U.S. and European Union (EU) regulators are vowing to step up scrutiny on the size and volume of commodity market bets as debate continues to rage about whether excessive speculation is driving up prices on energy, metals and agricultural products.
In an unprecedented rush, investors have pushed a total of $121.2 billion into commodities since the beginning of 2009, according to Barclays Capital. Hedge funds, pension funds and mutual funds in the United States have boosted their positions on oil, silver, corn and wheat to record highs in 2010.
In some commodities, the number of futures contracts outstanding now far outpaces the numbers traded in mid-2008, when commodity market prices shattered records. As a result, regulators in the United States and Europe are considering proposals on how to prevent the so-called speculators from manipulating the markets.
Contracts held by investors rose 12% this year through October and are 17% higher than June 2008, according to data compiled by The Wall Street Journal from the Commodity Futures Trading Commission (CFTC), the market regulator.
Speculative investors now make up a significantly larger proportion of the market than they did in 2008 in several commodities, including the $200 billion crude oil market, The Journal reported.
Investors have boosted their bullish bets on crude oil by 24% since June 2008, and now control 16% of the market, up from 13% little more than two years ago. Bets in the copper market are up 58% and have climbed 52% for silver, according to the CFTC data.
Meanwhile, prices for commodities have surged to new records. Gold is up 29% this year hitting a record just this week. Copper is up 22% and trading near its record high of $4.0775 per pound. Oil busted through the psychologically important barrier of $90 on Tuesday and silver prices are at 30-year highs.
Regulators take a dim view of excessive speculation in commodities markets, arguing that it can distort prices and make it harder for producers and users of commodities to manage their risk. They say it also may negate fundamental investment factors like supply and demand.
Traders point out that there is no data to prove such activity can artificially inflate prices in the commodity markets.
The Dodd-Frank Wall Street Reform and Consumer Protection Act imposed a January deadline for the CFTC to set limits on how many commodity futures contracts in energy and metals a speculator can own. A similar regulation for agriculture markets must be in place by mid-April.
The agency has been collecting data on the over-the-counter market to piece together a framework for the new law, but has yet to announce a firm position on trading limits.
CFTC Chairman Gary Gensler has been pressuring other commission members to take a tough position on excessive speculation and told The Journal the position-limit plan could be considered at a meeting scheduled for Dec. 16.
"Speculative money from the likes of hedge funds, index funds and pension funds is coming into the commodity markets at a blistering pace," CFTC commissioner Bart Chilton said in a speech he made yesterday (Wednesday) at a conference in New York.
"If prices are skewed in a manner that is not fair by speculators, consumers can pay more than they should," he added, noting that while speculation may not drive up prices, it can distort them.
In 2008, riots broke out over food prices and the lack of available and affordable food. The United Nations Food and Agricultural Organization (FAO) estimates that in 2007, 75 million people were added to the 850 million already defined as under-nourished and food insecure.
"Amidst the food price crisis, speculation is a major contributor to extreme price volatility, which is skewing agriculture commodity markets to such a degree that both farmers and consumers are losing out," the Institute for Agriculture & Trade Policy said in a report on the 2008 food crisis.
The European Commission (EC) yesterday followed in the footsteps of the United States, floating its own proposal to limit speculation in the markets, The Journal reported. The proposal is among a number of measures springing from a review to tighten trading regulations under the Markets in Financial Instruments Directive (MiFID), the EU's main securities trading law.
"I don't think there's any reason why we Europeans should be less rigorous than the Americans," Michel Barnier, the EU commissioner in charge of financial regulation, said at a press conference.
Among other proposals the MiFID review will include an examination of so-called "dark pools," or trades executed outside the regulated markets, and high-frequency trading systems, where hedge funds and traders make money on tiny discrepancies between the prices of different securities.
The commission said it may require the trading platforms to be fully regulated under MiFID, have "robust risk controls" and automated "circuit breakers" to prevent trading algorithms from causing market crashes, The Journal reported.
High frequency trading was widely blamed for last May's "flash crash" which caused markets to suddenly tumble precipitously. But a report released in October by U.S. regulators blamed the slide on the sale of a large block of stock futures by Waddell & Reed Financial Inc. (NYSE: WDR), a mutual fund based in Overland Park, Kansas.
News & Related Story Links:
- The Wall Street Journal:
Investors Pile Into Commodities
Dodd-Frank Wall Street Reform and Consumer Protection Act
- Institute for Agriculture & Trade Policy:
Commodities Market Speculation: The Risk to Food Security and Agriculture
- Wall Street Journal:
EU Seeks Limits on Commodity Trading
- Money Morning Archives:
- Money Morning:
You Heard it Here First: Silver's 30-Year High is Just the Beginning