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Speculators / Rising prices

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UptonStellington

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The abstract question: "Can truly free markets have bubbles?" lies at the root of much of the disagreement here.

Bubbles can happen in a free market. A true bubble is caused by an increase in demand spurred by an increase in the price of something and the consequent expectation of higher prices and opportunity for profit. A bubble is based on the expected growth in price, not the sober evaluation of a price too low. Even a rational trader can buy into an overpriced good if the expectation of profit is there. (The great financial men of the 1920's are said to have met in the late 20's and unanimously decided that stocks were overpriced, and that sitting out until the correction was the most rational course. Most of the men who came to that agreement ended up getting back into the market, lured by the fantastic profits being reaped.)

The current situation is a little different because it is based at least partially on a low dollar value, and even more importantly on a lowering dollar value. An expectation of inflation will raise the value of commodities by increasing their net present value. That is, if inflation is expected to rise to 10%, then the net present value of commodities owned a year from now increases by 10%. The NPV of commodities owned two years from now increases by 21%, etc. The value of a commodities will rise proportionately to their NPV at some point in the future when traders can no longer make a rational prediction of inflation.

We're in a bad situation right now with this credit mess. It looks as if the mortgage bailout as it stands now (not counting Indymac, Freddie and Fannie) has caused the infusion of about a trillion dollars, or more than 10% of our current nat'l debt. The rate of price inflation tends towards the ratio between the growth rate of money supply (including debt instruments) and GDP. With the economy heading into the tank ( per capita real GDP went negative in the fourth quarter of 2007) during a time a frantic money infusion, who knows what will happen when the Fed runs out of options. Bank failures are expected to domino over the next year or so, with the gov't picking up the tab (so far only $4-8B from IndyMac), so commodities brokers are having to extrapolate the growth of spending to stop the credit hemorrhage, the contraction of business in the face of tighter credit and lower consumer spending, etc, etc, to try to find a rational NPV of commodities owned two, three, five years from now. If the avg man starts taking his money out of $$$ and putting it somewhere "safer" you could well see a run away bubble of commodities that will out-pace even a long heavy bout of CPI inflation.

I am hedging against the ludicrous spending the gov't is doing now having disastrous effects, possibly worse that what we saw in the 70-80's. My money is on gold right now, because the gov't has too much control on the price of oil, and could lower it immediately by announcing an increase in U.S. production. While I agree that the present situation doesn't warrant $2000 gold yet, the price for the year of 1980 was around $600, which translates to about $1500 in today's dollars.

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Hedge Funds are being issued Subpoenas in new SEC probe...

The Securities and Exchange Commission has sent subpoenas to more than 50 hedge-fund advisers as part of its investigation into whether individuals spread false rumors to manipulate shares of two Wall Street firms, a person familiar with the matter said.

The subpoenas, sent as recently as Monday, are seeking trading and communications data related to short-selling and options trading in Bear Stearns Cos. or Lehman Brothers Holdings Inc., this person said.

...

Monday, Wall Street law firm Wachtell, Lipton, Rosen & Katz published a memo calling the new examinations into compliance programs "an important first step." But it said "the SEC needs to undertake additional bold measures to constrain abusive short-selling and rumor-mongering."

(From WSJ, but you should be able to read the majority without subscription here: http://www.traderdaily.com/news/item/20507.html)

otherwise, http://online.wsj.com/article/SB1216083953...p_us_whats_news

The day before, a comment made by "Macro Man" (London-based macro hedge fund trader):

At the same time, we have news that the SEC is looking at policing market rumours, particularly those surrounding the financials. Something tells Macro Man that this will be a one-way street; anyone suggesting that, for example, PIMCO and SAC have pulled Lehman's line will face reprisals, but anyone suggesting that Warren Buffett is going to buy Lehman for $100 per share will remain unscathed. The UK has a head start on this particular slippery slope, with the FSA pursuing banking sector rumour-mongers and imposing farcically low disclosure thresholds for short interest in banks doing rights issues.

(http://macro-man.blogspot.com/2008/07/slippery-slope.html)

(PIMCO and SAC are Lehman clients generating massive profits)

Speculators seem to be getting it both ways. If they're not causing higher prices then they're definitely causing lower prices.

Edited to add links..

Edited by yoni
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The scapegoat du jour of the whole situation with rising oil and commodity prices in general, at least amongst the people I speak with, seems to be speculators. It's always, "those damn speculators are responsible for this mess we're in."

Is there any merit to this claim? As far as I can see, it seems as though the speculators certainly fuel the fire. Then again, would that fire exist in the first place to the degree that it does if it weren't for significant amounts of government interventionist policy?

I was talking with my friend who is an energy analyst, and he says there is a big debate among the analyst community as to whether it is a bubble.

The feeling is that it would be due to the large amount of liquid capital that is floating around looking for places to make profits.

For recent history the simplified view of events that effected the US would go like this:

1. In the late '90s there was the dot-com bubble driven by this liquid capital, the big shots were able to pull out before and during the collapse and had money on their hands to invest in ...

2. The real estate bubble of the '00s, and again the big shots were able to pull out before and during the collapse and had money on their hands to invest in...

3. The oil bubble.

So it is all to say the price of oil is being driven by a large quantity of liquid capital looking for the highest rate of return, and finding that return by buying barrels of oil instead of real estate or dot-com stock.

At least that is one side of the debate.

Anyway, if this scenario is true one ought to be looking for the likely next bubble and get in on the ground floor.

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Heh.

Apparently Bush's executive order, cancelling the old executive order prohibiting offshore drilling on much of the US continental shelf, has caused oil futures to plummet. Even though a) the order was redundant because there is still an active law passed by Congress prohibiting drilling and b ) even if we were now free to exploit the continental shelf, it would take *years* for the oil to reach the market--and the futures in question come up a lot sooner.

This tells me a lot of the recent run-up has been purely a matter of future expectations rather than issues with current supply. It also says the market works if it is allowed to work.

edit: damn to hell the idiot who decided b ) was an emoticon for sunglasses.

Edited by Steve D'Ippolito
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This tells me a lot of the recent run-up has been purely a matter of future expectations rather than issues with current supply. It also says the market works if it is allowed to work.

Hmm... over a series of posts at the Carpe Diem blog (http://mjperry.blogspot.com/), an interesting point was made regarding supply. Imagine you are an OPEC member who knows there will be a greater supply of oil several years into the future because domestic drilling had been approved in the US, maybe driving down oil prices by $90. What would you do while oil is still upwards of $130 a barrel? You would sell as much of it as you can, putting downward pressure on current prices.

Of course, domestic/offshore drilling has not been completely approved, but this recent turn of events is a positive step. Not to mention, Lundin Petroleum's major find in Russia, with drilling planned to start in September.

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  • 2 weeks later...

We can probably end this discussion, since now even the Commodity Futures Trading Commission has released its Interim Report on Crude Oil, acknowledging that speculators had no particular role in price increases.

On page 33 (of the PDF document):

Taken as a whole, these statistical correlations and tests are consistent with the view that current oil prices are being driven by fundamental supply and demand factors.

The report was done in July 2008, and "current oil prices" means $140 a barrel.

The report as a whole has many interesting figures and statistics leading to this conclusion, and is a worthwhile read for anyone interest.

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We can probably end this discussion, since now even the Commodity Futures Trading Commission has released its Interim Report on Crude Oil, acknowledging that speculators had no particular role in price increases.

On page 33 (of the PDF document):

The report was done in July 2008, and "current oil prices" means $140 a barrel.

The report as a whole has many interesting figures and statistics leading to this conclusion, and is a worthwhile read for anyone interest.

Excellent, I can't wait for the humble apology from the politicians who called Oil companies in to testify, and all the citizens, and media outlets who sneered at the greedy businesses' who are overcharging and bleeding them dry. If anyone would like to watch it with me it is scheduled for next monday 10 a.m in the World of Make Believe Hyatt.

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Excellent, I can't wait for the humble apology from the politicians.....

Hah! ;) Despite the conclusions of this report, I fully expect Congress to continue along the path of regulating "speculators" out of the market and driving the trading overseas as a result.

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  • 1 month later...

A new study was just released called: See You Later, Speculator! Contrary to what the title implies, it is not saying goodbye to speculators, as in throwing them in jail or anything like that, but it is countering claims that speculators drive up prices.

"In one of the broadest and most authoritative studies to date, the Commodity Futures Trading Commission has offered hard statistical data that financial trading hasn't been driving price moves."

And further: "Lo and behold, the CFTC found that index traders and swap dealers actually reduced their stake in crude oil futures as prices spiked. The number of contracts held by these investors betting that prices would increase -- the net long position -- fell by 11%, and more were shorting oil than going long over the six-month period. In other words, index traders and swap dealers were driving the future price of oil down."

It also has something to say against those government officials who where looking for a scapegoat:

"Then again, the speculation furor [of government officials] was never about the evidence. The politicians wanted a fall guy for rising prices, since the real explanations of supply and demand and the falling dollar were partly their fault."

Got to love it, though I wonder if it will do any good; since these politicians were never for the facts in the first place.

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Now that oil prices have declined considerably, the US House is scheduled to vote on HR 6604. This is legislation that originally failed in July and is now back. I guess it's supposed to stop the kind of oil speculation that caused prices to drop. :D

From what I can tell after briefly reviewing the text of the bill, it will add lots of new and burdensome reporting requirements on traders as well as setting limits on the number of positions that one can hold in a given time period. It looks like another regulatory nightmare to me.

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If anyone else watches CNBC, then they know Rick Santelli. He's my favorite CNBC guest. He reports from the the floor of the CME and is adamantly pro-market. Although I don't know his thoughts on Objectivism, I have heard him mention Ayn Rand a time or two.

Anyway, he schools the CNBC hosts about oil speculation in this video http://www.youtube.com/watch?v=6oGAX1g60HU. It's really worth a listen to hear him stump the hosts between 4 and 5 minutes in. I think the main point he is making is that on the final expiration date of a future contract, at the final minute of trading for that contract, the final buyer must take delivery. Therefore that final buyer would not purchase the contract and take its delivery at (say) $120 when the spot-price of oil in the cash market is $80 (he could just buy oil in the cash market for $40 less).

Edited by adrock3215
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If anyone else watches CNBC, then they know Rick Santelli. He's my favorite CNBC guest. He reports from the the floor of the CME and is adamantly pro-market. Although I don't know his thoughts on Objectivism, I have heard him mention Ayn Rand a time or two.

Anyway, he schools the CNBC hosts about oil speculation in this video http://www.youtube.com/watch?v=6oGAX1g60HU. It's really worth a listen to hear him stump the hosts between 4 and 5 minutes in. I think the main point he is making is that on the final expiration date of a future contract, at the final minute of trading for that contract, the final buyer must take delivery. Therefore that final buyer would not purchase the contract and take its delivery at (say) $120 when the spot-price of oil in the cash market is $80 (he could just buy oil in the cash market for $40 less).

Correct. At some point the poor guy who bought that $120 contract will find it impossible to sell it and he is stuck, $40 a barrel for 100 barrels (I belive the standard contract is 100 barrels). If you trade futures you *must* pay attention and be ready to bail out--or eat the difference. You can lose a lot more money than you invested--theoretically the entire value of the contract (in this case $12,000). Brokerages typically require you to deposit a lot of spare cash before you start trading in case this sort of thing happens. When *that* cash runs out, you get a "margin call" and if you can't pony up the cash then you are in a world of hurt.

Futures markets are not for the faint at heart.

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