CFTC Points Finger, Traders Balk

The Chairman of the Commodity Futures Trading Commission (CFTC) is talking tough about instituting trading curbs on energy contracts. Gary Gensler, the new CFTC chairman as of May, is pulling an abrupt about-face from the previous administration's stance, which was very hands-off and pro-trader. Mr. Gensler believes that speculation by index investors contributed to massive volatility in the price of oil last year. The CFTC plans to issue a report next month suggesting that speculators played a significant role in driving wild price swings in the price of oil, which is a reversal of the findings of the CFTC last year, which claimed that it was purely supply and demand driving the prices swings. The UK's regulator, the FSA, has also cleared speculators of any responsibility for excessive oil price volatility. Who's right? The truth is probably somewhere in between. What began as a spike in oil prices based on fundamentals, turned into a pile-on of endowments, pensions and other investors looking to get in on the action as a hedge against inflation, or just a bet on something that was going higher. When $300 billion enters a market via new index products, as it did over the course of a few years, it is bound to drive up the price. Whether these folks should be allowed to play in the market is entirely a matter of interpretation. The previous administration believed that everyone was allowed to the party, while the current administration wants to break the party up. The fact that the price of oil is such a major determinant in economic growth is not something that this administration is taking lightly. While the prior administration's laissez-faire attitude may be reflected on wistfully by energy traders, at least the CFTC's tough stance doesn't involve invading any countries. Like I said, it's all a matter of interpretation.

The CFTC is planning to propose new curbs on trading positions in order to limit speculators' ability to drive commodity prices. Currently the CFTC only sets hard limits on speculative trading in certain agricultural markets, leaving the exchanges to set limits on other products. Exchanges only impose hard limits on energy products in the last three days of trading before a contract's expiration. The rest of the time, they impose accountability levels, which trigger additional oversight if exceeded. Mr. Gensler revealed today that in the past 12 months , a total of 70 different parties exceeded those accountability levels in the four major energy contracts. The CEO of the CME, Craig Donohue has apparently agreed to set hard limits on energy contracts, but he doesn't sound happy about it. Mr. Donohue argued that speculators have been wrongly targeted in the debate over energy prices and he believes that any effort to control prices or market volatility by position limits is a "failed strategy."

For some small foreshadowing of what could happen in the oil markets, we go to the New York Mercantile Exchange to check in with the natural gas market. Traders are grumbling about the new limits exchanges have imposed on natural gas trading. In the face of pending restrictions , natural gas prices have swung wildly and trading volume has declined markedly. In June, the New York Mercantile Exchange sent a notice that it would start imposing hard position limits on seven cash-settled natural-gas contracts, limits on the positions traders can hold in the three days before the contracts expire. This is supposed to limit volatility and seems to be working about as well as the price caps imposed on oil in the 70's. Natural gas prices jumped 11% in early June, followed by a 23% dive until July 13 and then rebounded 10% in recent days. Price volatility of three-month contracts shot up in June to the highest levels since the Gulf War, the First Gulf War, when the natural gas contract first started trading. So, you know, so far the restrictions are working really well in terms of curbing volatility.

Goldman: Manipulator or Victim?

Sergey Aleynikov, an ex-Goldman Sachs computer programmer, was arrested July 3rd and charged with a criminal complaint with stealing trading software. Teza Techonologies, the Chicago-based firm co-founded by a former Citadel Investment Group trader, said it suspended Aleynikov, who started work there the day before his arrest. The folks over at Zerohedge have spent an inordinate amount of time speculating and outright accusing GS of manipulating markets. I've maintained my usual level of skepticism, despite the fact that I love a good conspiracy theory, particularly when it pertains to an investment bank that seems to always get a bone from the government when it needs a boost. But I must admit, I'm seriously considering jumping on the Goldman-market-manipulator bandwagon. The Assistant US Attorney told a federal judge that Aleynikov's alleged theft poses a risk to US markets. He goes on to say that the code, which is worth millions (more likely billions if it really can manipulate markets), was transferred to a server in Germany and others may have access to it. "The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways." the attorney asserted. Theoretically speaking, the folks over at GS know how to use this magical code better than anyone. They're admitting it is so potent that it can manipulate markets. But don't worry, they would never use it to that end. GS only uses its power for good, not evil. Furthermore, I'm sure that the totally innocent guys at Teza had no idea that their employee was trying to steal a top secret code from GS that holds the market's fate in its hands. No doubt this trial will be an interesting one.

In what is bound to be more disheartening news for the folks at Goldman, the CFTC is proposing sweeping trading limits on oil, natural gas, and possibly other commodities. The agency is in the process of altering how it presents information to the public by incorporating data from swap dealers, foreign contracts tied to US futures, and professionally managed market positions such as hedge funds. Commodities swaps are all done OTC and the market is huge, so a bit more clarity on the size of the market should be a real eye-opener and possibly eye-popper. Goldman is a huge player in the commodities markets and likes to do things like put out research papers declaring that the price of crude will spike to $200 right before commodities prices take off. The investment bank cleverly lumps its equities, commodities and fixed income p&l together when it reports earnings, which for some reason seems to only annoy me and not the bone-headed analysts who cover the stock, because it does disguise the true volatility of the company's trading profits. Nevertheless, stricter trading limits on commodities is bound to cut into the firm's trading profits, as well as the other dealers that trade in commodities.

Hurricane Gustav Bludgeons Oil Prices, Spares People

In a great twist of irony, Hurricane Gustav did more for lowering the nation's gas bills than any of our congressmen could muster.  Forget about "evil speculators."  Who knew that the price of oil would surely fall if a tropical storm billed as the next Katrina turned out to be enormously overrated?  The price of oil is down over $7 on the news that Gustav did not do any major damage to the energy infrastructure in the Gulf.  I have yet to read reports of any human casualties, although have heard reports of significant property damage and that parts of the region will be without electricity for days.  Although certainly difficult for the residents of the Gulf Coast region and investors who were long oil futures, the nation just breathed a collective sigh of relief.  We all know who to thank the next time we fill up our gas tank.

Market Higher on Continued Declines in Commodities Prices

Commodities continue their recent sell-off, giving a boost to financials.  Lower commodities prices mean less inflation which takes the pressure off of the Fed to raise interest rates soon.  Higher interest rates would be yet another kick in the pants of the beleaguered banking industry.  As a consequence, each time commodities take another tumble, financials rally.  Furthermore, it is widely believed that many large hedge funds who have had success this year were long commodities and short financials.  If these players are unwinding their positions, this further reinforces the divergent movements between commodities and financial shares.

In the good news camp, analysts at UBS upgraded AIG this morning.  The stock promptly rallied in response to the upgrade, which I find amusing.  AIG reports earnings tomorrow.  Why on earth would an investor buy a stock the day before the earnings report just because some analyst at UBS, of all places, decided on a whim that this stock is a buy?  Is that because UBS knows subprime better than anyone?  UBS has certainly lost enough money in the past year because of its subprime exposure, so I suppose that could be the reason.  In any event, once again, without irony, this is reported in the financial press as if it were significant news.  Bloomberg even has the misleading headline "AIG Rises as UBS Upgrades to Buy on Narrower Losses" implying that the company has already reported narrower losses, which is certainly not the case.  Personally, I'm going to wait to hear the actual earnings report from the company itself.  Call me crazy but I don't have an particularly itchy trigger finger.

Meanwhile, in actual earnings news, D.R. Horton reported a wider than expected loss of $399.3 million or $1.26 a share.  Analysts were expecting a loss of 70 cents a share.  Wrong again.  The homebuilder took a $330.4 million charge for inventory impairments and other charges, Revenue dropped 44% to $1.43 billion, the number of homes closed fell 36% while net orders declined 56%.  Still searching for that bottom in homebuilders...   

Sam's Club and Costco Limiting Rice Purchases

Two big warehouse chains are restricting rice sales per customer to limit hoarding of the precious commodity. The recent sharp increase in rice futures has created significant challenges for a large portion of the world that relies on rice as a diet staple. Governments around the world have begun banning rice exports in a desperate attempt to ensure that enough supplies remain within their borders. One of the most useful things I ever learned in an economics class is that price caps and trade restrictions create shortages and exacerbate an already difficult situation. Jimmy Carter demonstrated this quite effectively in the 70's (let's hope he does better with solving the Middle East peace crisis.) At any rate, the price of rice continues to surge and threatens to cause panic in parts of the world where people could possibly starve without it. However, the US is not part of that world. Thankfully, if Sam's Club runs out of rice, it may cause problems for Asian-themed restaurants, but nobody in America is going to starve. Our grocery stores are stocked with a dizzying array of substitutes. While it is certainly true that food prices are increasing across the board, we have yet to reach a state where we need to ration our staples. So I find this move by Sam's Club and Costco to be rather bizarre and somewhat irresponsible as it could create a panic where one need not exist.

When Bad News is Good News

The employment report was a bit of a disappointment, showing cracks in the "strong job market" argument that bulls had been using to justify their buying. Nevertheless, the market managed to come back from a loss to finish roughly unchanged on Friday. Meanwhile, in related news, anecdotal evidence is popping up everywhere I turn that inflation is about to bust out and rear its ugly head in the US. Commodities prices continue to roar and post new highs. Gold and oil are on the rally train again. "Bah! Who cares about gold and oil?" say the bulls, "you can't eat it!" Well, check out the commodity that 3 billion people depend upon for nourishment. Rice prices are soaring, causing major calamities all over the globe for developing nations. Every day I read something new about some part of the world that is experiencing growing inflation. The BRIC's are starting to have problems with inflationary pressures.The middle east is experiencing high inflation due to the weak dollar that is causing a surge in commodities prices. Although all the stats in the US point to low inflation, with the rest of the world experiencing problems and the US still hugely reliant on imports, how soon before it hits us too? The stock market loves all this news. We are again on the "all the problems are behind us, you've got to buy stocks!" train. Call me crazy, but I still think bad news is bad news!