Daniel Dicker, a former oil trader writing at TheStreet.com, contends that there is a way to test the hypothesis that speculation is influencing oil prices (a view that Dicker supports). Exchanges could impost a “liquidiation only” requirement, which was last used to break the Hunt brothers’ attempted corner of the silver market in the early 1980s (hat tip reader Michael).
Note that while we believe that oil prices will inevitably move higher as supplies become more scarce, we have trouble believing a 50% price appreciation in five months is solely the result of fundamental factors. Reader Juan provided this quote from presentation by Frank Veneroso last year to the World Bank:
[O]ne may ask, is it a bubble? Two years ago the noted money manager Jeremy Grantham posed this question in an interesting way. He presented a chart of the real inflation adjusted oil price going back to 1875.He then noted: “Over the years we have asked over 2000 professionals for an exception to our claim that every asset class move of 2 sigmas away from trend had broken, and not one of the 2000 has ever offered an exception! This should be scarier than the fact that GMO has tried so hard to find one and failed. But we always have said that intellectually you can imagine a paradigm shift in an asset class price, even if we have been unable to document one yet in history. …
However, one must note that some of these two sigma moves took a while to revert. Juan reports that a two sigma move of oil in the late 1990s did not fully correct (it saw only a one sigma fall). But the general premise is worth noting.
Dicker has mixed feelings about this idea but believes it is likely to be implemented.
From TheStreet.com($):
I’ve been a strong advocate for the position that the price of oil, while under fundamental upward pressure, contains an enormous speculation premium…I’ve always argued that the speculation in the market has not been manipulative but just a rush to improve gains in commodities…The futures markets, however, were designed as simple price discovery mechanisms…Because of this, the rush to invest in oil and other commodities has had a geometric effect in price that you would not witness with other asset classes…
Unfortunately, some problems do not lend themselves to simple solutions..Two instruments are called upon to rein in excessive speculation: position limits and margins. Let me add two more that will surely be called upon soon: a ban on pension and indexed investment in commodities. Let’s take all four and describe why they’ll be less than useless.
Margin increases will have a very limited effect on the commodity markets, because the leverage on them is so high to begin with. …Position limit tracking would be practically impossible and even less useful; those who wanted to skirt them could easily…avoid all invented limitations on positions….
More interesting is the idea of limiting pension and indexed investment in oil. But here too, the managers of those funds would be easily able to access the over-the-counter markets domestically…
You see, all the solutions that I have heard proposed require that you define the motive of the participant — that you somehow figure out which contract of oil is initiated as a true hedge or as a speculative investment, and in this, even the participants themselves would be hard-pressed to know.
That is the environment we have created. Everyone’s a trader — very little in the futures markets is “purely” hedge or “purely” speculation anymore…
In one instance, however, the speculation premium was “successfully” tested – in the silver markets in 1980 when the Hunt brothers attempted to corner the market. As silver approached $50 an ounce in January 1980, the commercial participants asked for relief from the enormous margin calls from ever-rising prices. The CFTC and the Comex (the predecessor to the Nymex) responded effectively by imposing “liquidation-only” trading — traders were allowed only to close existing positions and not permitted to initiate new positions.
This forced purely speculative positions to be closed rapidly, as they could no longer be “rolled” into future months at expiration. This caused the price of silver to drop by $12 the day after it was imposed, a decrease of over 20%! Over the course of the next three months, as contract months expired, the price dropped over 50%.
While I do not advocate such a move,…I believe that in an election year this will inevitably be suggested and implemented. The effects would be astonishing and immediate. Energy funds would be buried, and commodity-biased portfolios hurt badly…
One thing is for sure: A “liquidation-only” market would settle finally and for all time the argument about speculation premium in the oil markets
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Flush this:
Barclays warns of a financial storm as Federal Reserve’s credibility crumbles
http://www.telegraph.co.uk/ money…barclays127.xml
Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall “below zero”.
“We’re in a nasty environment,” said Tim Bond, the bank’s chief equity strategist. “There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth.”