In testimony before the U.S. Senate’s Committee on Homeland Security and Governmental Affairs last week, the U.S. Commodity Futures Trading Commission’s chief economist claimed that their analyses have not discovered price manipulation in the commodity’s markets, but at least one portfolio manager testified that speculators are using CFTC loopholes to avoid detection and regulation.
Michael W. Masters, managing member and portfolio manager at Masters Capital Management LLC in testimony before the committee blamed legal loopholes and the enormous investment clout of speculative funds for pressuring commodity prices well above supply-demand market fundamentals. However, Jeffrey Harris, CFTC’s chief economist, pointed out that his staff’s economic analysis indicates that broad-based manipulative forces are not driving the recent higher futures prices in commodities across-the-board.
“That said, we continue to gather information from the entire marketplace and welcome outside analysis and perspectives so that we can ensure that our view of these markets is complete and accurate,” he added.
Masters claimed that “Index Speculators” are pouring billions of dollars into the commodities futures markets, speculating that commodity prices would increase. He said assets allocated to commodity index trading strategies increased from $13 billion at the end of 2003 to $260 billion as of March, and the prices of the 25 commodities that compose these indices increased on average 183 percent in those five years.
“In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China,” he explained to the senate committee. “Annual Chinese demand for petroleum has increased over the last five years from 1.88 billion bbl to 2.8 billion bbl, an increase of 920 million bbl. Over the same five-year period, Index Speculators demand for petroleum futures has increased by 848 million bbl. The increase in demand from Index Speculators is almost equal to the increase in demand from China.”
Masters said his data shows that Index Speculators have stockpiled from the futures market about 1.1 billion bbl of crude oil, effectively adding eight times as much oil to their stockpiles as the U.S. has added to the Strategic Petroleum Reserve over the last five years.
Masters warned that the commodities futures markets are much smaller than the capital markets. He said in 2004, the total value of futures contracts outstanding for all 25 index commodities amounted to about $180 billion compared to global equity markets which totaled $44 trillion.
“That year, Index Speculators poured $25 billion into these markets, an amount equivalent to 14% of the total market,” he added.
Masters also explained that there is a critical distinction between traditional speculators and index speculators—traditional speculators provide liquidity by buying and selling futures. Index speculators buy futures and then roll their positions by buying calendar spreads.
“They never sell. Therefore, they consume liquidity and provide zero benefit to the futures markets,” he said.
Masters blamed the CFTC for today’s speculative price spikes. He said that the CFTC took deliberate steps to allow certain speculators unlimited access to the commodities futures markets.
“The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation,” he added.
Masters said that the swaps loophole allows a hedge fund that wants a $500 million position in wheat, which is beyond position limits, can then enter into swap with a Wall Street bank and the bank buys $500 million worth of wheat futures without anyone the wiser.
Masters said the commodities futures price bubble can be burst if the U.S. Congress “prohibits commodity index replication strategies as pension investments, should act immediately to close the swaps loophole and compel the CFTC to reclassify all positions in the commercial category of the Commitments of Traders Reports to distinguish those positions that are controlled by “Bona Fide” physical hedgers from those controlled by Wall Street banks.”
Following testimony, Joe Lieberman, I-Conn. and the committee’s chairman, blamed index speculators for driving crude oil and agricultural commodity prices to record highs.
“At home, rising food and gasoline prices put a real and immediate strain on family budgets. And overseas, the consequences are even more dire,” Lieberman said. “My own conclusion is that index speculators are responsible for a big part of the commodity price increases, and we in Congress ought to do the best we can to protect the public interest in an effort to bring food and energy prices down.”
Ranking committee member Susan Collins, R-Maine, said Americans are facing record gasoline prices and the fastest rise in food prices since 1990.
“In my own State of Maine the average family uses between 800 and 1,000 gallons of oil during the winter. Many I have spoken with are unable to afford the rising costs of these basic family needs,” she added.
Collins said the committee will continue its investigation into these issues and may consider legislation to ensure that financial speculation in commodity markets does not affect consumer prices at gasoline outlets and grocery stores.
During the hearing, the committee listened to testimony that included barring certain institutional investors, such as pension funds, from investing in commodity markets through the use of index funds and closing the so-called swaps loophole that allows large investors to sidestep limits on speculative activity in the commodity markets.
Lieberman pointed out that speculative activity in commodity markets from 1998 to 2008, the share of long interests—that is, market positions that benefit when prices rise—in commodities held by financial speculators increased from 25 percent to 66 percent of the commodity market.
He said that in the five-year period from 2003 to 2008, investment in index funds tied to commodities increased from $13 billion to $260 billion.
This hearing was the second in a series looking at the affect of various federal policies on the spiking costs of food and fuel.
