Ahh, The Working Poor

[....lybob]

I'll try this again, the quantity/level of demand matters for any market. If the amount of money flowing into commodity futures (via ETFs) doubles relative to the # of existing contracts, will that not have an impact on prices? It's simple supply and demand. Futures prices are pushed up as new money continuously flows into the markets. The amount of money flowing in has increased by over 2500% in that last 7 years!

 

Net inflows have constantly increased (with the exception of the middle of the crisis as $ fled to safety). ETFs take "long" positions and only "sell" when they need to rollover to new contracts as existing contracts expire. Because of this fixed behavior "smart money" takes advantage by buying during the rollover, as it causes prices to fall; then selling back to the ETFs as they are required to purchase new contracts. I think Business Week had a headline story last summer warning "dumb" investors about the pitfalls of speculating in commodities through ETFs--how you could lose money even as commodity prices were increasing...

 

Add to this that Wall Street banks like Morgan are feeding the flows by becoming "owners" of the underlying commodity, so it allows them to be qualified as hedgers rather than speculators and eliminates their contract limits.

 

It's amazing that some people will argue to their death that doubling the money supply will double prices, but apparently a 2000%-plus increase in demand in a market won't affect prices....

"It is difficult to get a man to understand something when his salary depends on not understanding it." Upton Sinclair

Edited January 7, 2011 by ....lybob

[TPS]

"It is difficult to get a man to understand something when his salary depends on not understanding it." Upton Sinclair

I understand.

 

Btw,

here's the link to the B-Week article--it's a good read.

Contango!

[DC Tom]

I'll try this again, the quantity/level of demand matters for any market. If the amount of money flowing into commodity futures (via ETFs) doubles relative to the # of existing contracts, will that not have an impact on prices? It's simple supply and demand. Futures prices are pushed up as new money continuously flows into the markets. The amount of money flowing in has increased by over 2500% in that last 7 years!

 

Net inflows have constantly increased (with the exception of the middle of the crisis as $ fled to safety). ETFs take "long" positions and only "sell" when they need to rollover to new contracts as existing contracts expire. Because of this fixed behavior "smart money" takes advantage by buying during the rollover, as it causes prices to fall; then selling back to the ETFs as they are required to purchase new contracts. I think Business Week had a headline story last summer warning "dumb" investors about the pitfalls of speculating in commodities through ETFs--how you could lose money even as commodity prices were increasing...

 

Add to this that Wall Street banks like Morgan are feeding the flows by becoming "owners" of the underlying commodity, so it allows them to be qualified as hedgers rather than speculators and eliminates their contract limits.

 

It's amazing that some people will argue to their death that doubling the money supply will double prices, but apparently a 2000%-plus increase in demand in a market won't affect prices....

 

So what you're saying is that I can make a killing by buying a stock, then buying out-of-the-money options to drive the stock price up...

[TPS]

So what you're saying is that I can make a killing by buying a stock, then buying out-of-the-money options to drive the stock price up...

If you don't know the difference between an option and futures contract, and why the analogy doesn't work, I'd be happy to explain it to you.

[GG]

If you don't know the difference between an option and futures contract, and why the analogy doesn't work, I'd be happy to explain it to you.

 

.. and over this period if the guys who actually need delivery of that commodity thought that ETFs are causing such significant price hikes, they would simply stick them with the delivery obligation at the end of the contract.

 

The way you describe it is that there would be significant volatility near contract expiration dates, and plenty of opportunities for smart investors to totally short squeeze the ETFs who have to sell to renew contracts. Yet that doesn't happen.

 

So the reality is that the increased market liquidity doesn't jack up the prices like you're postulating.

[TPS]

.. and over this period if the guys who actually need delivery of that commodity thought that ETFs are causing such significant price hikes, they would simply stick them with the delivery obligation at the end of the contract.

 

The way you describe it is that there would be significant volatility near contract expiration dates, and plenty of opportunities for smart investors to totally short squeeze the ETFs who have to sell to renew contracts. Yet that doesn't happen.

 

So the reality is that the increased market liquidity doesn't jack up the prices like you're postulating.

I guess you didn't read the Business Week article. Here's a snippet:

Here's an example. The Standard & Poor's Goldman Sachs Commodity Index (S&P GSCI), which tracks 24 raw materials, is the basis for as much as $80 billion of investment. Managers of funds linked to the index, created by Goldman in 1991, have to buy their next-month futures contracts between the fifth and the ninth business day of each month. During that period in May 2010, fund managers sold contracts for June delivery of crude oil priced at $75.67 a barrel, on average, according to data compiled by Bloomberg. Managers replacing those futures with July contracts had to pay $79.68. After the roll period ended, the July contract fell back to $75.43. For each of the thousands of contracts, in other words, managers paid $4 for nothing—and the value of their funds dropped accordingly.

 

Contango isn't the only reason commodity ETFs make lousy buy-and-hold investments. Professional futures traders exploit the ETFs' monthly rolls to make easy profits at the little guy's expense. Unlike ETF managers, the professionals don't trade at set times. They can buy the next month ahead of the big programmed rolls to drive up the price, or sell before the ETF, pushing down the price investors get paid for expiring futures. The strategy is called "pre-rolling."

 

"I make a living off the dumb money," says Emil van Essen, founder of an eponymous commodity trading company in Chicago. Van Essen developed software that predicts and profits from pre-rolling. "These index funds get eaten alive by people like me," he says.

It's apparent you don't understand the futures market when you state "they would simply stick them with the delivery obligation at the end of the contract." The 100s of billions of of dollars in contracts held by the ETFs never take delivery, they offset near expiration, then buy new-dated contracts (see above).

 

As for Options vs Futures: option values are mainly related to the difference between the current price and the specific strike price, which is fixed; and, since it gives the right to buy or sell at that strike price without the obligation, an investor can simply let it expire at the end of the contract. Buying "out of the money" options only increases the option premium, not the underlying price of the asset because you are contracted (have the right) to buy/sell at the stike price.

Futures contracts differ significantly in two ways. First, owning a contract requires an action at expiration--either delivering or taking delivery, or--WHAT THE MAJORITY OF TRADERS DO, offset their positions at expiration. If one is long, then one must sell the same contract at expiration to close your position. NO DELIVERY TAKES PLACE.

The other significant difference is that since the futures contract represents an obligation to deliver (receive) at some future date, its price IS directly related to the spot, because it becomes a spot contract at expiration--the price of the futures contract converges to the spot price at expiration.

 

Example: If a June wheat contract today is priced at $8/bushel and the spot price is $7.50 today, the $0.50 difference is known as the basis; the futures price higher than the spot today is known as a contango market. As time goes by and we approach expiration in June, the June contract price converges (the basis goes to 0) with the spot becuase it's now a spot transaction. If the spot price in June turns out to be higher (say $8.50) than what I bought the contract for today (january), then I made money when I offset and sell it in June. In reality, as the price rises (falls) over time my account is marked-to-market and profits (losses) are automatically added (subtracted) to (from) my account. A baker who is hedging his purchase of wheat in June will do exactly this. He has to pay $8.50 in June, but he made $0.50 profit on his futures contract, so his actual price is the price of $8 he paid for the contract today (january).

 

Rapidly increasing prices causes problems for the sellers (e.g. farmers) of the contracts as they are taking marked-to-market losses and have provide more collateral to their exchange account.

 

Bottom line: it's very easy to manipulate prices by pouring money into futures contracts which bids up their prices--it's supply and demand. This is why there have always been contract limits on speculators. Things changed in 2000 with the Commodity Futures Modernization Act which "deregulated" the futures markets making it easier for speculators to bypass the limits.

 

you guys don't seem very objective about this.

[birdog1960]

 

 

you guys don't seem very objective about this.

about this?

 

but what is the small investor to do if: a. these vultures successfully prey on index funds

b. actively managed funds lose to index funds about 70% of the time and charge large fees

c. hedge funds take big chunks of roi as profit

there doesn't appear to be a good option for the "dumb money" that likely constitutes the vast majority of 401k's and therefore the vast majority of US retirement money. the vultures are getting rich by assuring that a significant proportion of hard working, diligently saving americans will retire with less than they planned and less than they need.

 

am i missing something or should we all just give up saving and spend?

[GG]

I guess you didn't read the Business Week article. Here's a snippet:

 

It's apparent you don't understand the futures market when you state "they would simply stick them with the delivery obligation at the end of the contract." The 100s of billions of of dollars in contracts held by the ETFs never take delivery, they offset near expiration, then buy new-dated contracts (see above).

 

As for Options vs Futures: option values are mainly related to the difference between the current price and the specific strike price, which is fixed; and, since it gives the right to buy or sell at that strike price without the obligation, an investor can simply let it expire at the end of the contract. Buying "out of the money" options only increases the option premium, not the underlying price of the asset because you are contracted (have the right) to buy/sell at the stike price.

Futures contracts differ significantly in two ways. First, owning a contract requires an action at expiration--either delivering or taking delivery, or--WHAT THE MAJORITY OF TRADERS DO, offset their positions at expiration. If one is long, then one must sell the same contract at expiration to close your position. NO DELIVERY TAKES PLACE.

The other significant difference is that since the futures contract represents an obligation to deliver (receive) at some future date, its price IS directly related to the spot, because it becomes a spot contract at expiration--the price of the futures contract converges to the spot price at expiration.

 

Example: If a June wheat contract today is priced at $8/bushel and the spot price is $7.50 today, the $0.50 difference is known as the basis; the futures price higher than the spot today is known as a contango market. As time goes by and we approach expiration in June, the June contract price converges (the basis goes to 0) with the spot becuase it's now a spot transaction. If the spot price in June turns out to be higher (say $8.50) than what I bought the contract for today (january), then I made money when I offset and sell it in June. In reality, as the price rises (falls) over time my account is marked-to-market and profits (losses) are automatically added (subtracted) to (from) my account. A baker who is hedging his purchase of wheat in June will do exactly this. He has to pay $8.50 in June, but he made $0.50 profit on his futures contract, so his actual price is the price of $8 he paid for the contract today (january).

 

Rapidly increasing prices causes problems for the sellers (e.g. farmers) of the contracts as they are taking marked-to-market losses and have provide more collateral to their exchange account.

 

Bottom line: it's very easy to manipulate prices by pouring money into futures contracts which bids up their prices--it's supply and demand. This is why there have always been contract limits on speculators. Things changed in 2000 with the Commodity Futures Modernization Act which "deregulated" the futures markets making it easier for speculators to bypass the limits.

 

you guys don't seem very objective about this.

 

Thanks for the lesson professor. But what you have not proven is that by increasing the size of the market 20-fold has led to dramatic price increases. The fact that futures have to be settled give the user of that commodity significant leverage over the financial player because they're smart guys too, and if they see intraperiod price swings that are too high, they'll simply move to the spot market for all their purchases and you'd see huge losses by the financial players.

 

What you're describing is a vehicle for the financial players to juice up their profits between the settlement dates, but it certainly does nothing to prove that the financial players are manipulating the market at the expense of the commodity users. The proper analysis would compare whether the increased market size is bad because you have more speculators involved or is it good because you have more liquidity and more players to even out the bets.

[TPS]

Thanks for the lesson professor. But what you have not proven is that by increasing the size of the market 20-fold has led to dramatic price increases. The fact that futures have to be settled give the user of that commodity significant leverage over the financial player because they're smart guys too, and if they see intraperiod price swings that are too high, they'll simply move to the spot market for all their purchases and you'd see huge losses by the financial players.

 

What you're describing is a vehicle for the financial players to juice up their profits between the settlement dates, but it certainly does nothing to prove that the financial players are manipulating the market at the expense of the commodity users. The proper analysis would compare whether the increased market size is bad because you have more speculators involved or is it good because you have more liquidity and more players to even out the bets.

What I have tried to describe is NOT manipulation, rather "influence" on price. What I have argued is that speculators, specifically indexed commodity fund trading, have siginificantly influenced price over the recent past. I've never said speculators are bad, because they do provide the liquidity function. I won't quote Keynes again, but there is a reason speculators always had position limits.

 

Do you believe in the forces of supply and demand? It's pretty straightforward. If the flow of money into commodity futures is steadily increasing, and these represent new long positions so open interest is rising, does this NOT influence price? Maybe you can tell me how futures prices actually change? If it's not supply and demand, what is it? If for every buyer there is a seller, are you saying prices never change?

Do me a favor: read the Senate's 2009 investigation on wheat prices and the impact from index traders.

 

Last point--less than 3% of all futures transactions are delivered. Almost all transactions are offset before delivery is required.

[Captain Caveman]

Isn't bitching about someone else's wages a little... anti-capitalist?

[GG]

What I have tried to describe is NOT manipulation, rather "influence" on price. What I have argued is that speculators, specifically indexed commodity fund trading, have siginificantly influenced price over the recent past. I've never said speculators are bad, because they do provide the liquidity function. I won't quote Keynes again, but there is a reason speculators always had position limits.

 

Do you believe in the forces of supply and demand? It's pretty straightforward. If the flow of money into commodity futures is steadily increasing, and these represent new long positions so open interest is rising, does this NOT influence price? Maybe you can tell me how futures prices actually change? If it's not supply and demand, what is it? If for every buyer there is a seller, are you saying prices never change?

Do me a favor: read the Senate's 2009 investigation on wheat prices and the impact from index traders.

 

Last point--less than 3% of all futures transactions are delivered. Almost all transactions are offset before delivery is required.

 

Of course they impact the price. But since your cause celebre over the past three years has been to blame futures investors & ETFs for runaway commodity price spikes, it is worthwhile to question that claim. So now that you are vascilating on whether the ETFs cause the outsized price hikes looks liked your position is reeled in.

 

Of course more participants in the market affect prices, but it's not necessarily for the bad. One good outcome is that with so many more players, you have less opportunity for someone to corner a commodity market. Especially with such a low % of actually settled contracts, a financial player can be busted by the commodity owner. Plus, you seem to imply that the smart guys on Goldman's futures desk are taking full advantage of the dum ol bumpkins at Cargill's trading desks. But the reality isn't quite that naive.

[Magox]

What I have tried to describe is NOT manipulation, rather "influence" on price. What I have argued is that speculators, specifically indexed commodity fund trading, have siginificantly influenced price over the recent past. I've never said speculators are bad, because they do provide the liquidity function. I won't quote Keynes again, but there is a reason speculators always had position limits.

 

Do you believe in the forces of supply and demand? It's pretty straightforward. If the flow of money into commodity futures is steadily increasing, and these represent new long positions so open interest is rising, does this NOT influence price? Maybe you can tell me how futures prices actually change? If it's not supply and demand, what is it? If for every buyer there is a seller, are you saying prices never change?

Do me a favor: read the Senate's 2009 investigation on wheat prices and the impact from index traders.

 

Last point--less than 3% of all futures transactions are delivered. Almost all transactions are offset before delivery is required.

As a former CFTC and NFA commodity trader, you have no clue in what you are saying.... Stick to theorizing skippy

[TPS]

Of course they impact the price. But since your cause celebre over the past three years has been to blame futures investors & ETFs for runaway commodity price spikes, it is worthwhile to question that claim. So now that you are vascilating on whether the ETFs cause the outsized price hikes looks liked your position is reeled in.

 

Of course more participants in the market affect prices, but it's not necessarily for the bad. One good outcome is that with so many more players, you have less opportunity for someone to corner a commodity market. Especially with such a low % of actually settled contracts, a financial player can be busted by the commodity owner. Plus, you seem to imply that the smart guys on Goldman's futures desk are taking full advantage of the dum ol bumpkins at Cargill's trading desks. But the reality isn't quite that naive.

WTF? How has my position changed? You seem to be the one squirming here.

I've said all along that the money flowing in from ETFs and other investments related to the indexes take long positions, which puts upward pressure on prices. And that money has constantly increased, so how do you think that's impacted futures prices?

 

Geez, a shocker! You finally admit that increased demand can influence price.

 

And what I said was that smart money takes advantage of the fact that managers of ETFs are required to maintain a specific quantity of long positions in the commodities that make up the index. The example I posted from the B-Week article didn't even mention Goldman, nor did I. And it's not taking advantage of Cargill's guys; it's taking advantage of ETFs which are required to maintain the contracts. Do you even read what's posted?

 

Final point: how many times do I have to say that no one has to take delivery of the commodity as long as you offset the contract before the delivery date, which is usually a few days before expiration? No financial player gets "busted." Hell, even most owners of commodities don't deliver; they use the futures contract as a financial hedge, then sell in the spot market.

 

Last final points: Yes, I do believe that speculation was the driving force in pushing up the price of oil before the global crisis in 2008. Yes, I do believe that investment funds are influencing commodity prices as much if not more than the fundamentals. More players and more investment, means more bubble.

Edited January 10, 2011 by TPS

[TPS]

WTF? How has my position changed? You seem to be the one squirming here.

I've said all along that the money flowing in from ETFs and other investments related to the indexes take long positions, which puts upward pressure on prices. And that money has constantly increased, so how do you think that's impacted futures prices?

 

Geez, a shocker! You finally admit that increased demand can influence price.

 

And what I said was that smart money takes advantage of the fact that managers of ETFs are required to maintain a specific quantity of long positions in the commodities that make up the index. The example I posted from the B-Week article didn't even mention Goldman, nor did I. And it's not taking advantage of Cargill's guys; it's taking advantage of ETFs which are required to maintain the contracts. Do you even read what's posted?

 

Final point: how many times do I have to say that no one has to take delivery of the commodity as long as you offset the contract before the delivery date, which is usually a few days before expiration? No financial player gets "busted." Hell, even most owners of commodities don't deliver; they use the futures contract as a financial hedge, then sell in the spot market.

 

Last final points: Yes, I do believe that speculation was the driving force in pushing up the price of oil before the global crisis in 2008. Yes, I do believe that investment funds are influencing commodity prices as much if not more than the fundamentals. More players and more investment, means more bubble.

 

No impact

 

No impact?

[birdog1960]

looks like sarkozy and other g20 leaders agree with TPS reuters will soon see what results from it.

[GG]

WTF? How has my position changed? You seem to be the one squirming here.

I've said all along that the money flowing in from ETFs and other investments related to the indexes take long positions, which puts upward pressure on prices. And that money has constantly increased, so how do you think that's impacted futures prices?

 

Geez, a shocker! You finally admit that increased demand can influence price.

 

And what I said was that smart money takes advantage of the fact that managers of ETFs are required to maintain a specific quantity of long positions in the commodities that make up the index. The example I posted from the B-Week article didn't even mention Goldman, nor did I. And it's not taking advantage of Cargill's guys; it's taking advantage of ETFs which are required to maintain the contracts. Do you even read what's posted?

 

Final point: how many times do I have to say that no one has to take delivery of the commodity as long as you offset the contract before the delivery date, which is usually a few days before expiration? No financial player gets "busted." Hell, even most owners of commodities don't deliver; they use the futures contract as a financial hedge, then sell in the spot market.

 

Last final points: Yes, I do believe that speculation was the driving force in pushing up the price of oil before the global crisis in 2008. Yes, I do believe that investment funds are influencing commodity prices as much if not more than the fundamentals. More players and more investment, means more bubble.

 

If your thesis were correct, then you would see a steadily rising prices of commodities that are in excess of inflation. But that hasn't really happened. The EFTs may magnify some of the price swings that are caused by natural factors that influence commodity prices, but that's not a given anyway because you have as many people betting on the opposite side. The fact that ETFs have to hold a certain long position provides an opportunity for some to capture that basis, but in no way does it influence base commodity pricing. Even in the article that you link, despite the talk about the lomg positions by the funds, the main driver of the price movement is the worry about the upcoming cold spell and the drawdown of gas reserves. I can argue that without a more liquid market, the cold concern would cause the price to spike even higher.

 

The reason that there's virtually no physical delivery of the contracts is because everyone views the market behaving as it should, so there's no need to physically settle. But if the participants feel that something is amiss then they would abandon the futures and move to spot market.

 

If anything, Sarkoczy's bandwagon jumping reinforces my view that the market is working just fine. Funny how no politicians were concerned about the commodities market when the price of corn shot up in '08 thanks to the ethanol boondogle.

[Alaska Darin]

lets face it, Union people are the Salt of the earth while the finance industry seems to attract those with low moral character

 

Idiot.

[DC Tom]

 

Idiot.

 

He's probably in finance.

[birdog1960]

 

 

If anything, Sarkoczy's bandwagon jumping reinforces my view that the market is working just fine. Funny how no politicians were concerned about the commodities market when the price of corn shot up in '08 thanks to the ethanol boondogle.

yeah, i read the comments after the article too. just because they were wrong to not condemn ethanol from corn (and they were) doesn't mean they're wrong about this.

[....lybob]

yeah, i read the comments after the article too. just because they were wrong to not condemn ethanol from corn (and they were) doesn't mean they're wrong about this.

ethanol from corn never made sense from the science but made perfect sense from the commercial agriculture operations industry subsidies point of view - right now bio-oil from algae, yeast or bacteria is our best bet for a transportation fuel with cellulosic ethanol being a distant second. Methane is relatively easy to produce and if more cars were built or converted to natural gas then it could be a player as a transportation fuel.