testimony from May 20 08 on the effects of reflexivity.....the unwinding is underway. Sorry graphics missing. Need this as html.
MichaelMastersWrittenTestimony.pdf (286KB)
Testimony of
Michael W. Masters
Managing Member / Portfolio Manager
Masters Capital Management, LLC
before the
Permanent Subcommittee on Investigations
Committee on Homeland Security and Governmental Affairs
United States Senate
May 20, 2008
Good morning and thank you, Mr. Chairman and Members of the Committee, for the
invitation to speak to you today. This is a topic that I care deeply about, and I
appreciate the chance to share what I have discovered.
I have been successfully managing a long-short equity hedge fund for over 12 years
and I have extensive contacts on Wall Street and within the hedge fund community. It's
important that you know that I am not currently involved in trading the commodities
futures markets. I am not representing any corporate, financial, or lobby organizations. I
am speaking with you today as a concerned citizen whose professional background has
given me insight into a situation that I believe is negatively affecting the U.S. economy.
While some in my profession might be disappointed that I am presenting this testimony
to Congress, I feel that it is the right thing to do.
You have asked the question “Are Institutional Investors contributing to food and energy
price inflation?” And my unequivocal answer is “YES.” In this testimony I will explain
that Institutional Investors are one of, if not the primary, factors affecting commodities
prices today. Clearly, there are many factors that contribute to price determination in the
commodities markets; I am here to expose a fast-growing yet virtually unnoticed factor,
and one that presents a problem that can be expediently corrected through legislative
policy action.
Commodities prices have increased more in the aggregate over the last five years than
at any other time in U.S. history.1 We have seen commodity price spikes occur in the
past as a result of supply crises, such as during the 1973 Arab Oil Embargo. But today,
unlike previous episodes, supply is ample: there are no lines at the gas pump and there
is plenty of food on the shelves.
If supply is adequate - as has been shown by others who have testified before this
committee2 - and prices are still rising, then demand must be increasing. But how do
you explain a continuing increase in demand when commodity prices have doubled or
tripled in the last 5 years?
What we are experiencing is a demand shock coming from a new category of
participant in the commodities futures markets: Institutional Investors. Specifically,
these are Corporate and Government Pension Funds, Sovereign Wealth Funds,
University Endowments and other Institutional Investors. Collectively, these investors
now account on average for a larger share of outstanding commodities futures contracts
than any other market participant.3
These parties, who I call Index Speculators, allocate a portion of their portfolios to
“investments” in the commodities futures market, and behave very differently from the
traditional speculators that have always existed in this marketplace. I refer to them as
“Index” Speculators because of their investing strategy: they distribute their allocation of
dollars across the 25 key commodities futures according to the popular indices – the
Standard & Poors - Goldman Sachs Commodity Index and the Dow Jones - AIG
Commodity Index.4
I’d like to provide a little background on how this new category of “investors” came to
exist.
In the early part of this decade, some institutional investors who suffered as a result of
the severe equity bear market of 2000-2002, began to look to the commodity futures
market as a potential new “asset class” suitable for institutional investment. While the
commodities markets have always had some speculators, never before had major
investment institutions seriously considered the commodities futures markets as viable
for larger scale investment programs. Commodities looked attractive because they have
historically been “uncorrelated,” meaning they trade inversely to fixed income and equity
portfolios. Mainline financial industry consultants, who advised large institutions on
portfolio allocations, suggested for the first time that investors could “buy and hold”
commodities futures, just like investors previously had done with stocks and bonds.
Index Speculator Demand Is Driving Prices Higher
Today, Index Speculators are pouring billions of dollars into the commodities futures
markets, speculating that commodity prices will increase. Chart One shows Assets
allocated to commodity index trading strategies have risen from $13 billion at the end of
2003 to $260 billion as of March 2008,5 and the prices of the 25 commodities that
compose these indices have risen by an average of 183% in those five years!6
COMMODITY INDEX INVESTMENT COMPARED
TO S&P GSCI SPOT PRICE COMMODITY INDEX
100
200
300
400
500
600
700
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
S&P GSCI SPOT PRICE COMMODITY INDEX
$-
$50
$100
$150
$200
$250
$300
COMMODITY INDEX "INVESTMENT"
(BILLIONS OF DOLLARS)
OTHERS
DJ-AIG
SP-GSCI
S&P GSCI
Source: Goldman Sachs, Bloomberg, CFTC Commitments of Traders CIT Supplement,
calculations
MAR
CHART ONE
According to the CFTC and spot market participants, commodities futures prices are the
benchmark for the prices of actual physical commodities, so when Index Speculators
drive futures prices higher, the effects are felt immediately in spot prices and the real
economy.7 So there is a direct link between commodities futures prices and the prices
your constituents are paying for essential goods.
The next table looks at the commodity purchases that Index Speculators have made via
the futures markets. These are huge numbers and they need to be put in perspective to
be fully grasped.
In the popular press the explanation given most often for rising oil prices is the
increased demand for oil from China. According to the DOE, annual Chinese demand
for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion
barrels, an increase of 920 million barrels.8 Over the same five-year period, Index
Speculators' demand for petroleum futures has increased by 848 million barrels.9 The
increase in demand from Index Speculators is almost equal to the increase in demand
from China!
Commodity Purchases By Index Speculators The Last 5 Years
Sector Commodity Units
Previous Futures
Market Stockpile
January 1, 2003
Net Purchases
Last 5¼ Years
Current Futures
Market Stockpile
March 12, 2008
Agricultural Cocoa Metric Tons 18,828 303,352 322,180
Coffee Pounds 195,716,944 2,238,858,056 2,434,575,000
Corn Bushels 242,561,708 2,138,383,292 2,380,945,000
Cotton Pounds 544,934,999 5,548,915,001 6,093,850,000
Soybean Oil Pounds 163,135,678 4,312,624,322 4,475,760,000
Soybeans Bushels 81,028,272 890,616,728 971,645,000
Sugar Pounds 2,291,358,746 46,094,097,254 48,385,456,000
Wheat Bushels 166,738,225 967,351,775 1,134,090,000
Wheat KC Bushels 54,746,014 102,618,986 157,365,000
Livestock Feed Cattle Pounds 104,446,612 365,453,388 469,900,000
Lean Hogs Pounds 517,414,747 3,827,425,253 4,344,840,000
Live Cattle Pounds 669,766,732 5,099,033,268 5,768,800,000
Energy Brent Crude Oil Barrels 47,075,357 144,524,265 191,599,621
WTI Crude Oil Barrels 99,880,741 538,499,579 638,380,320
Gasoil Metric Tons 1,682,662 6,027,680 7,710,342
Heating Oil Gallons 1,067,859,608 2,568,925,661 3,636,785,269
Gasoline Gallons 1,102,184,401 2,488,458,616 3,590,643,018
Natural Gas Million BTUs 330,652,415 1,932,356,225 2,263,008,640
Base Metals Aluminum Metric Tons 344,246 3,232,406 3,576,652
Lead Metric Tons 82,019 158,726 240,745
Nickel Metric Tons 20,147 101,988 122,135
Zinc Metric Tons 133,381 1,182,091 1,315,472
Copper Metric Tons 220,096 1,144,538 1,364,634
Precious Metals Gold Troy Ounces 979,863 8,742,401 9,722,264
Silver Troy Ounces 11,126,862 152,866,187 163,993,049
Sources: Goldman Sachs, Standard & Poors, Dow Jones,
CFTC Commitments of Traders CIT Supplement, calculations
In fact, Index Speculators have now stockpiled, via the futures market, the equivalent of
1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own
stockpile as the United States has added to the Strategic Petroleum Reserve over the
last five years.10
Let’s turn our attention to food prices, which have skyrocketed in the last six months.
When asked to explain this dramatic increase, economists’ replies typically focus on the
diversion of a significant portion of the U.S. corn crop to ethanol production.11 What
they overlook is the fact that Institutional Investors have purchased over 2 billion
bushels of corn futures in the last five years. Right now, Index Speculators have
stockpiled enough corn futures to potentially fuel the entire United States ethanol
industry at full capacity for a year.12 That’s equivalent to producing 5.3 billion gallons of
ethanol, which would make America the world’s largest ethanol producer.13
Turning to Wheat, in 2007 Americans consumed 2.22 bushels of Wheat per capita.14 At
1.3 billion bushels, the current Wheat futures stockpile of Index Speculators is enough
to supply every American citizen with all the bread, pasta and baked goods they can eat
for the next two years!
Index Speculator Demand Characteristics
Demand for futures contracts can only come from two sources: Physical Commodity
Consumers and Speculators. Speculators include the Traditional Speculators who have
always existed in the market, as well as Index Speculators. Five years ago, Index
Speculators were a tiny fraction of the commodities futures markets. Today, in many
commodities futures markets, they are the single largest force.15 The huge growth in
their demand has gone virtually undetected by classically-trained economists who
almost never analyze demand in futures markets.
Index Speculator demand is distinctly different from Traditional Speculator demand; it
arises purely from portfolio allocation decisions. When an Institutional Investor decides
to allocate 2% to commodities futures, for example, they come to the market with a set
amount of money. They are not concerned with the price per unit; they will buy as many
futures contracts as they need, at whatever price is necessary, until all of their money
has been “put to work.” Their insensitivity to price multiplies their impact on commodity
markets.
Furthermore, commodities futures markets are much smaller than the capital markets,
so multi-billion-dollar allocations to commodities markets will have a far greater impact
on prices. In 2004, the total value of futures contracts outstanding for all 25 index
commodities amounted to only about $180 billion.16 Compare that with worldwide
equity markets which totaled $44 trillion17, or over 240 times bigger. That year, Index
Speculators poured $25 billion into these markets, an amount equivalent to 14% of the
total market.18
Chart Two shows this dynamic at work. As money pours into the markets, two things
happen concurrently: the markets expand and prices rise.
One particularly troubling aspect of Index Speculator demand is that it actually
increases the more prices increase. This explains the accelerating rate at which
commodity futures prices (and actual commodity prices) are increasing. Rising prices
attract more Index Speculators, whose tendency is to increase their allocation as prices
rise. So their profit-motivated demand for futures is the inverse of what you would
expect from price-sensitive consumer behavior.
You can see from Chart Two that prices have increased the most dramatically in the first
quarter of 2008. We calculate that Index Speculators flooded the markets with $55
billion in just the first 52 trading days of this year.19 That’s an increase in the dollar
value of outstanding futures contracts of more than $1 billion per trading day. Doesn’t it
seem likely that an increase in demand of this magnitude in the commodities futures
markets could go a long way in explaining the extraordinary commodities price
increases in the beginning of 2008?
There is a crucial distinction between Traditional Speculators and Index Speculators:
Traditional Speculators provide liquidity by both 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.20
Commodity Futures Market Size
100
200
300
400
500
600
700
800
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
S&P GSCI Spot Price Index
Dollar Value of
Commercial Positions
Dollar Vale of Traditional
Speculators' Positions
Dollar Value of Index
Speculators' Positions
Source: Bloomberg, CFTC Commitments of Traders CIT Supplement, calculations
MAR
CHART TWO
It is easy to see now that traditional policy measures will not work to correct the problem
created by Index Speculators, whose allocation decisions are made with little regard for
the supply and demand fundamentals in the physical commodity markets. If OPEC
supplies the markets with more oil, it will have little affect on Index Speculator demand
for oil futures. If Americans reduce their demand through conservation measures like
carpooling and using public transportation, it will have little affect on Institutional
Investor demand for commodities futures.
Index Speculators’ trading strategies amount to virtual hoarding via the commodities
futures markets. Institutional Investors are buying up essential items that exist in limited
quantities for the sole purpose of reaping speculative profits.
Think about it this way: If Wall Street concocted a scheme whereby investors bought
large amounts of pharmaceutical drugs and medical devices in order to profit from the
resulting increase in prices, making these essential items unaffordable to sick and dying
people, society would be justly outraged.
Why is there not outrage over the fact that Americans must pay drastically more to feed
their families, fuel their cars, and heat their homes?
Index Speculators provide no benefit to the futures markets and they inflict a
tremendous cost upon society. Individually, these participants are not acting with
malicious intent; collectively, however, their impact reaches into the wallets of every
American consumer.
Is it necessary for the U.S. economy to suffer through yet another financial crisis
created by new investment techniques, the consequences of which have once again
been unforeseen by their Wall Street proponents?
The CFTC Has Invited Increased Speculation
When Congress passed the Commodity Exchange Act in 1936, they did so with the
understanding that speculators should not be allowed to dominate the commodities
futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain
speculators virtually 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.21 This has effectively
opened a loophole for unlimited speculation. When Index Speculators enter into
commodity index swaps, which 85-90% of them do, they face no speculative position
limits.22
The really shocking thing about the Swaps Loophole is that Speculators of all stripes
can use it to access the futures markets. So if a hedge fund wants a $500 million
position in Wheat, which is way beyond position limits, they can enter into swap with a
Wall Street bank and then the bank buys $500 million worth of Wheat futures.23
In the CFTC’s classification scheme all Speculators accessing the futures markets
through the Swaps Loophole are categorized as “Commercial” rather than “Non-
Commercial.” The result is a gross distortion in data that effectively hides the full impact
of Index Speculation.
Additionally, the CFTC has recently proposed that Index Speculators be exempt from all
position limits, thereby throwing the door open for unlimited Index Speculator
“investment.”24 The CFTC has even gone so far as to issue press releases on their
website touting studies they commissioned showing that commodities futures make
good additions to Institutional Investors’ portfolios.25
Is this what Congress expected when it created the CFTC?
Congress Should Eliminate The Practice Of Index Speculation
I would like to conclude my testimony today by outlining three steps that can be taken to
immediately reduce Index Speculation.
Number One:
Congress has closely regulated pension funds, recognizing that they serve a public
purpose. Congress should modify ERISA regulations to prohibit commodity index
replication strategies as unsuitable pension investments because of the damage that
they do to the commodities futures markets and to Americans as a whole.
Number Two:
Congress should act immediately to close the Swaps Loophole. Speculative position
limits must “look-through” the swaps transaction to the ultimate counterparty and hold
that counterparty to the speculative position limits. This would curtail Index Speculation
and it would force ALL Speculators to face position limits.
Number Three:
Congress should further compel the CFTC to reclassify all the 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. The positions of Wall Street banks should be further broken down
based on their OTC swaps counter-party into “Bona Fide” Physical Hedgers and
Speculators.
There are hundreds of billions of investment dollars poised to enter the commodities
futures markets at this very moment.26 If immediate action is not taken, food and
energy prices will rise higher still. This could have catastrophic economic effects on
millions of already stressed U.S. consumers. It literally could mean starvation for
millions of the world’s poor.27
If Congress takes these steps, the structural integrity of the futures markets will be
restored. Index Speculator demand will be virtually eliminated and it is likely that food
and energy prices will come down sharply.
APPENDIX: HOW TO CALCULATE INDEX SPECULATORS’ POSITIONS
If someone knows how much money is invested in the total index then it is easy to
calculate how much must be in each commodity in dollars and in futures contracts.
Total Dollars Invested
In Index X Weight Of Individual
Commodity = Dollars In Individual
Commodity
Total Dollars Invested
In Index X Weight Of Individual
Commodity / Dollar Value Of A
Commodity Contract = # Of Contracts In An
Individual Commodity
And therefore if someone knows how many contracts are in an individual commodity
along with the dollar value of a contract and the weight of that commodity in the index
then you can calculate the total dollars invested in the index as follows:
# Of Contracts In An
Individual Commodity X Dollar Value Of A
Commodity Contract / Weight Of Individual
Commodity = Total Dollars Invested
In Index
The CFTC starting in January 2006 has been publishing the Commodity Index Trader
Supplement to the Commitments Of Traders report. This supplemental report shows
the reported positions of Index Speculators in 12 different agricultural commodities. Of
the 12, two commodities:, KC Wheat and Feeder Cattle, are part of the S&P GSCI (and
not the DJ-AIG) and one commodity: Soybean Oil, is part of the DJ-AIG (and not the
S&P-GSCI). Note that 95% of dollars indexed to commodities are replicating either the
S&P-GSCI or DJ-AIG.
Both the S&P-GSCI and DJ-AIG publish on a daily basis the individual weights of their
constituent commodities. Also futures market data providers like Bloomberg publish
daily closing prices for the commodities. Since the futures contract terms do not change
that enables someone to calculate the daily dollar values of the individual commodity
contracts.
So with these three data points it is simple to calculate the total dollars invested in the
S&P-GSCI and the DJ-AIG on a weekly basis. And once the total dollars invested in
these two indices is known then that results in the ability to calculate the number of
contracts held by Index Speculators in the other 13 non-agricultural commodities.
A detailed example of this 3 step process follows.
Step One - Estimate Total Amount Invested In S&P-GSCI and DJ-AIG
According to the CFTC’s January 17, 2006 CIT report, Index Specualtors had positiions
in KC Wheat, Feeder Cattle and Soybean Oil of 21366 , 5613 and 59264 contracts
respectively. Plugging in the weights and contract values from the appropriate sources
yields the following calculations:
21,366 X $18,762.50 / 0.82% = $48,887,753,049
5,613 X $56,137.50 / 0.68% = $46,338,204,044
59,264 X $12,732.00 / 2.77% = $27,240,045,054
So the S&P-GSCI had somewhere between $46 and $49 billion invested in it and the
DJ-AIG had around $27 billion invested in it. This corresponds well to the figures
published by Goldman Sachs and Dow Jones.
CALCULATIONS OF INDEX SPECULATORS’ POSITIONS (JANUARY 17, 2006)
PERCENTAGE
WEIGHTS
POSITIONS
(in millions) Contract
Dollar
Value
POSITIONS
(in contracts) Combined
Position
Estimate
CFTC
Actual
Positions S&P-GSCI DI-AIG S&P-GSCI DI-AIG S&P-GSCI DI-AIG
Cocoa 0.2% 0.0% $95.5 $0.0 $15,710 6,081 0 6,081 9,390
Coffee 0.8% 2.9% $373.2 $799.0 $46,425 8,039 17,201 25,240 28,777
Corn 2.0% 5.9% $954.0 $1,600.0 $10,438 91,398 153,292 244,689 305,264
Cotton 0.9% 3.2% $444.9 $862.0 $27,995 15,891 30,777 46,668 53,741
Soybean Oil 0.0% 2.8% $0.0 $753.0 $12,732 0 59,173 59,173 59,264
Soybeans 1.4% 7.8% $672.5 $2,116.0 $28,563 23,543 74,073 97,617 103,304
Sugar 1.9% 3.0% $884.9 $808.0 $17,438 50,742 46,352 97,094 124,487
Wheat 2.1% 4.8% $1,009.1 $1,300.0 $16,438 61,393 79,082 140,475 181,986
Wheat KC 0.8% 0.0% $396.0 $0.0 $18,763 21,106 0 21,106 21,366
Feed Cattle 0.7% 0.0% $329.5 $0.0 $56,138 5,869 0 5,869 5,613
Lean Hogs 1.4% 4.4% $663.8 $1,185.0 $23,790 27,902 49,824 77,726 69,591
Live Cattle 2.7% 6.1% $1,293.2 $1,660.0 $38,620 33,486 42,982 76,468 71,834
Brent Crude Oil 14.5% 0.0% $6,901.3 $0.0 $64,900 106,337 0 106,337
WTI Crude Oil 31.3% 12.8% $14,888.0 $3,482.0 $66,310 224,521 52,516 277,036
Gasoil 3.1% 0.0% $1,472.7 $0.0 $54,725 26,911 0 26,911
Heating Oil 8.0% 3.8% $3,823.7 $1,048.0 $75,243 50,818 13,924 64,742
Gasoline 7.9% 4.1% $3,780.5 $1,105.0 $76,579 49,368 14,424 63,792
Natural Gas 10.6% 12.3% $5,030.8 $3,355.0 $91,680 54,873 36,591 91,464
Aluminum 3.1% 6.9% $1,464.4 $1,866.0 $59,475 24,621 31,383 56,004
Lead 0.3% 0.0% $156.4 $0.0 $31,800 4,918 0 4,918
Nickel 0.7% 2.7% $312.8 $724.0 $88,182 3,547 8,214 11,762
Zinc 0.7% 2.7% $355.6 $736.0 $51,900 6,852 14,184 21,036
Copper (LME) 2.8% 0.0% $1,335.1 $0.0 $116,575 11,453 0 11,453
Copper (CMX) 0.0% 5.9% $0.0 $1,602.0 $54,225 0 29,542 29,542
Gold 1.8% 6.2% $875.9 $1,694.0 $55,430 15,802 30,568 46,370
Silver 0.2% 2.0% $99.2 $545.0 $45,100 2,201 12,080 14,280
TOTAL 100% 100% $47,613 $27,240
Source: Standard & Poor’s, Dow Jones, Bloomberg Data
Step Two - Calculate Position Size For Other Commodities
If $47.6 billion is used as an estimate for the S&P-GSCI and then $27.2 billion is used
for the DJ-AIG it is possible to calculate (using the formulas above) Index Speculators
positions in all the other commodities. The table above shows the results.
Step Three - Compare With Actual CFTC Figures For Accuracy
The final column in the table shows the actual figures released by the CFTC. As you
can see in almost all cases the estimates generated using this method yield results that
are less than the actual reported results. That increases one’s confidence that this
method is in fact conservative.
Final Note
This method of calculating Index Speculators is almost identical to the methods used by
Philip Verleger (www.pkverlegerllc.com), Steve Briese (www.commitmentsoftraders.org)
and others. It is not clear who deserves the credit for developing it but it clearly is not
us.
1 “Reserve Management, The Commodity Bubble, The Metals Manipulation, The Contagion Risk To Gold
And The Threat Of The Great Hedge Fund Unwind To Spread Product.” Frank Veneroso, July 19, 2007,
pp. 5-6. venerosoassociates.net
%20Public%2071907.pdf
2 hsgac.senate.gov
fuseaction=Hearings.Detail&HearingID=dc7368c2-0ea1-4151-9fc5-06317a5bba79
3
Commodities Futures Markets Open Interest
2008
LONG / DEMAND SIDE
Physical
Hedger
Traditional
Speculator
Index
Speculator
COCOA 33% 48% 19%
COFFEE 26% 35% 39%
CORN 41% 24% 35%
COTTON 32% 27% 41%
SOYBEAN OIL 46% 22% 32%
SOYBEANS 30% 28% 42%
SUGAR 38% 19% 43%
WHEAT 17% 20% 64%
WHEAT KC 37% 32% 31%
FEED CATTLE 17% 53% 30%
LEAN HOGS 18% 20% 63%
LIVE CATTLE 13% 24% 63%
WTI CRUDE OIL 59% 10% 31%
HEATING OIL 37% 16% 47%
GASOLINE 41% 20% 39%
NATURAL GAS 62% 10% 28%
GOLD 22% 55% 23%
SILVER 27% 46% 28%
AVERAGE 33% 27% 39%
Source: CFTC Commitments of Traders CIT
supplement plus calculations
ENDNOTES
4 For more information visit:
djindexes.com for the DJ-AIG or for the S&P-GSCI
www2.standardandpoors.com
2,3,4,0,0,0,0,0,0,1,1,0,0,0,0,0.html
Index Component Weights
as of March 12, 2008 S&PGSCI
DI-AIG
Weighted
Average
Agricultural Cocoa 0.2% 0.0% 0.1%
Coffee 0.6% 2.9% 1.5%
Corn 3.3% 5.7% 4.2%
Cotton 0.9% 2.5% 1.5%
Soybean Oil 0.0% 2.9% 1.1%
Soybeans 2.2% 7.2% 4.1%
Sugar 1.0% 3.1% 1.8%
Wheat 5.3% 5.6% 5.4%
Wheat KC 1.2% 0.0% 0.8%
Livestock Feed Cattle 0.3% 0.0% 0.2%
Lean Hogs 0.8% 2.2% 1.4%
Live Cattle 1.7% 3.9% 2.6%
Energy Brent Crude Oil 13.4% 0.0% 8.3%
WTI Crude Oil 38.3% 12.9% 28.6%
Gasoil 5.0% 0.0% 3.1%
Heating Oil 4.9% 3.8% 4.5%
Gasoline 4.2% 3.6% 4.0%
Natural Gas 6.8% 13.1% 9.2%
Base Metals Aluminum 2.5% 7.7% 4.5%
Lead 0.5% 0.0% 0.3%
Nickel 0.9% 2.7% 1.6%
Zinc 0.6% 2.7% 1.4%
Copper 3.1% 7.3% 4.7%
Precious Metals Gold 1.9% 7.1% 3.9%
Silver 0.3% 3.0% 1.3%
Source: Standard & Poor’s, Dow Jones
5 “Investing and Trading in the GSCI,” Goldman, Sachs & Co., June 1, 2005 and calculations based upon
the CFTC Commitments of Traders Report, CIT Supplement, see the Appendix for more information on
how to calculate Index Speculators' positions.
6
Commodity Futures Price Inreases
March 2003 - March 2008
Agricultural Cocoa +34%
Coffee +167%
Corn +134%
Cotton +40%
Soybean Oil +199%
Soybeans +143%
Sugar +69%
Wheat +314%
Wheat KC +276%
Livestock Feed Cattle +34%
Lean Hogs +10%
Live Cattle +23%
Energy Brent Crude Oil +213%
WTI Crude Oil +191%
Gasoil +192%
Heating Oil +192%
Gasoline +145%
Natural Gas +71%
Base Metals Aluminum +120%
Lead +564%
Nickel +282%
Zinc +225%
Copper +413%
Precious Metals Gold +183%
Silver +331%
Source: Bloomberg Financial Data
7 The CFTC states on its website that “In many physical commodities (especially agricultural
commodities), cash market participants base spot and forward prices on the futures prices that are
?discovered' in the competitive, open auction market of a futures exchange.” - “The Economic Purpose of
Futures Markets and How They Work,” U.S. Commodities Futures Trading Commission, http://
www.cftc.gov/educationcenter/economicpurpose.html
As an additional example, when Platts, an energy markets pricing service, surveys crude oil pricing in
physical markets around the globe they are receiving bid and offer quotations from market participants
expressed as WTI Light Sweet Crude minus a spread. - “Platts Oil Pricing and Market-on-Close
Methodology Explained,” Platts - a McGraw Hill Company, July 2007. platts.com
whitepapers/moc.pdf?a=i Note that if and when Platts receive price quotes as Brent Crude or Dubai
Crude plus or minus a spread there is still a direct and stable relationship between WTI, Brent and Dubai.
8 Please remember if demand for oil stays the same then prices will stay the same. If supply is constant
then demand has to increase for prices to increase. That is why we examine increases in demand.
Increase In Chinese Demand For Petroleum
Last 5 Years
CONSUMPTION
(Barrels Per Year)
YEAR OVER
YEAR CHANGE
2002 1,883,660,777
2003 2,036,010,338 152,349,561
2004 2,349,681,577 313,671,240
2005 2,452,800,000 103,118,423
2006 2,654,750,989 201,950,989
2007 2,803,010,200 148,259,211
TOTAL CHANGE 919,349,423
Source: Energy Information Association, US
Department of Energy
9 This table takes the numbers from the main table in the body of the statement and converts them to their
barrel equivalents. The Petroleum consumption numbers that the DOE provides for Chinese
consumption include all forms of petroleum both crude and refined.
Increase In Index Speculator
Demand For Petroleum
Last 5 Years
Petroleum Product Barrels
WTI Crude Oil 538,499,579
Brent Crude Oil 144,524,265
Gasoil 44,122,619
Heating Oil 61,164,897
Gasoline 59,249,015
TOTAL CHANGE 847,560,374
10 Energy Information Association - U.S. Department Of Energy.
tonto.eia.doe.gov
11 “The End Of Cheap Food,” The Economist, December 6, 2007 economist.com
articlesBySubject/displaystory.cfm?subjectid=7216688&story_id=10252015
12 “Ethanol Reshapes the Corn Market,” Economic Research Service - U.S. Department Of Agriculture,
Allen Baker and Steven Zahniser April 2006. ers.usda.gov
Ethanol.htm
13 “Ethanol Production Could Be Eco-Disaster, Brazil's Critics Say,” Kelly Hearn, National Geographic
News, February 8, 2007, news.nationalgeographic.com
14 Economic Research Service, U.S. Department of Agriculture, ers.usda.gov
consumption.htm
15 see endnote #2
16 Because the base metals are traded on the London Metals Exchange, Bloomberg did not have open
interest data prior to 2005. Since prices and open interest expressed in contracts have been rising
steadily the last five years we took 2005's base metal data and added it to 2004 actual numbers to come
up with a conservative estimate for 2004 open interest. These are daily numbers averaged across the
entire year.
Average Daily Dollar Value Of Open Interest
(in millions) 2002 2003 2004 2005 2006 2007 2008
COCOA $ 1,815 $ 1,510 $ 1,569 $ 1,883 $ 2,040 $ 2,690 $ 4,062
COFFEE $ 1,408 $ 1,693 $ 2,748 $ 3,769 $ 4,203 $ 6,308 $ 9,521
CORN $ 5,435 $ 5,118 $ 8,182 $ 7,657 $ 15,059 $ 23,763 $ 37,427
COTTON $ 1,646 $ 2,990 $ 2,645 $ 2,841 $ 4,259 $ 6,822 $ 11,689
SOYBEAN OIL $ 1,441 $ 1,952 $ 2,456 $ 1,944 $ 3,186 $ 5,756 $ 8,868
SOYBEANS $ 4,883 $ 7,306 $ 9,480 $ 8,846 $ 10,129 $ 20,882 $ 37,399
SUGAR $ 1,521 $ 1,712 $ 2,772 $ 5,120 $ 8,634 $ 8,174 $ 15,509
WHEAT $ 1,836 $ 1,862 $ 2,647 $ 3,827 $ 7,414 $ 11,608 $ 19,742
WHEAT KC $ 1,304 $ 1,081 $ 1,240 $ 1,525 $ 3,099 $ 4,094 $ 6,253
FEED CATTLE $ 540 $ 757 $ 804 $ 1,298 $ 1,518 $ 1,409 $ 1,818
LEAN HOGS $ 602 $ 858 $ 1,873 $ 2,309 $ 3,285 $ 3,875 $ 4,465
LIVE CATTLE $ 2,670 $ 3,595 $ 3,556 $ 4,859 $ 6,701 $ 7,909 $ 8,764
BRENT CRUDE $ 6,556 $ 8,486 $ 12,620 $ 19,388 $ 31,094 $ 45,653 $ 52,832
WTI CRUDE $ 16,052 $ 20,400 $ 33,620 $ 55,297 $ 80,996 $ 130,699 $ 199,970
GASOIL $ 3,990 $ 3,695 $ 5,461 $ 10,196 $ 14,749 $ 21,006 $ 22,917
HEATING OIL $ 4,412 $ 5,105 $ 8,242 $ 11,838 $ 13,575 $ 17,903 $ 23,854
GASOLINE $ 3,714 $ 3,947 $ 7,304 $ 10,276 $ 11,366 $ 16,085 $ 24,213
NATURAL GAS $ 23,551 $ 27,812 $ 25,897 $ 42,427 $ 45,067 $ 54,075 $ 72,834
ALUMINUM $ 0 $ 0 $ 0 $ 12,286 $ 23,676 $ 27,589 $ 32,741
LEAD $ 0 $ 0 $ 0 $ 677 $ 981 $ 2,226 $ 2,134
NICKEL $ 0 $ 0 $ 0 $ 1,986 $ 4,415 $ 6,690 $ 6,608
ZINC $ 0 $ 0 $ 0 $ 2,696 $ 6,759 $ 6,917 $ 6,428
COPPER $ 0 $ 0 $ 0 $ 11,864 $ 26,516 $ 28,921 $ 32,717
GOLD $ 5,639 $ 9,851 $ 13,221 $ 13,860 $ 18,929 $ 24,891 $ 43,700
SILVER $ 1,976 $ 2,438 $ 3,745 $ 4,286 $ 6,447 $ 7,437 $ 12,935
TOTAL $ 90,991 $ 112,168 $ 150,082 $ 242,955 $ 354,097 $ 493,382 $ 699,400
Source: CFTC Commitment of Traders and Bloomberg. Delta-equivalent options positions
are included but spread positions are omitted. For Base Metals, Brent Crude and Gasoil
open interest represents futures only. No data for Base Metals in 2002-2004.
17 CIA World Factbook. cia.gov
18 There is no publicly available data that shows inflow data for commodity indexation trading strategies
but some approximations can be made. The end of year “investment” figures are published by the
respective index companies (or they can be calculated) and the annual performance is known. Therefore
the amount that the prior year's investment has grown or shrunk can be calculated. Then the difference
in the yearly change has to come from net inflows. When during the year the inflows occurred is not
known, so the assumption is made that all net inflows occurred evenly throughout the year. Changing
assumptions on net inflow timing only affects the rate of growth for that year's inflow which never amounts
to more than a few billion dollars difference.
Estimated Annual Inflows
S&P-GSCI DJ-AIG TOTAL
2004 $16.2 $8.9 $25.1
2005 $4.8 $12.4 $17.2
2006 $28.3 $11.3 $39.6
2007 $14.7 $15.4 $30.1
2008 $35.1 $20.0 $55.1
TOTAL $99.1 $68.0 $167.1
19 ibid.
20 This table is a good reference in comparing the differences between market participants.
Types Of Futures Market Participants
HEDGER INDEX SPECULATOR
TRADITIONAL
SPECULATOR
Sheds Price Risk Takes On Price Risk Takes On Price Risk
Hedges Underlying
Position
Profits From
Price Moves
Profits From
Price Moves
Consumes Liquidity Consumes Liquidity Provides Liquidity
Price Sensitive Insensitive To Price Price Sensitive
Take Long And
Short Positions Long Only Take Long And
Short Positions
21 “And that actually happened in 1991 with a particular swap dealer that was hedging an OTC transaction
with a pension fund, and the swap dealer came to us, and we said, "yeah, that qualifies for a hedge
exemption," so we granted a hedge exemption to the swap dealer. And in the years since then, we've
done the same for other swap dealers, as well.”
(Remarks of Don Heitman, Division of Market Oversight, CFTC Agricultural Advisory Committee Meeting,
Washington, D.C., December 6, 2007)
(www.cftc.gov/stellent/groups/public/@aboutcftc/documents/file/aac_12062007.pdf)
22 “Commodities: Who's Behind the Boom?,” Gene Epstein, Barron's, March 31, 2008
23 “Similar hedge exemptions were subsequently granted in other cases where the futures positions
clearly offset risks related to swaps or similar OTC positions involving both individual commodities and
commodity indexes. These nontraditional hedges were all subject to specific limitations to protect the
marketplace from potential ill effects. The limitations included: (1) The futures positions must offset
specific price risk; (2) the dollar value of the futures positions would be no greater than the dollar value of
the underlying risk; and (3) the futures positions would not be carried into the spot month.”
(72 FR 66097, Notice of Proposed Rulemaking, Risk Management Exemption From Federal Speculative
Position Limits, , November 27, 2007.)
(http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/file/e7-22992a.pdf)
(The language in 72 FR 66097 above also appears in 71 FR 35627, CFTC Request for Comments,
Comprehensive Review of the Commitments of Traders Reporting Program, June 21, 2006.)
(http://www.cftc.gov/foia/fedreg06/foi060621a.htm)
24 (72 FR 66097, Notice of Proposed Rulemaking, Risk Management Exemption From Federal
Speculative Position Limits, , November 27, 2007.)
(http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/file/e7-22992a.pdf)
25 “CFTC Study Finds Independent-Moving Commodity and Equity Markets,“ December 19, 2007, http://
www.cftc.gov/newsroom/generalpressreleases/2007/pr5425-07.html
cftc.gov@aboutcftc/documents/file/amarketofone.pdf
26 Pension fund consultants have been advocating portfolio allocations of between 5% and 12% to
commodities indices. Considering that worldwide institutional assets are about $29 trillion, if Institutional
Investors heed the advice of their consultants, index replication could easily reach $1 trillion. $1 trillion on
$29 trillion would represent an average allocation of just 3.5%.
“Investing In Collateralised Commodities Futures,” Russell's Research For Excellence, Yvonne Ooi and
David Rae, 2005
Strategic Asset Allocation and Commodities, Ibbotson Associates, Thomas M. Idzorek, March 27, 2006
Pension Funds $26 trillion : “UK pension fund returns at five-year low,” IFAonline, Jennifer Bollen,
January 28, 2008. ifaonline.co.uk
Sovereign Wealth Funds $3 trillion : “Sovereign Wealth Funds,” Council On Foreign Relations, Lee
Hudson Teslik, January 18, 2008. cfr.org
27 “WFP says high food prices a silent tsunami, affecting every continent,” World Food Program - United
Nations, April 22, 2008. wfp.org |
