Blaming speculators is fun, easy and wrong

Blaming speculators is fun, easy and wrong: James Saft | Special Coverage | Reuters
There has been an explosion in marginal demand from Asia and emerging markets. And in many markets, notably oil, large producing nations may not see it in their best interests to maximize production, especially given the low rates of return now on offer for the money their oil will fetch. Companies too are being slow to ramp up production, preferring what they see as a safer strategy of buying back shares and paying out dividends.

U.S. monetary policy, moreover, is calibrated for an exhausted consumer and a fragile banking system at home, rather than the ongoing booms in Shanghai and elsewhere. U.S. interest rates are negative in real terms, which stimulates demand around the world, not just in hard-hit Florida and Nevada.

And that is why speculator hunting is so popular right now. A U.S. interest rate set to keep energy and food prices under control is a lot higher than current rates, and implies a level of growth and unemployment that the Federal Reserve is unlikely to want to sign off on, especially in an election year.The United States, in essence, faces an unpleasant growth and inflation trade-off of which high commodities prices are but a symptom. There are lots of things that have happened in the past year that argue for greater regulation, but the rise of commodity prices just isn’t one of them.

Looking for hedge funds under the bed is fun and makes great headlines, but its not going to be part of the solution. In the longer term the solution includes people changing their behavior; technological innovation and the efficiency it brings; and new investment in production.

And while it’s easy to be optimistic about the longer term, for the next year or two it looks like a lousy mix of lower growth and higher inflation.

– It’s always nice to have a scapegoat, and in the end it often doesn’t matter much if it’s witches, sunspots or, in the case of soaring prices for food and energy, those nasty old speculators.

A growing chorus, from American lawmakers to OPEC producers, has laid the blame for commodity price inflation on “hot money” bets by investors.

Facing considerable political pressure, U.S. regulator the Commodity Futures Trading Commission and its British counterpart reached a deal with ICE Futures Europe (ICE.N: Quote, Profile, Research, Stock Buzz) to impose regulations on London-traded U.S. crude futures, though it said it had found “no smoking gun” linking price rises to speculators.

It is impossible to know for certain if leveraged speculative bets by hedge funds and banks are a significant contributor to the run-up in commodities prices, but there are good reasons to be skeptical. First, the evidence doesn’t support it. But almost as importantly, it is one of those arguments that, if true, would be almost unbelievably convenient.

People tend to place a disproportionate probability on the outcome that will most favor them.

And if it is not speculators, then we need to face the reality of higher prices, the implications of which are inflation, recession or some ugly combination of the two.

Francisco Blanch, head of global commodities research at Merrill Lynch in London, said he finds no link between speculative activity and systematic price increases in commodities.

“So far the available data doesn’t support the idea that speculators are driving prices up: quite the contrary,” said Blanch.

“We are in a stage of denial with regards to inflation.”

There has been a massive rise in recent years in contracts held on exchange-traded commodities futures, which some argue shows speculative activity.

But, Blanch points out, many of the markets which have seen the largest rises in this trading, such as sugar and lean hogs, haven’t seen the kind of price appreciation experienced by oil and others.

Blaming investors in index investments in commodities doesn’t work either, Merrill argues, nor is there a clear correlation between open-interest on futures and spot prices.

Indeed many commodities which are not part of indices, such as coal, rice and iron ore, have gone up considerably over the past several years despite the fact that being outside the index makes them essentially immune to speculative money flows. Cash metal cobalt, used in the aerospace industry, has more than trebled in price since the start of 2006.

Barclays researchers point out that the size of assets committed to commodity index investment, which they estimate at $140 billion, is tiny in comparison to the $5.4 trillion of futures trading that happens every month in the 25 commodities that are commonly included in indices.


To be sure, we can’t dismiss the influence of speculators out of hand. Speculation, aided and abetted by too lax regulation and too loose monetary policy, has been at the heart of many spectacular asset market rises in recent times, with the housing bust a prime example.

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