Saturday, May 31, 2008

Passive Long only commodity funds...

...being probed by the CFTC.

As I have said, it was only a matter of time (and high and increasing commodity prices) before political pressure was put to bear on the subject. This has happened multiple times historically and generally presages the end game for commodity bubbles.

Commodity Policies Set for Revision

Published: May 31, 2008
The chief regulator of the nation's commodity markets will unveil
early next week a set of policy changes to address public and
political concerns that market malfunctions may be contributing to
rising food and energy prices, according to people who have been
briefed about the agency's plans.

The new regulatory steps will be announced by the Commodity Futures
Trading Commission, which oversees exchanges that play a central role
in establishing worldwide prices for commodities ranging from corn to
crude oil.

The announcement may also shed some light on a commission
investigation into a sharp spike in cotton prices this year, these
people said. They discussed the proposal on the condition that they
not be named, because the agency is still completing its plans.

The agency has been wrestling for more than a year over farm industry
demands that it examine the role that new financial investors are
having in the futures markets, especially those who are investing
through commodity index funds.

As commodity prices have risen over the last several years, these
funds have become an increasingly large player in the commodity
futures markets, rising from a stake of roughly $13 billion in 2003 to
an estimated $250 billion this year.

Unlike traditional commodity investors or balanced hedge funds, these
index funds do not both buy and sell commodity futures — they only
buy, reflecting investors' desire for a stake in a rising market.

That lopsided trading pattern has generated complaints — most recently
at a hearing last week before the Senate Committee on Homeland
Security and Governmental Affairs — that index investors are
artificially driving up commodity prices at the expense of consumers.
One Senate witness even proposed that federally regulated pension
funds, a major source of index fund investments, should be forbidden
from investing in commodities because of their impact on consumer

The CFTC has already taken steps to gather more market data about the
role of index funds, and it has held off approving several rule
changes that would have given those funds more leeway to invest in
commodity futures contracts. It was considering relaxing its rules for
index traders early last year before the sharp run-up in commodity


...between supply and demand were mentioned in the last (light-hearted) post. The below describes one of them. On a related note, it is interesting to note that the weaponization of the dollar (SARs, KYC, Sarb-ox, etc.) is tempting trading partners to weaponize their currencies as well...and oil is the defacto currency of Russia.

By Henry Meyer

May 31 (Bloomberg) -- Russian Prime Minister Vladimir Putin compared the U.S. to a ``frightening monster'' and urged France to distance itself from its American ally.

``How can one be such a shining example of democracy at home and a frightening monster abroad?'' Putin said in an interview with French newspaper Le Monde transmitted live to journalists in Paris yesterday.

Putin, speaking the day after meeting French President Nicolas Sarkozy, said the U.S. was creating ``new Berlin Walls'' in Europe by pushing the North Atlantic Treaty Organization to expand into ex-Soviet states Georgia and Ukraine.

Friday, May 30, 2008

Commodities as WMDs

A "rogue state" (or consortium of rogue states) , emboldened by recent economic weakness in the United States, have designed weapons that will pressure the Capitalist Pigs/Infidels/Superpower to the point of eventual capitulation and outright subjugation.

These weapons are called "commodities" the most important of which is known as "oil". These deadly weapons operate in the following way: Their prices rise forever, starving the west of energy, food, and high quality chocolate.

The U.S. has deftly identified this threat and is sending their best agents to investigate and attempt to defuse these WMDs. The men and women of the United States "Commodity Aggregate Demand Destruction Organization" or "CAN-DO" will not find this easy. Their mission will take them from the Great Steppe to the Arabian Desert to the Equatorial Jungles of South America. They will eschew danger and bravely step onto their private jets, eat at the best restaurants at the Burj Al Arab, and discuss America's position over cocktails until those prices come down.

The above "movie script" type of treatment contains some grains of truth. In the case of oil, political and speculative forces (speculative defined as trend followers buying because the price is going higher along with the long-only passive commodity funds) have, in my opinion, put a wedge between true supply and true demand.

Tuesday, May 27, 2008

One notices...

...the men in Newport Beach proclaiming the end of the world. Or at least the end of America. I, for one, am not going to convert to the prophet of doom's religion as this kind of talk is as old as snake oil.

For their sake, I hope it does not end soon...who will they sell their short-duration securities to and actually book that nice profit they have been recording?

So let's discuss "creating demand by fear".

A comically simple rule: One needs a supply of buyers who want what you have. What if you are a very, very, very large bond manager? Would you too exclaim "Ragnarok is upon us...Sleipnir! to me! the end of time draws nigh!!! (Very would say such a thing at the end of the world. I was merely trying to think of something that befits the absurdity of the scenario), magnanimously warn the general populace of this "fact" and advise same to purchase BONDS because BONDS performed well during past invasions from the 7th plane of hell.

And, as fate would have it, the very, very, very large bond manager just happens to have some of those bonds to sell you. Ah, the quintessence of serendipity! Manna from heaven indeed.

Of course, this same wonderful bond house has never done anything like this in the past...nor have they been spectacularly wrong in their views of the world...

Nautical references...

...comparing the market to the seas are standard issue fare amongst financial publications.

And so, with auspicious timing, the REcapitulator recently spent time in the Florida Keys as well as Miami. He engaged in a variety of activities that, if placed into the Cartesian coordinate system, would definitely fall to the "business AND pleasure" upper right quadrant. Key West in particular is an interesting destination.

Anecdotally, I saw a very large amount of vacationers (it was Memorial Day weekend here in the States) and much frivolity - not one would expect in a full blown "recession".


But enough blathering about the superior climate and local tempermant of the beatiful Keys compared to my native Chicago and oblique references to "recession" as a google news volume term...much has happened since my departure.

Commodities (oil especially) are still in full-blown, short squeezing, bubble mode. Governmental cries of "foul play" by vicious "speculators" now echo across the globe in 100 different languages. The Euro has staged an impressive comeback (all eyes on Ireland at the moment) and financial asset markets are "choppy", and it will be "difficult sailing ahead", etc., etc. Even Soros has taken up the charge:

I can only repeat "an investor gets paid for taking risk" so many times. How one can quantify this remains more art than science, but suffice to say, this is a very good environment to be long on U.S. least until mid-summer. Short term dollar weakness is a concern, but again, all eyes on Ireland...

Wednesday, May 14, 2008


Even Businessweek (which is always late to the party) has jumped on the "speculators and profiteers have caused the spike in oil price" bandwagon.

As this meme spreads, and regulators and legislators begin the odious process of marginalizing profits, legislating measures designed to reduce consumption, up to and including an outright ban for pension and retirement funds from investing in long-only commodity structures, oil will experience significant MEAN REVERSION.


The end of rate cuts will indeed boost demand for U.S. assets, but the below snippet from a Bloomberg article does not go into the relative demand arguments I have posited for some time now.

Just as capitalism is the "least worst system", U.S. assets have, for the most part, taken their body shots and are moving on. This is not the case with the Euro area and Asia.

Dollar Bears Turn Bullish With Fed Approaching End of Rate Cuts

By Bo Nielsen

May 14 (Bloomberg) -- The U.S. dollar will strengthen against most major currencies in the next six months as the Federal Reserve stops reducing interest rates, a survey of Bloomberg users showed.

The end of rate cuts will boosts the allure of American assets for international investors, according to U.S. respondents in the monthly Bloomberg Professional Global Confidence Index, which questioned 3,447 users from Chicago to London to Hong Kong. While users in the U.S. grew optimistic about the greenback, participants in Germany and France became pessimistic about the euro for the first time since the survey started in November.

Monday, May 12, 2008

The Paper Dragon

Besides the man made disaster of inflation, China can now count unfortunate natural disaster as another factor for would-be FDI.

The export-led recovery by the U.S. has hit China hard, and dollar strength will be de jure policy for China going forward.

This event will not be handled well by the official media sources in Beijing, and will only serve to remind China bulls that the country has a myriad of institutional risks that are only now being recognized.

When you have 10% growth and low inflation, herd-like investors extrapolate that to infinity. When you have 8% growth and 8% inflation, herd like investors extrapolate that to infinity as well.

Friday, May 09, 2008

We have heard this music before...

...and the rhythm will change soon.

Oil is now in full "everyone should buy even when its making new records every day" mode.

Major brokerage firms are now putting their weight into the upward surge...which is more of a signal for the intent to have their proprietary traders short it than anything else.

Wednesday, May 07, 2008


A Question: What has historically happened to volatility (for the puts and calls on both near and far expiry futures), open interest, and prices for the underlying commodity when exchanges raise margins?

The answer is important. I have said before that news follows price movements, and the fact that exchanges realize when fundamentals change is a similar truism.

NYMEX to Change Margins for Crude Oil, Related Futures Contracts

NEW YORK, N.Y., May 6, 2008 -- The New York Mercantile Exchange, Inc. today
announced margin changes for its crude oil and related futures contracts,
beginning at the close of business tomorrow.

Margins for the crude oil, crude oil calendar swap, and crude oil financial
futures contracts will increase to $7,250 from $6,500 for clearing members,
$7,975 from $7,150 for members, and to $9,788 from $8,775 for customers.

Margins for the NYMEX miNYTM crude oil futures contract will increase to
$3,625 from $3,250 for clearing members, to $3,988 from $3,575 for members,
and to $4,894 from $4,388 for customers.

Margins for the NYMEX MACI index futures contract will increase to $1,450
from $1,300 for clearing members, to $1,595 from $1,430 for members, and to
$1,958 from $1,755 for customers.

Paper Dragon

I have made the argument here before that China is experiencing a bubble of its own and that 10% growth is unsustainable in a De facto centrally planned economy rife with cronyism and corruption. (not to mention that nearly 50% of the "earnings" of Chinese companies derive from stock market gains)

In addition to the above, it is beneficial to analyze the micro market and determine what events could serve as a catalyst to the inevitable volatility. The below is one such instance.

China's markets brace for massive share inflow: report Tue May 6, 1:11 AM ET

Chinese stock markets are bracing for fresh pressure in May when a massive number of new shares will become freely tradable after being locked up under local regulations, state media said on Tuesday.

A total of 284.1 billion yuan (40.6 billion dollars) worth of shares will become freely tradable in May at the expiry of a mandatory lock-up period, the Shanghai Securities News reported.

This is up nearly 90 percent from 150 billion yuan of newly tradable shares in April but was still in line with the monthly average for the whole year, according to the paper.

China's stock market hit a historic high in October, but then slumped by nearly half in the ensuing months, partly due to the overhang of these shares.

Only in late April did the market stage a rally, encouraged by a decision by Beijing policy makers to cut a stock transaction tax to one third.

Out of the shares that will become tradable in May, slightly more than half will be in Bank of Communications, the newspaper said.

Spreading Memes

The aforesaid memes regarding the commodity bubble are spreading fast. And a certain large investment bank has published another "peak oil" report that puts the price of oil between $150 and $200. Interesting timing, and one wonders what the prop traders at that institution are doing (i.e., selling into strength and booking profits prior to a crash).

In any case, more of these "backlashes" to ANY mechanism that distorts actual market supply and demand (save the sacred cow of crop subsidies in the U.S. and the EU) will follow.

The Biofuels Backlash
May 7, 2008
St. Jude is the patron saint of lost causes, and for 30 years we
invoked his name as we opposed ethanol subsidies. So imagine our
great, pleasant surprise to see that the world is suddenly awakening
to the folly of subsidized biofuels.

All it took was a mere global "food crisis." Last week chief economist
Joseph Glauber of the USDA, which has been among Big Ethanol's best
friends in Washington, blamed biofuels for increasing prices on corn
and soybeans. Mr. Glauber also predicted that corn prices will
continue their historic rise because of demand from "expanding use for

Monday, May 05, 2008

Commodity bubble, toil and trouble (part III)

Not a pleasant for commodity bears, to be sure.

Today's commodity rally has all the signs of a last gasp death throw prior to accepting its fate.

One notes that in the previous 5 commodity bull markets (defined as 40%+ year on year gains, which most commodities have either met or exceeded), day to day autocorrelation decreased at the peak.

With negative commodity memes spreading, the rolling over of futures contracts while paying physical storage prices, and the natural increases of supply (ex-oil as the Saudis continue to peg price and let quantity float) that appear during bubbles, this rally will not have legs.

Saturday, May 03, 2008

In light of my previous post...

The ECB is about to experience what happens when supposedly "independent" central banks face negative economic growth prospects.

Having a rule that is jettisoned at the first sign of stress does not set a good precedent for the Euro.

by Monica Houston-Waesch

The departure of two European Central Bank Governing Council members this summer could rebalance of group that has left interest rates unchanged since last June.

Nicholas Garganas, whose term expires June 14, announced on Friday that he won't seek reappointment as head of the Greek central bank. Austrian Klaus Liebscher previously has said he will leave when his term ends Aug. 31.

Their departures follow increased pressure political pressure from both France and Italy this year for the ECB focus less on inflation and more on growth, jobs, and foreign exchange rates.

The ECB's key mandate is price stability, which it says is the best contribution to sustainable growth and employment. Central to the policy debate today is whether rates still need to remain at high levels even as the economy slows, reducing inflation pressures.

Liebscher, a long-term anti-inflation crusader who has been with the ECB since its inception, looks likely to be replaced by Austrian Social Democratic politician and academic Ewald Nowotny, who had until recently been the head of the previously trade union-owned bank Bawag PSK. "It would appear that Mr. Nowotny, were he to be appointed governor, would represent a significant shift towards a less-hawkish perspective than the positions adopted by Mr. Liebscher," Julian Callow, chief European economist at Barclays Capital Research, said in a note to clients.

Friday, May 02, 2008


The compression of interest rates throughout the developed world is in full swing. The ECB will follow, regardless of the fact that the only input for their decision function on monetary policy is supposedly "price stability" (i.e., inflation and inflation expectations)

Hong Kong Cuts Base Rate to 3.5 Percent, Tracking Fed (Update1)

By Nipa Piboontanasawat
May 2 (Bloomberg) -- The Hong Kong Monetary Authority cut
its base rate to 3.5 percent after the Federal Reserve lowered
its benchmark by a quarter of a percentage point to 2 percent.
The move matched the Fed's, cutting its base rate by 25
basis points from 3.75 percent, Joseph Yam, chief executive of
the city's de facto central bank told reporters in Hong Kong
``In Hong Kong, there is limited room for deposit rates to
go down further, and this will affect lending rates too as banks
try to maintain the spread,'' Yam said.
The Federal Reserve on April 30 reduced the benchmark U.S.
interest rate and indicated it's ready to pause after seven cuts
since September. Hong Kong's currency is pegged to the U.S.
dollar, which typically means the city's monetary policy follows
that of the Fed.
``The U.S. economy is quite weak and the housing market
there is the key,'' Yam added. ``Energy and commodity prices are
affecting inflation expectations.''
A basis point is 0.01 percentage point.