While politicians look to lynch index funds, shorts are the more harmful commodity speculators
June 11, 2008
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The following article by Ted Butler is right on the money. I have been following the short activity on gold and silver on a regular basis for several years now. The price manipulation by the largest shorts is clear as day when you track the COT and then compare it to what follows with prices.
We could be approaching a period of extreme volatility for commodities, folks! Investors heavy into agriculture and energy beware... while the technical indcators may look strong and supply shortfalls very real, any wholesale action to regulate the futures markets in these commodities could cause epic swings in prices in both directions. I will watch this issue very closely, but since most commodity investors are likely sitting on some nice gains, I would urge people to insert some 'stop loss' orders beneath their holdings to protect from the scariest swings. Even if the stops are well below present values, at least one would be protected from the devastating losses if regulators impose some sort of forced liquidation of long positions.
Mr. Butler is correct to point out that gold and silver are a totally different story, and anyone who groups them in and claims they too have been driven up by speculators would by grossly misinformed.
Here is Mr. Butler's article from:
http://news.silverseek.com/TedButler/1213126384.php
The Real Speculators
By: Theodore Butler
The unprecedented price volatility in crude oil, grain and other commodities, has focused our attention and galvanized a collective opinion. "Too much speculation" is the cry of the day. There appears to be much truth in that statement, since few can point to supply and demand factors that account for the shocking price moves. But maybe we are not looking closely enough at the speculation angle.
The most visible culprit for the excessive speculation is said to be the index funds. These are huge institutional funds that hold significant long positions in many commodity futures markets (but not in COMEX gold or silver futures). I have previously written about index funds. This is an important topic, although I have been clear to state that I have no vested interest in whether they continue to hold their big long positions or not.
http://www.investmentrarities.com/01-16-07.html
http://www.investmentrarities.com/03-04-08.html
http://www.investmentrarities.com/04-01-08.html
Presently, there is a political frenzy developing to more closely regulate the index funds, and perhaps even force them to sell their long positions, thereby lowering the price of oil and other commodities. While I question whether these index funds should have been allowed to amass such a large position they were permitted to amass their positions legally and openly.
Should the index funds be forced to dump their long positions, that would likely pressure, at least temporarily, oil and other commodity prices. Perhaps a temporary lowering of prices is all the politicians are interested in. That way they could declare victory over the evil speculators and go back to their business of efficiently running (ruining?) the country.
But before the index funds are tarred and feathered and run out of town on a rail, let’s clear up a common misperception that it has been a sudden influx of index fund buying that has caused the recent dramatic increase in the price of crude oil. That is simply not true. The index funds are holding the same size, or smaller, long position in crude oil than they held 10 months ago, when crude oil was $70/barrel. Ditto for the large long speculators and smaller (unreported) traders on the NYMEX, according to CFTC data in the Commitment of Traders Report (COT). The data clearly shows that long traders on the NYMEX have not been buying aggressively and running up the price of crude. Well, if speculators are behind the recent sharp run-up in oil prices and the long-side traders haven‘t been buying, then who has been buying oil?
The answer is painfully obvious - the speculative shorts have been doing the buying. Public COT data proves this. The buying back of previously sold short futures contracts, primarily in the commercial category, account for the bulk of the buying over the past eight months or so, when oil was trading at $70.
There is always a short for every long position in every commodity futures contract. When enough longs panic and sell aggressively, prices plummet. When enough shorts panic and buy back their short positions aggressively, prices soar. Oil prices didn’t jump sharply because many new longs came into the market. They jumped because, at the margin, enough shorts panicked and bought back contracts they previously sold short, to prevent their losses from getting larger.
So while I agree that speculation caused oil prices to jump sharply, at least we should correctly identify which speculators did the buying. It was the shorts, not the longs. In fact, the data shows that the longs were selling. That’s not to say that oil prices won’t plunge in the future. They will, when enough longs panic and sell. To a large extent, this is the trading pattern of most markets.
By correctly identifying the real cause of the recent price spike caused by the speculative oil buying, we come to the real hidden problem with speculation. That problem is that large numbers of shorts are, effectively, trapped with their short positions. The shorts are trapped because the index funds buy and hold for the long term. That doesn’t mean prices can’t go down sharply while the index funds are long. For example, the wheat market rose almost 100% and then fell by 40% with hardly a change in the index funds’ large position. But because the index funds hold and don’t sell, regardless of whether prices rise or fall, large numbers of shorts can’t exit their short positions, even if prices fall. And when prices do fall, there are no complaints about index funds, just when prices rise.
Recently, some commentators have labeled the index funds as not playing fairly, because they don’t sell, but instead invest for the long term. But there is no rule that anyone can’t invest in futures for the long term. The index funds were clear in their intentions as they came into the futures market over the past several years. Everyone knew beforehand how they behaved and they certainly didn’t sneak into the market; because they were so big, you could see them coming a mile away. The shorts initially licked their chops, because they knew the index funds wouldn’t demand delivery and therefore attempt to squeeze the shorts. The shorts also knew the index funds would have to roll over their positions constantly, giving the shorts an opportunity to extort spread advantages due to the mandatory roll-over behavior of the index funds.
But there is such a thing as the law of unintended consequences, and that law has prevailed in the trading dance between the index funds and the shorts. When the index funds initially established their positions in oil or grain futures, there was no extreme tight supply/demand situation. That’s why great numbers of shorts sold into the index fund buying. But then conditions tightened up and the shorts appear to be on the wrong side and are looking for a way out. The easiest solution for the shorts is to have the regulators mandate that the index funds sell.
The real story should be told. It doesn’t seem fair to me to label the index funds as the real speculators when they back their purchases with the full cash value of the contracts and hold for the long term, while casting the short speculators masquerading as commercials, who are out for a quick buck, as innocent victims. If the regulators want to change the rules against the index funds, let them do so. Just don’t pretend these funds are evil and the short speculators are without blame. If we get shortages in oil or grain or anything else, prices will go higher, with or without the index funds.
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