We have seen unmitigated selling in most commodities over the last few weeks or so. Some have stated that the reason for such selling is worries about the global economy as well as just good all profit taking, all of that can be true, but one big reason for the weakness has to be what the CTFC is proposing later this month.
The Commodity Futures Trading Commission (CTFC) will consider plans for greater regulation of Oil, Gas, and other Commodities markets.
Its planning to review exemptions to position limits handed out to Goldman Sachs and Morgan Stanley that basically allows them to corner any market they are trading in.
Looking carefully at the situation. Both Goldman and Morgan Stanley have huge commodities trading operations. They are able to build positions in commodities without any oversight into their position limits, which basically allows them to do what the Hunts did with the Silver Market many decades ago.
That was only Silver, what MS and GS basically been given is to have free reign to run up the prices of any hard/soft commodity, you know the ones that people use to fuel their cars and feed their bellies. These two were the primary cause for $147 Oil and soaring grains prices. When the bubble popped last year, you saw a crash on all hard/soft commodities.
How do they do it?
Both GS and MS are very significant OTC Swaps participants, and they’re very significant dealers for OTC swaps in the commodities market. Especially the energy swaps market which basically is the Wild Wild West. Energy swaps are trades in which parties exchange the difference between two price payments, one fixed and one floating, for a specific commodity for a period of time.
Any type of regulation or change in position limits will force GS and MS to find other ways to reduce their risk or reduce the size of their commodity swaps books. Basically they are leveraged to the sockets with these swaps, and the only way they can lose money is if someone tells them you cant do this anymore. The recent downdraft in commodities especially Crude Oil is because of this proposed change.
Most of what we have seen over the last few years in commodities markets has nothing to do with the fundamentals, it was all cornered speculation.
What typically happens is this:
Goldman And Morgan Stanley because of their CFTC exemption accumulate vast amounts of futures contracts in any commodity. They are able to buy far more contracts then what they are regulated to do, because of the amount of money they both have as well as this given exemption.
BTW...this exemption was to be given for real hedging not speculation.
After building up a massive position that no ones knows about, magically an analyst report on how great the demand is for global commodities is sent out from guess who? Morgan Stanley and Goldman Sachs!
This Report basically is bullshit to pull the wool over peoples eyes to support the trading positions of GS and MS.
Case in point: The $200 Crude Oil prediction call by the Goldman commodities analyst in 2007 when the price of Crude was 75. Self Serving.
Back to the CTFC.
Exchanges regulated by the CFTC are allowed to set their own position limits or accountability levels which are designed primarily to keep one party from gaining too much control of a market. The limits are applied to futures that call for actual delivery of the commodity rather than settling in cash.
Remember Commodity Futures settle for the physical good while Stock Equity Futures settle for cash. These guys at GS and MS went so far to actually buy Oil Barges to store the oil they were buying.
Investment banks typically use commodity market transactions to protect themselves against financial risk from deals that have very little to do with the actual production or consumption of the commodity in question. That differs from hedging done by energy producers or consumers who have a direct stake in the price.
Again futures markets were developed for farmers to hedge against price declines/advances, not for speculation.
The Nymex’s position accountability levels and limits restrict oil traders to 10,000 net futures for any one trading month, and 20,000 net futures for all months, though they can’t exceed 3,000 contracts in the last three trading days of the spot month. Natural gas traders are limited to 12,000 net futures and 1,000 in the last three trading days.
Traders can go above those levels, though such moves open them up to review by the exchange, which can tell them to reduce or freeze their position. Traders can often get around the Nymex limits via loopholes that allow them to invest in futures and swaps on other exchanges. The CFTC is trying to close some of those loopholes, which have been blamed for price fluctuations and wild price swings.
The only way to keep speculators out of the market is position limits.
The WSJ has an article today that:
U.K. Prime Minister Gordon Brown and France’s President Nicolas Sarkozy believe volatile oil prices have caused grave damage to the world economy and must be addressed urgently, they said in an article they wrote for the Wall Street Journal today.
“The oil market is complex, but such erratic price movement in one of the world’s most crucial commodities is a growing cause for alarm,” they wrote in the article, posted on the newspaper’s Web site.
Many people are misguided when they say that position limits on investment banks would cause liquidity to dry up and prices to rise. Totally false. These guys don't need to have exemptions, just make an orderly market, speculate if you want to, but do it within the confines of the exchange rules.
Bottom line....this market was created for hedging not gambling.
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