Thursday, March 25, 2010

CFTC's March 25th Hearings on the Metals Markets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The CFTC (Commodities Future Trading Commission) held hearings on March 25th on whether to set controls on metal's trading in the U.S. futures markets. A representative from CME (Chicago Mercantile Exchange) testified that the CFTC's attempt to put hard limits on speculative activity in the U.S. metals markets is an attempt by the government oversight agency to overstep its bounds. A spokesman for HSBC claimed that limits on metal trading were simply unnecessary. The CFTC itself said it continues to look into allegations of market manipulation in the silver market in the summer of 2008.

The CFTC has previously held hearings on setting trading limits in energy and agricultural commodities. One of the reasons that the CFTC claims it needs to set position limits in trading is because of the finite supply of any commodity. The limits are supposedly protecting the market (from itself apparently) and the CFTC claims that government bureaucrats know more about how trading should be done than market participants. While there are actual glaring examples of how the gold and silver markets are manipulated by the big players, these are rarely on the CFTC's agenda. Like the other major market regulatory body, the SEC, the CFTC just doesn't seem to notice the behavior from the big money insiders that really distorts the market. For instance, CFTC hearings last summer on energy focused on ETF UNG, which held 20% of natural gas futures contracts. Even though this was an investment vehicle heavily used by small investors, the CFTC decided it was a danger to the integrity of the markets, as opposed to the trading activities of the big banks and hedge funds. The SEC took the same approach by paying limited attention to Bernie Madoff's $65 billion investment scam for almost two decades, but during the same period was very likely to use its resources to investigate some dentist in New Jersey who suspiciously bought a 1000 option contracts and made a couple of bucks.

The CFTC's concerns with energy and agricultural trading are obviously politically motivated. Politicians want to keep the prices of these commodities down since they are necessities and the source of destabilizing inflation. The UK prime minister and French president actually wrote a widely circulated article about how energy prices need to be determined by the big government's of the world just before the CFTC's energy hearings last summer. The U.S. had price controls on energy commodities in the early 1970s and the results were long lines at gas stations and fuel shortages. Under pricing in the markets always leads to trouble down the road.

The excuse for the CFTC considering limits on metal trading is even less justified than for energy or agriculture. As the HSBC representative pointed out, metals are not wasting assets that are consumed and then no longer available as is the case for oil and food commodities. Metals get recycled. Almost all of the gold that has ever been mined is still thought to be in existence. Higher prices increase the recycling rate and bring more supply to market, so the markets for gold and silver are self-correcting. While 50% of silver is used for industrial purposes, only 13% of gold is employed for manufacturing practical items. Most gold is used to make jewelry. Does the gold market need to be controlled, so the rich can be assured of getting good prices on holiday presents?

The CFTC is also not looking at where the actual manipulation is taking place in the gold market. This is done through central bank leasing to the large banks and hedge funds. They lease the gold for a small price and then can sell it on the market to raise some quick cash. This activity held down the price of gold in the 1990s and the early 2000s. The price of gold rose as leasing activity diminished. Artificially lowering the price of a commodity doesn't seem to come under the definition of market manipulation as far as the CFTC is concerned. Central banks, large international banks and big hedge funds also seem to be citizens above suspicion as Madoff was for the SEC.

While the CFTC is looking into manipulation into the silver markets, it may not mean that much. This is probably happening because silver investor Ted Butler has worked tirelessly to bring the situation to the public's attention, thereby putting some heat on the agency. How much the CFTC actually looks this time has yet to be determined. The SEC investigated Madoff many times, but just couldn't discover his blatantly obvious crooked activities. For some time, two big banks have frequently had huge short positions in silver futures -seemingly bigger than the Hunt Brother's who were convicted on federal charges on manipulating the silver prices in the 1980s. The CFTC has already investigated silver twice before in the 2000s and didn't find any irregularities. The SEC investigated Madoff more than two times.

Steve Sherrod, acting director of surveillance at the CFTC’s division of market oversight noted in today's hearings that when Comex silver prices fell sharply in the summer of 2008 that there was no significant change in the total long or short positions in the commitment of traders’ positions in the agency’s weekly data. Nor was there a significant change in open interest during the period of July and August 2008. Sherrod tried to explain away this seeming impossibility by stating, “One could explain a change in short open interest on the BPR (bank participation report) by a change within the classification system; if the usage code changed from non-bank to bank for a trader with a short position, then an increase in the short open interest would appear on the BPR, without any change in the COT (commitment of traders) Report. Another explanation would be a merger or acquisition where a bank assumes the position of a non-bank entity, both of whom were under the same commercial classification. That may not result in a change in open interest and may not result in a change in aggregate position within a COT classification. But it may result in an increase in the reported position on the BPR.”  Readers should carefully note Sherrod's wording (and language that seems more geared to hide what is going on than to clearly explain it). While this may have been what happened, Sherrod indicates that it also may not have been what happened. So how does this enlighten us?

The small investor shouldn't expect much, if anything, from the CFTC. It is realistically a government body that uses its powers to protect the big money interests, although it will claim that whatever it does is to benefit the public. Markets can also not be controlled without serious negative consequences. Government's have attempted to do so hundreds of times throughout the ages and it has never worked. Most commodity trading is international as well (natural gas is an exception), so restrictions in trading in the U.S. means that business will just move overseas. In this doesn't happen quickly enough, shortages will appear. You will have the CFTC to thank for them when they do.

Disclosure: None

NEXT: Euro Zone Support Package Doesn't Solve the Problem

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

1 comment:

Anonymous said...

In early 2008 JPM "purchased" Bear Stearns and by Aug or Sept 2008 Bear Stearns positions were intergated into JPM's hence the change in classification from non bank to bank and the zero net effect in open interest. Sherrod couldnt come out and say that but considering the chain of events its plain to see that is what happened.