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The Persistent Power of Finance, Um, JP Morgan

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By C.P. Chandrasekhar, Professor of Economics, School of Social Sciences, Jawaharlal Nehru University, New Delhi. Cross posted from Triple Crisis

In a move that went contrary to what is expected of regulators, the Securities and Exchange Commission of the US approved in mid-December a controversial JP Morgan-created exchange-traded fund (ETF) backed by physical supplies of copper. The fund will use investor money to buy and hold copper, presumably to earn a profit when prices rise. According to a NASDAQ analysis the investment vehicle will register 6.18 million shares backed by 61,800 metric tonnes of copper in physical form stored in warehouses approved by the London Metal Exchange or located in the Netherlands, Singapore, South Korea, China and the US, and not approved by the LME. With this decision of the SEC, copper joins metals such as gold, silver, platinum, and palladium that are already traded through ETFs. If the JP Morgan proposal goes through so would another ETF proposed by Blackrock titled iShares Copper Trust, which awaits SEC approval.

Copper is a metal much in demand for electricity wiring and various industrial uses that are growth areas in many emerging markets. The result is that copper has been trading in rather tight markets. According to the International Copper Study Group, apparent global usage of copper rose by grew by 5.2 per cent during the the first nine months of 2012 as compared with the corresponding period of 2011, driven largely by a 19 per cent increase in China’s apparent usage. China accounted for 43 per cent of world usage over this period. As a result the refined copper balance for the first nine months of 2012 points to a deficit of 594,000 tonnes, which was more than a third of refined copper production with capacity utilised to the extent of 80 per cent. While slowing growth in China may have led to accumulation of inventories, the market is indeed tight. According to the Economist Intelligence Unit, copper will be the strongest performer among metals in 2013, with prices rising by 12 per cent thanks to the supply-demand balance.

Given this context, the SEC’s decision has been mired in controversy though taken after a delay of more than two years since JP Morgan first proposed the fund. The fundamental issue is whether the process of buying and holding claims on physical stocks of copper would keep supplies out of a tight market and drive up prices to deliver speculative gains to financial investors. Copper traders and users argue it would. The JP Morgan and Blackrock ETF’s together would, in their view, reduce copper available for immediate delivery by about 34 per cent and “wreak havoc” as a result of a “substantial artificially induced rise in near-term copper prices.” Complainants include companies such as Southwire, Encore Wire, Luvata and AmRod and a trading house, Red Kite.

The SEC on the other hand has held that since copper held by the fund can be redeemed in three business days against a share purchase, there would be no “meaningful change” in availability. Rather, in its view this provides another route to purchasing copper and thereby increases competition in the market. This argument makes little sense since creating a financial instrument against physical copper is essentially a way of offering one more alternative asset to financial investors interested in profiting from speculation in the copper market. At a time when restrictions on futures trading in commodities has been recommended by the Dodd-Frank Wall Street Reform and Consumer Protection Act, inducing additional elements of speculation into the market is hardly defensible.

Moreover, the SEC’s argument, which suggests that it has bought into JP Morgan’s reasoning, flies in the face of facts. Thus, according to the Financial Times, since the launch of physical gold ETFs in the US in 2004, they have collectively acquired $140 billion worth of gold (which is more than what most central banks hold), in the aftermath of which gold prices have risen by 282 per cent. Similarly, a new palladium ETF launched in 2010 acquired 505,000 ounces in two months, which was equivalent to 42 per cent of mine production over the period. The result was that prices rose to a two-year high, forcing even JP Morgan to admit that ETF buying had “crowded out” the market.

Stuart Burns, writing on Seeking Alpha, refers to similar evidence from the aluminium market. According to him: “Financial involvement has distorted the aluminium market so badly that there are officially some 5 million tons and potentially twice that sitting isolated from the market in park-and-ride finance deals. The resulting competition for metal has created premiums for primary ingot over and above the LME price.”

In sum, the SEC was not short of evidence to reject JP Morgan’s proposal. That it has instead decided to back it points to the influence that finance capital exerts. At the time of the 2008 financial crisis there was enough evidence that it was not because of regulatory failure but in part because of regulatory capture and collusion that matters took the turn they did. The post-crisis debate had raised expectations that this would be corrected. The SEC’s decision, along with developments in other markets, is strong evidence that those expectations have been belied.

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37 comments

  1. YankeeFrank

    The idea that those who wish to profit from a rise in the price of a commodity would freely sell that commodity instead of holding, and thus squeezing, supply in order to encourage that price rise is laughable on its face. That the SEC claims such speculators are instead providing what amounts to liquidity and increased accessibility just shows they don’t care at all how ludicrous their assertions are.

    Speculation in commodities must be banned, period.

      1. F. Beard

        How about banning the use of credit (i.e. essentially counterfeit money) to speculate with? Why should an unlimited (“loans create deposits”) money supply be available to bid against a finite resourse?

  2. HAL

    There are also silver and oil ETFs – should these also be prohibited? How about futures contracts? Do you think that the existence of gold ETFs is what made the price increase, or negative real interest rates and currency debasement across the globe? The implicit rhetorical post-hoc ergo propter hoc you employed is not what I expect of the writing on this site.

    If there are positive returns to purchasing and holding commodities, investors (particularly those concerned about inflation) will want to purchase them. There are a lot of ways that our financial system is totally fucked. Allowing a broader class of investors access to investments commodity metals in ETF format is not one of them.

    A more legitimate complaint would be that JPM, in particular, is a bad-faith market participant as seen through their “not-quite-shady-enough-to-press-charges” manipulation of the silver market. Ordinarily, I’d say that’s fine, too, and if they want to pile up derivative exposure to a commodity (in the case of silver, a massive short position) in the course of running an ETF, then that’s a risk they can bear, and market participants might prefer and switch into a more reputable ETF (like Eric Sprott’s PSLV) or not. Of course, since JPM is TBTF and therefore backstopped by the taxpayers, their involvement is much more problematic, but that doesn’t really have much directly to do with commodities or ETFs.

    1. Yves Smith Post author

      You seem to have missed the details of the SEC ruling, which we posted on before. Silver and oil ETFs are based on financial futures. There are reasons to think oil ETFs have a direct impact on commodity prices (I discussed this at length on the blog and in ECONNED) because OPEC prices are set by long term contract based on an average of futures prices called the BWAVE. And I think there IS reason to be concerned about that (as in having people just seeking an inflation hedge, as opposed to acting in the market as speculators, meaning liquidity providers, distorts real economy pricing mechanisms). Look at the oil bubble in early 2008, for instance.

      The product that JPM got approved allows JPM to warehouse copper, not just create a financial futures product. That will have a DIRECT impact on the physical market. The CFTC was opposed but JPM end ran them by going to the SEC.

      http://www.nakedcapitalism.com/2013/01/sec-gives-jp-morgan-and-other-big-banks-license-to-manipulate-commodities.html

      I don’t object to using gold as an inflation hedge, that has limited real economy uses (mainly jewelry and dentistry). In general, in precious metals, the “store of value” and jewelry uses have exceeded industrial applications.

        1. Yves Smith Post author

          Please reread my comment. I never said any such thing, plus I made it clear that my objection to the JPM product is that it will involve warehousing copper.

          People speculate in physical gold and silver other than by buying ETFs. I know quite a few people who own gold and a few who’ve speculated in silver (when the Hunts tried cornering silver, a lot of normal people sold their silver services to dealers who were clearly going to melt them for the metal value. I know a small # who own physical silver rather than ETFs).

          1. OpenThePodBayDoorHAL

            Yves I think you’ve missed this one. Silver and Gold ETF’s are contractually “backed” by physical silver and gold (whether they uphold those contractual obligations, or wiggle out by “holding” gold that has been leased to someone else is another question). Adding copper to this list of metals is a bad thing. But perhaps the most insidious thing that happens when there are all of these paper claims on silver and gold: they turn silver and gold into “fiat” money. The gold and silver price no longer reflects the limited supply and demand of the metals, the very characteristic that makes them the favorites of the gold/silver bugs for backing a currency. We are well and truly through the looking glass.

        2. skippy

          Physical… is only empirical if you hold it… every thing else is trust~

          Skippy.. in light of the machinations by the sellers to date… WTF are you gabbing about.

      1. HAL

        I don’t understand – isn’t JPM already allowed to warehouse copper? Do you have to have a license to rent a warehouse and put a bunch of copper in it? There are hedge funds who rent boats and fill them with oil, parked near Houston or London. There are timber REITs that allow individual investors to gain exposure to forestland (and then perhaps horde lumber by not cutting trees down when prices are low). In a truly free market, these sorts of actions (like the Hunt brothers silver corner) are self-limiting. If you buy up a commodity above what people are otherwise willing to pay for it, either supply will increase or demand will fall, and you’ll never really be able to cash out.

        I think SME Mofo below nails it on the head. The banks get to print their own money and borrow for free, and then use this free money to buy durable, useful commodities, then what you have is bad money crowding out good. The solution is not to try to prohibit people from investing in commodities, but to stop giving TBTF banks unlimited free money.

        I agree that it’s a problem, but I can’t say I’m surprised that the SEC rulemaking process didn’t acknowledge that JPM et al are given a bunch of free money and would like to buy durable, non-printable goods with them. When you have a professor of US administrative law who is genuinely surprised by the outcome of this SEC action, get back to me.

        1. Yves Smith Post author

          A free market is an oxymoron and does not produce virtuous outcomes. I wrote about that at length in ECONNED.

          First, I have a problem with a TBTF bank that is clearly government backstopped speculating in copper, so you already are barking up the wrong tree with your argument. But even accepting your premise, there is a big difference between a firm (which can only do so much damage) warehousing copper and making it easy for them to do other people’s money to do that, which will greatly increase the capital they employ.

          And on top of that, go Google “date rape” and “GSCI” and see how banks abuse customers (or see my writeup: http://www.nakedcapitalism.com/2007/02/how-big-traders-can-extract-excessive.html). These products are not the manifestation of any kind of desirable behavior, they are licenses for banks to take advantage of investors and distort real economy markets. Just one example: volatility is attractive to traders. I’ve sat on trading desks and seen traders push HUGE markets around. Volatility is a nightmare to businessmen trying to plan and deters investment.

    2. bmeisen

      How about a commodity based ETF that targets a specific location – I’m thinking bread in Deluth. The fund buys bread from Wonder’s Deluth factory and holds it until the price increases, sometime around noon, at which point it begins releases that are timed to optimize returns.

  3. OMF

    This is extremely serious. As with real estate, it is clear that allowing financiers influence over any market causes price distortions and inefficiency. This is unsurprising given the essentially criminal practices of modern finance. To see this happen(worldwide) in fundamental industrial commodities is disturbing.

    The solution is clear: Ban these financial instruments. ETFs should be wound up and metals trading returned to efficient historical standards which have stood the test of time.

    I imagine some young “geniuses” with more experience playing video games than with commodities markets will take exception to this. Irrelevant. The world’s trading systems do not exist for the intellectual edification of arrogant, misallocated geeks, nor for the enrichment of criminal bankers.

    There needs to be a clearing out of the SEC, and a subsequent clearing out of all these toxic trading instruments as soon as possible.

  4. Conscience of a Conservative

    Not following the logic here. I cannot find anything inherently wrong with customers of JP Morgan or another bank deciding to be long a physical commodity.

    1. LucyLulu

      Okay. I live in Egypt and spend 80% of my income on food. Speculators buy up grains after the drought this summer, driving up the price of wheat 50%. I have to decide which days of the week I want to eat.

    2. profoundlogic

      Logic suggests that when you have people like Blythe Masters or others working behind the scenes to boost profits of the firm (be it JP Morgan or any one of our other infected financial bohemuths) there are going to be negative consequences for the general public not privy to the insider loop.
      The issues here are multi-fold. First the EFT in question is tied to physical and not to a futures contact as she clearly points out. Second, you are also dealing with a firm which has made it blatantly clear that they’ll use their bailout-recapitalised balance sheet to go balls-to-the-wall at the roulette wheel if they think it will juice their bottom line (London Whale). Heads they win; tails we lose. Free money is free money when you have the right cufflinks.

    3. Yves Smith Post author

      We accept that there are limits to speculative activity if it can produce externalities or lead to destructive behavior. You are not allowed to buy insurance on your neighbor’s house because you have an incentive to burn it down.

      On this site, I called the oil bubble in 2008 and traded it correctly (shorting at over $140/barrel) because it was clear speculators were impacting the price (with oil, you can identify links between futures speculation and cash prices that are not present in other markets). Some economists (James Hamilton in particular) thinks the runup in oil prices was what kicked off the GFC (as in it pushed subprime borrowers faster than they would have died otherwise). Not saying I buy that, but the price runup did have a significant real economy impact. This JPM product provides a far more direct link to influence market prices than you saw with oil futures in 2008.

      Put it another way: after what Enron did to electricity prices in California, you are seriously going to tell me unfettered speculation in essential real economy commodities is just dandy?

      1. diptherio

        ooh, ooh, painting metaphor….

        So, society is like a wall, “sins” are like imperfections on the wall, and ideology is the paint that supposedly covers up those “sins.”

        But as any (good) painter can tell you, a coat of paint doesn’t actually hide imperfections. In fact, it can make them more apparent. If you really want a beautiful wall, you have to spend a bunch of time scraping off all the imperfections first. Good painters spend more time scraping and sanding than actually painting. Only lazy painters neglect the tedious task of preparing the surface and just slap a coat of paint on it.

        So, for purposes of the metaphor, if we want to end up with a “beautiful” society, we need to first spend a lot of time scraping away imperfections, i.e. removing all the crime and corruption, the systemic fraud, the captured regulators, etc. Only after we’ve done all that can we justifiably cover the whole thing with our preferred color, i.e. ideology.

        But if we get lazy and just throw the ideology on without first concerning ourselves with the pre-existing flaws in society, we just end up highlighting the flaws and actually making them worse. So if we try to throw our “efficient markets” ideology on top of a system rife with informational asymmetry and manipulation, we only end up worsening those problems.

        Like paint before it’s been applied, ideologies are pure. The world, OTOH, like all surfaces, is full imperfections, contradictions and paradox. Different ideologies are like different colors of paint, each pure, each unique, and each just as valid as any other. The problem arises when, mesmerized by the beauty of our preferred ideology, entranced by its pure, perfect hue, we become over-anxious and try to apply it to society before society has been adequately “cleaned up.” The results are predictable. If you stand back a bit and squint your eyes it looks OK. But if you put your glasses on and stand a little closer it just looks like absolute crap.

        All of our arguing over ideologies amounts to this: screaming at one another over which color of paint is better (which is ridiculous, since this is essentially a matter of taste), without first having addressed ourselves to scraping, sanding and stripping all the dirt and grime and detritus off the wall we intend to paint. Regardless of who wins the “color war,” the end result is going to be a shoddy looking piece of work.

        End philosophical aside.

        1. knowbuddhau

          I like your metaphor, diptherio. I really like how you extend it to reform/revolution.

          As an experienced house painter, I can confirm that painting is indeed all about the prep. I spend the vast majority of my time cleaning, repairing surface imperfections (spackling, puttying, caulking, priming, etc.), masking, and stirring, before I apply any paint.

          The fun part: taking a nice, well-crafted Purdy brush; fully loading it with all the paint it can carry; and brushing like mad, is all too short. Spray painting is even worse. I often spend more time setting up the spray rig, then cleaning it out, than actually painting.

          If you do the prep right, intending beauty with every move you make before ever opening a can, the paint seems to flow itself in place. Before you know it, it’s time for touch-up, where you put a little more where it’s supposed to be, and remove it from where it’s not. Then, you’re on to the next job, where it starts all over again.

          I will point out that one doesn’t need to, and never really gets the chance anyway, to perfect an object before it gets painted. I never get the chance to make things as beautiful as I know I can. Beautiful enough will do.

          Houses are outside, after all. Birds are just going to crap on your work anyway. And bugs always land in the paint before it dries. Also, no matter how tall the ladder you stand on, there’s always something just out of reach. When doing interiors, there’s often a whole family waiting to get on with their lives.

          It only needs to be as paint-worthy as you can get it in a reasonable time. Mistakes will be made. Touch-up happens.

          And even when you’re done, it’s not over. Like rust, dirt and rot never sleep. Even the best paints, applied by the best painters, using the best methods, will fade over time.

          I’ve been thinking along these lines for some time now. Grateful for the chance to explore them with you.

          BTW, they don’t call me Sir Preps-A-Lot for nothing. ;-}

    4. Lune

      I’d argue that hoarding is a sign of market inefficiency: if someone who has no use for a product buys it, then the market isn’t being efficient. After all, the goal of market efficiency should be to ensure that every product be exploited to its maximum utility. A hoarder is an indication that mechanism has broken down.

      If JPM can make money by hoarding copper (as opposed to using it), then there’s something wrong. In this case, we know what’s wrong. JPM has a spigot of free money available due to its governmental backstop, which none of the copper users have. Secondly, they are large enough (TBTF) to be able to substantially affect the price of copper with their purchases. Combine unlimited free money with monopoly-type power to dominate a market and you get a gross distortion of the free market.

      If you gave users unlimited free money, they’d hoard the copper themselves since their cost of carry would be minimal, and JPM wouldn’t have a supply (at least at current prices). Conversely, make JPM’s cost of capital / cost of carry determined by the free market and they’ll find hoarding copper for years to be a losing proposition. Either would be a substantial improvement over JPM introducing market inefficiency into a market that otherwise is functioning fairly well.

  5. SME MOFO

    1. Print Money.

    2. Give it to your friends in exchange for piles of worthless claims on stinky mortgage portfolios.

    3. They buy huge quantities of useful stuff that can be cheaply archived without spoilage, that has no counterparty risk, and that can be shipped away if .gov gets grabby.

    4. They juice returns by continuously rehypothecating claims to a wide cast of slow moving chumps, shorting vega, pinning expirations, and shoving the pricing around on Sunday nights when a guy named stu and his cousin are the only market makers awake.

    5. Profit!

  6. allcoppedout

    These ETFs look like the monopoly blaggs prevalent in the 18th century – such as Barings’ attempt to monpolise cochineal, then a major commodity in the tanning industry.

  7. Schofield

    How is this copper speculation any different than the banks blowing an inflationary house price bubble? The outurn is to artificially raise costs for the real economy. The Obama administration is utterly corrupt!

  8. Tom

    Instead of cornering a market they just get enough leverage to grab the steering wheel and drive prices. The result is low risk investment with guaranteed returns. Sort of taking QE mainstream in private hands.

  9. Tom

    I think it is clear that the moneyed interests are following a path toward plutocracy – whether it is deliberate or, a result of their blind establishment of laws and politics to serve their (captains of financial rent seekers) legally binding requirement to increase shareholder value (another debate as to whether they are or are not meeting these requirements). The result of their actions in their ideologically constructed ‘free market’ is a race toward plutocracy (already there).
    I believe the direction is deliberate in a sub-conscious way – it still does not make their actions less assignable or less fraudulent and less culpable when in opposition to democracy and our constitution.
    A simple reading of Investopedia definition of Plutocracy is enough:

    Plutocracy
    A government controlled exclusively by the wealthy either directly or indirectly. A plutocracy allows, either openly or by circumstance, only the wealthy to rule. This can then result in policies exclusively designed to assist the wealthy, which is reflected in its name (comes from the Greek words “ploutos” or wealthy, and “kratos” – power, ruling).

    Investopedia Says:
    A plutocracy doesn’t have to be a purposeful, overt format for government. Instead, it can be created through the allowance of access to certain programs and educational resources only to the wealthy and making it so that the wealthy hold more sway. The concern of inadvertently creating a plutocracy is that the regulatory focus will be narrow and concentrated on the goals of the wealthy, creating even more income and asset-based inequality.

    Certainly the continuum of outcome can be defined differently and debate can be had…are we in an oligarchy, fascism or other non-USA form of governance? The point remains, we are off the rails and dragging all the cars off the tracks… the direction is established, where we land is not.

  10. tawal

    So where is the ETF buying the physical copper from? The “market” or some big private horder, like the Koch’s?

    1. sierra7

      Just got a “giggle” remembering “Wall Street”, the movie!
      One line in particular….the manager of the opening scenes of the “trading floor”:
      “…..Too much Godda&* free money out there!”

      How appropriate for the present time!!

  11. Titus Pullo

    I’m with Yves on this one. The SEC’s decision ends the distinction between precious metals traditionally used for investment and metals we consume in large quantities. This means that the “real” economy may be detrimentally affected by the “financial economy”.

    Interestingly, in 1996 when a Japanese financier Yasuo Hamanaka,”Mr. Copper” (the chief copper trader at Sumitomo Corporation (one of the largest trading companies in Japan at), did this and his company was fined $125 million by the US government and “Mr Copper” jailed after Sumitomo lost 2.6 billion dollars (a huge sums at the time) in unauthorized copper trading by on the London Metal Exchange.

    Sumitomo deflected criticism of its illegal actions by implicating JPMorgan Chase and Merrill Lynch as funders of the scheme – the banks had granted loans structured as futures derivatives. As a result, Sumitomo, JPMorgan Chase and Merrill Lynch all were found guilty.

    A well, Mutatis mutandis

  12. Lune

    Does anyone know how JPM was able to sidestep the CFTC? I think that’s the real question here.

    JPM was smart to get this through the SEC. Not only are they thoroughly captured, but as a regulator of equities, they have no real mandate to consider the external ramifications of their actions. Equities are purely a financial instrument plain and simple.

    The CFTC, OTOH, while not being immune to regulatory capture, at least understands that the point of commodities futures isn’t to enable speculator riches, but to facilitate transactions between actual producers and consumers.

    I’m surprised the SEC would approve this over the objections of the CFTC, but depending on how cleverly JPM structured the ETF, they might not have had a choice…

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