naked capitalism

ndk says:

Now that’s much more convincing data. What a spectacular climb in open interest with these revised numbers! I’m hopeful we get a chance to test the correlation between non-commercial open interest and prices on the downside to make this more than a hypothesis.

Regarding your second shortcoming, being economically illiterate, let me offer my condolences. I’d imagine that your ignorance is related to not sharing the belief that major new buyers are unable to affect the fundamental-based pricing of a market. The story goes that the other players will adjust their positions accordingly as the new whale eases into place, so there will be only a transfer of exposure. The price of the asset will still reflect its true value.

Is Yves an idiot, or is that a spurious argument? A word to the wise. This argument has been heavily applied in a second situation: foreign government/central bank purchases of U.S. treasuries.

ndk says:

And since you obviously know the answer to most everything, you might as well explain why spot prices have a higher correlation to long dated futures vs actual supply and demand variables.

I was being sarcastic, and even threw in the for good measure. I agree with the idea that markets don’t necessarily integrate such large new sources of capital cleanly, and apologize both that it didn’t come across in text well and to anyone else I’ve offended.

Thanks for linking the paper, but it strikes me as an exercise in overfitting. It also performs that overfitting against the same data we disparaged a couple posts back.

I think the last few years should have taught us about applying excessive mathematical modeling to markets that involve human beings, with all our caprice and stupidity.

Juan says:

mxq,

thanks for the paper and the Financial Week article that you had linked to in another comment, but it seems the authors of the former are treating the post-1987 oil price regime as a unit rather than recognizing the transformation within this as production and shipments of benchmark crudes fell sufficiently to force a supplanting of the physical to futures pricing channel by the futures to physical channel, something clearly marked by Saudi Arabia, Iran and Kuwait’s shift to use of IPE BWAVE and NYMEX WTI as benchmarks in 2001. The futures, not the physical, became the benchmarks from which it seems odd that short term futures would be less correlated to speculation than to supply. Oh well, perhaps only a methodological artifact.

Anonymous says:

SemGroup (now under chapter 11) is another example of sheer speculation. The 20,000 berrels per day producer amassed 5,000 days (13 years) of short positions. Do you classify them as commercial (as their business suggests) or speculatative player (as their exchange behavior suggests)?
However such large shorts never got the coverage in the news as they do not serve any political purpose.

Anonymous says:

When crude hit $140 @ barrel I posted on The Oil Drum: ‘If it looks like a duck, walks like a duck, and quacks like a duck, it is probably a duck’…Meaning, at that point I thought that even a hermit living in a cave could see that crude oil prices were being influenced by speculation more than demand. I also shorted oil untill it dropped to $123.

For my posts I received no end of negative comment on The Oil Drum, no doubt some of it from long oil posters and the remainder from cheerleaders for peak oil.

Although I do believe that oil is a finite commodity I do not believe that we are running out of the stuff yesterday. Above ground factors are, and will remain, as much a determinate of oil pricing as demand is for some time to come, imo.

Since I no longer post at TOD, I will use this opportunity to give my response to those who heaped scorn upon my humble opinions and remained long oil just a wee bit too long…and to all the cheerleaders for peak oil at TOD.

Nah, nah, na, nah, na!

River

Canadian Peaker says:

that’s cool guys, just ignore all the reports that prove speculation is lagging prices, not leading them, and that speculation is just savvy investors taking advantage of a barrel of oil whose price will systematically keep rising forever (less some imperfect blips along the way) because of SUPPLY AND DEMAND.

You guys are fooling yourself if you think $200/barrel oil isn’t on the way, this minor correction is just correcting the over compensation the market acheived when fear mongering came into play.

You guys make me laugh, blame everyone but yourselves, good ol’ Americans, it’s never your fault, it’s got to be someone else…

Anonymous says:

Too much either/or thinking, not enough meaningful attempt to understand the truth.

Many people, including self posted that speculation may be responsible for some price rise and that manipulation probably was responsible for nothing.

Several told speculation premium was in the range of max $30USD at the time of $147 oil.

Oil is now c. $34 down.

It remains to be seen if it’ll be down more on the short run.

On the long run? Who knows – recession is here. All bets on demand are off.

However, what is still missing is:

1) Proof of how speculation actually affected the sport price of ALL major crude types

2) Analysis how much of the recent fall had to do more with speculation unwinding and how much real demand dropping

It is easy to claim “I was right”, when one half of one’s assumptions appears to be wrong.

More than half of the price rise since fall 2007 is still unexplained by any claimed speculative premium.

If the floor settles at c. $110, then the price rise was more about fundamentals than anything else.

People should remember, that being write with one’s assumptions does not prove anything and that appearances can be deceiving.

We need facts. Let’s wait and see if any surface.

Anybody who is interested in the real workings of the market understands this.

Correlation chasers can go back to their Statistics 101 books and look in the index under “inference, statistical”.

Juan says:

anon 12:14 PM,

1) Proof of how speculation actually affected the sport price of ALL major crude types

This is a feature of the formula pricing structure put in place post-1987. This structure is one in which the prices of various grades of oil are set +/- in reference to a few (3) benchmark crude oils. From this it is not hard to understand that if, say, the price of Brent benchmark crude is pushed up, those referenced to it will also rise (even though rates of change within this can vary).

During the first years of the above, the direction of causation ran primarily from physical trade in benchmark oils to futures, i.e. prices were still dominated by actual sales/purchases of physicals even allowing for the Gulf War spike and slightly later (1993) Metallgesellschaft hedging debacle.

But production and shipments of benchmark oils were declining; the markets became increasingly thin, which facilitated manipulations. And it was just the latter which, in 2001, led dominant producers like Saudi Arabia to make an important shift away from pricing in relation to physical benchmarks to use of futures prices themselves as benchmarks. In this case, that meant shipments to Europe became priced relative to the Brent Weighted Average (BWAVE) as determined on the IPE (become ICE) while shipments to U.S. referenced NYMEX determined WTI lt swt.

The primacy of price determination moved from the physical to the financial where it became, at best, only real market related. The door had been opened.

OK, now think about what else was taking place at the same time:

-Returns from equities were collapsing.
-Very large IBs were recommending addition of uncorrelated investments, commodities, to portfolios, which I think also agreed with CAPM informed reallocation strategies.
-The 2000 Commodity Futures Modernization Act, along with its greater deregulation and exemptions for electronic trading and swaps dealers, had gone into effect.
-Reflationary policies, etc, were driving down cost of money.
-Leveraged speculation was facilitated.

Now, given all of the above + a credit forced expansion, it is hard to even imagine that a commodity price bubble would not arise.

So the head of one of Citi’s commodity desks could note with confidence that:

A flood of investment funds is driving…prices much higher than can be supported by fundamental analysis of supply and demand. It’s a bubble which could grow a lot bigger before bursting.

mentioning as well that

All commodities are involved. All classes of commodities – base and precious metals, energy and softs (agricultural goods), have enjoyed substantial price gains.

Long standing investors in commodity markets (hedge funds, CTAs, etc.) are being joined by long-only funds (mutual funds, pension funds, etc.) who are implementing an asset allocation shift away from more traditional sectors.
…
The growth in investment has been facilitated by new instruments, principally indices and others such as ETFs. Funds of funds are also an increasingly important means of siphoning money into a mix of investment instruments. However, direct investments on the commodity exchanges are also increasing.
Fund flows dwarf those of commodity markets.

The financialization of commodities, bubbling up of prices and some of the amazing rationales were more interesting than what they guaranteed, greater fragility and price drops.

[a theoretical base for the above may not be available within neoclassic econ but, with its concept of fictitious capital, is within at least one of the heterodox traditions]