Index funds and commodities 2

Further lifting (of comments like cactus) by juan:

“…the term ‘speculators’ tends to imply short-term traders while it’s my understanding that most of the index funds take longer term or more ‘sticky’ positions, but this can become a matter of semantics that detracts from what Briese and some others have tried to bring out — a financialization of price and at least a few of the major actors.

So, a few clips not from the Barron’s article but another and related posting by Steve Briese:

What you didn’t read in the Barron’s cover story
The Commodity Exchange Act addresses excess speculation in commodity markets, and states that “the Commission shall…fix such limits on the amounts of trading which may be done or positions which may be held by any person.” The only exceptions are “to permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs”(7 USC 6a).

The CFTC regulations 17 CFR 1.3(z) further spells out who is to be considered a bona fide hedger in such intricate detail as to make it unmistakable that exemptions to speculative limits are intended only for those commonly known as “the trade” who carry on a cash business in the commodity itself.

The Commission acknowledges that speculative limits apply to indexers: “Mutual funds (or for that matter institutional traders) who want to gain commodity exposure”, whether in an individual commodity future or in several commodity futures that make up an index, are not entitled to an exemption as a bona fide hedger.”

But what agency takes away with one hand, it gives back with the other: “Swaps dealers that have swap agreements with clients that provide the clients with a return on an index of commodities can hedge the exposure from that agreement by buying futures contracts in the commodities underlying the index.”

The illogic of limiting position sizes for indexers dealing directly in futures while exempting indexers who use a swap deal intermediary has apparently not escaped the Commission’s attention. And it has a proposal on the table to correct this inequity. In November the agency proposed new exemptions for “risk management positions,” which would open the door to all indexers while, of course, leaving the swap dealer exemptions in place.
In proposing the new exemptions, the CFTC acknowledges that index-based positions differ enough from bona fide hedges as to make hedge exemptions inappropriate under current law. It does not state where it found the authority to classified swap dealers as hedgers in the first place. It is also unclear why swap dealers should be accorded special treatment.

Their cozy arrangement began during the Reagan Administration under CFTC Chairman Wendy Graham (the other half of the Texas Senator Phil Grahm’s duo that Barron’s dubbed “Mr. & Mrs. Enron”). She began exempting swaps from CFTC oversight in 1989, and in 1992 granted Enron regulatory exemption for its energy-swap operation just five days before resigning her Chair to join Enron’s audit committee.

In 2000 the CFTC officially granted dealers broad relief with the result that today swaps are cleared through the US futures clearing systems alongside futures contracts, thus affording exchange level payment guarantees to non-exchange traded and non-regulated derivative contracts.

Then in 2006, in undertaking a “Comprehensive Review of the Commitments of Traders Report” the Commission acknowledged that its practice of reporting the positions of swap dealers under the “commercial” category may be misleading. Though it received a record public response with practical unimity for continued and expanded position reporting, it bowed to the one dissenter.

The International Swaps and Derivatives Association (ISDA), although opposed to a separate reporting category altogether, allowed that “If the Commission decides otherwise, we recommend that any additional reporting be in a no more than two-year pilot program that we would be prepared to work with the Commission to design with a limited number of commodities.” The resulting “COT-Supplemental” report consists of just twelve markets and its two-year mandate expires at the end of this year.

More enlightening than the swap dealers wish for anonymity, was the reason stated in the ISDA’s letter to the CFTC: “the [swap dealer] category is highly concentrated, with, we believe, the top four swap dealers composing over 70% of the category. In some of the lower-volume commodities markets, only a single swap dealer is a dominant participant”.

With one to four unregulated swap dealers controlling upward of 60% of the long open interest in some markets, the CFTC’s has created a nightmarish level of concentration. Even assuming that their dealings in fact originate from non-leveraged investors, sudden setbacks in other investment areas could easily jeopardize a swap dealer’s ability to meet margin calls, al la Bear Stearns.
Complete at Commitments of Traders.

corrected link
to Gene Epstein’s Barron’s cover story Commodities: Who’s Behind the Boom?

Next, the ‘Chart’ link above was not intended to be LAN but Nymex light sweet crude oil contract, continuous, for the last decade — this one for benchmark West Texas Intermediate captures the same move. I would note that according to Citigroup commodity analyst Alan Heap, (Beyond Fundamentals…), long only funds such as index began entering late 2003-early 2004

Finally, Frank Veneroso (Veneroso Associates) made an interesting presentation at the World Bank Executive Forum last year.
Veneroso Associates:
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
which can be accessed here and places greater emphasis on the role of hedge funds.