but totally different prices.
As a capitalist economy prices move to “allocate” or match up buyers and sellers. So when you’ve got a tremendous new source of demand in the form of Index Speculators prices have to rise to induce sellers to meet that demand.