HedgeWorld has published several stories of late on the great debate over commodities prices, especially those of the energy group. Is there a speculation-driven bubble underway? or is the increase result of the fundamentals? Alfred Marshall is supposed to have said that even a parrot can be taught to be a competent economist. He need only be instructed to squawk “supply” or “demand”!
In understanding crude oil or natural gas prices, do we have to expand the parrot’s vocabulary?
I wrote about this matter this week under the inspiration of a speech by Michigan Senator Carl Levn, and a discussion with an expert at Barclays link here , and the general farm commodities subcommittee of the House rather helpfully followed up on the subject for me yesterday and here .
Here are three bullet-points from the first of those stories, to help get us started:
â¢ More hedges than speculation:
One of the flaws in many arguments for the bubble-theory is the identification of derivatives trading with speculation. Much derivatives trading is done for industrial hedging.
Fact: NYMEX in a recent statement, said that the percentage of open interest in NYMEX crude oil futures held by non-commercial participants, i.e., speculators, vis-Ã -vis commercial participants actually decreased over the past year even as crude oil prices have increased dramatically.
Meaning= A good sign that “rampant speculation” is not a “key factor in price spikes.â
â¢ A lot of hedges by industries: see Greenwich Associates’ May 2008 paper on âthe global commodity boom.â
Itâs a recent survey of how companies around the world hedge their energy commodities exposure gives some sense of the predominance of commercial (non-speculative) use of derivatives.
Not all this hedging occurs on regulated exchanges, either. Much of it involves over-the-counter products. Indeed, Greenwich found in its study that the bulk of the active trading volume in over-the-counter commodity derivatives comes from petroleum producers, utilities and airlines. That’s important, because it, too, helps to correct the over-emphasis upon hedge funds.
â¢ It only works one way: When itâs up?
It is interesting that Sen. Carl Levin (D-Mich.) doesn’t complain of the price decreases caused by Amaranth. Yet one would make as much sense as the other. A complaint brought against Amaranth and trader Brian Hunter by the Commodity Futures Trading Commission actually focuses on two trading days in 2006: Feb. 24 and April 26. It alleges that on each of those days, Mr. Hunter and Amaranth sold heavily on the New York Mercantile Exchange in order to artificially depress natural gas and futures prices and benefit their significant short positions on the IntercontinentalExchange.
No net effect in either direction, up or down, is the obvious or inevitable result of Amaranth-like activity, however characterized. “We [at Barclays] see fundamental supply and demand factors driving the market price of crude oil and distillates. We don’t see hedge funds or speculation as having a significant impact,” according to their expert, Paul Horsnell said.
Surely if the collapse of Amaranth Advisors in 2006 tells us anything it tells us that prices don’t do what the Brian Hunters of the world… Otherwise Amaranth would still be in business.
On the other hand:
A story yesterday by Michael Fischer discussed the strategies of CrossBorder Capital and its chief executive Michael Howell.
Mr. Howellâs view, which he attributes to his schooling at Salomon Brothers, is that its much more important to understand the markets than to understand the economy.
Iâll give him the last word here. âIt may well be that the economy drives the market, but that ultimately might be decades or years or never. Generally, you need to understand the market; you need to understand who is buying, who needs to buy, who has the cash to buy and basically what the direction of the money flow is. And that is what we focus on. That’s what we describe as âliquidity research.’ We’re looking at where the money is and where the money is going.â
That approach allows a lot of room for hedge funds and speculators to have an impact within this âdecades or years.â What do our readers think?