March 21, 2012

TOPIARY TIME:

Speculators are driving up gas prices (Dennis Kelleher, 3/21/12, @CNNMoneyMarkets)

Commodity markets -- including those for wheat, corn and crude oil -- are very different from capital markets, which exist for anyone to speculate in stocks.

The commodity markets, however, are for commercial purchasers and producers to control their risks by hedging against future price moves.

Commodity futures markets were created so that wheat farmers and oil producers could sell their products today -- even though they won't produce and deliver them for months.

A food company that uses wheat to make cereal could pay a farmer today for delivery in a few months. The farmer can then plant his crops knowing there will be a buyer at a set price come harvest time.

Similarly, commercial buyers can plan today because they know what price they will pay tomorrow. Commodity futures markets allow buyers and sellers to match up and ensure that they get paid.
Speculators are allowed to participate on a limited basis because there aren't always enough sellers to match the demand for buyers, or buyers to match the availability of sales.

For decades, market participants have known that commodity markets work best when speculators make up 30 percent of market activity, with the remaining 70 percent devoted to commercial traders.
With the new tidal wave of investment, that ratio has flipped. Now, speculators are about 70 percent of activity in many commodity markets and commercial hedgers only about 30 percent. This is largely the result of investment banks creating and selling "commodity index funds" that gamble on, and usually drive up, food and energy prices.

Our organization, Better Markets, has conducted a comprehensive study showing that this "invasion of the commodity index funds" has radically changed the price structure of commodity markets.

In the past, prices were based largely on supply and demand, but they are now driven up by investors placing self-fulfilling bets on higher prices for oil, wheat and other products.

The study finds strong evidence of a direct causal link between speculative buying and selling, and changes in commodity price curves resulting in increasing prices.

To combat this and, in particular, to remove the speculative price distortion, commodity index funds should be prohibited.

Posted by at March 21, 2012 6:37 AM
  

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