Study concludes commodity prices have been raised by Commodity Index Fund trading activity

[JohnWxy]

the study concluded that commodity prices are “likely higher than justified purely by fundamentals and the commodity markets have become more volatile as the volume of trading by index funds and other non-commercial traders has increased sharply.”

I could have excerpted much more of the report but could not due to copyright limitations. There is much more that needs to be read in this report. (check out the section http://ethanolrfa.org/page/-/ENTRIX%20Speculation%20Paper.pdf?nocdn=1&utm_medium=email&utm_campaign=New+Reports+Fault+Speculation+for+Volatile+Commodity+Food+Prices&utm_content=New+Reports+Fault+Speculation+for+Volatile+Commodity+Food+Prices+CID_284b92e095cb531b6481bde94e6c788a&utm_source=Email+marketing+software&utm_term=Cardno+Entrix+#page=13">"Does Speculation Affect Commodity Prices? pg. 13 of report

Here is an excerpt explaining commodity index funds (emphases are my own):

The development of financial derivatives such as commodity index funds has provided a
mechanism by which non-commercial entities can increase their participation in the futures
markets. A commodity index tracks a basket of commodities to measure their performance in
much the same way a mutual fund tracks ―baskets‖ of individual stocks. Commodity indexes are
often traded on exchanges, allowing investors to gain easier access to commodities without
having to enter the futures market. The value of these indexes fluctuates based on their
underlying commodities, and this value can be traded on an exchange in much the same way as
stock index futures.6 Energy –petroleum in particular– plays a major role in index funds. For
example, energy futures account for 65 percent of the S&P GSCI Commodity Index (formerly
the Goldman Sachs Commodity Index) while grains account for about 10 percent of the index
value.7 The S&P GSCI is widely recognized as the leading measure of general commodity price
movements in the economy. Since petroleum has such a large relative weight the index is
largely driven by the price of oil and petroleum products institutionally mandated ratios sway
market activity. In other words, as the price of oil increases, grain prices also increase and
more corn must be purchased to maintain mandated index proportions.

{what they mean is the index fund must maintain stated proportions invested in each commodity in the index fund. If oil goes up in value this means the fund manager must buy additional contracts in other commodities to maintain the proper proportion invested in each of the commodities in the fund. Oil is by far the most aggressively traded commodity - World-wide. (Meaning it's price is more volatile - relative to actual market demands for the commodity in the real market-place from processors and final consumers). When Oil is driven up in price this forces the index fund manager to buy other commodities in the index fund in order to keep the proportions invested in each commodity in line with the stated policy of the index fund. The result is when oil goes up in price it automatically causes increased buying of contracts for other commodities - causing their prices to go up with oil._JW}

Investors in commodity indexes include index funds, swap dealers, pension funds, hedge funds
and mutual funds, exchange traded funds (ETFs), exchange traded notes (ETNs) and similar
exchange-traded products. Lehman Brothers reports that total Assets Under Management
(AUM) in commodity indices increased from ―…a negligible amount in 2002, to $77 billion is
January 2006, to peak at $297 billion in July 2008. Between July and September 2008 the
volume of AUM fell to $187 billion‖.8 In 2007 the CFTC began tracking and reporting on index
investment in a broad range of commodities. The growth in index investment in corn and the
relationship to corn prices is illustrated in Figure 8.

The Lehman analysis of speculation and commodity markets indicates that index investors
typically are large in size and have substantial impact on liquidity in the markets. Further
they are almost entirely biased toward long positions and generally invest in commodities at
idiosyncratic times for broader strategic exposure. Even though index traders rarely hold
new information since they are anonymous, traders can misinterpret an index inflow as a
bullish statement by a trader with superior information. Consequently index inflows can thus
impact both prices and volatility.9

The effect of the commodities index funds appears to have created a condition known as
―contango‖ where the futures price is above the expected future spot price. Consequently, the
futures price will decline to the spot price before the delivery date. This is known as
convergence. Contango results in a vicious circle of upward spiraling prices and a situation
where sellers delay sales in anticipation of more price increases; and buyers increase
purchases for inventory in fear of even greater future price increases. The Institute for
Agriculture and Trade Policy (IATP) points out that ―As commodity prices have become more
volatile and convergence less predictable since 2006, the futures market has lost some of its
price discovery and risk management functions for many market participants.‖10

more can be read on the affect of Commodity Index Fund trading in the Senate testimony by Michael Masters, hedge fund manager.

[ChandlerJr]

1. Prior to The Commodity Futures Modernization Act of 2000

Most all of this was prohibited by regulations dating back to the Depression of the 30's. It's also known as the "Enron Loophole".

The Commodity Futures Modernization Act of 2000 (CFMA) is United States federal legislation that officially ensured the deregulation of financial products known as over-the-counter derivatives. It was signed into law on December 21, 2000 by President Bill Clinton.

http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000

[dixiegrrrrl]

3. Good ole Bill...NAFTA and now this.

[JohnWxy]

4. The CFMA was added at the last minute as a rider to an 11,000 pg Funding Bill that had to be passed.

in order to keep the Government running. The omnibus funding bill was passed along with the rider (CFMA) and virtually nobody knew that the CFMA was in there.

The WH was supportive of another, earlier form of the CFMA but which did not meet Sen. Phil Gramm's liking. Gramm wanted definite explicit language in there prohibiting the CFTC from regulating or even monitoring trades of 'over-the-counter' derivatives (this includes energy futures contract - ala ENRON) and any trades of derivatives between Banks (including Credit Default Swaps). This language was added to the CFMA and then Gramm slipped it in as a rider to the funding bill (11,000 pages) which was veto proof. The funding bill was passsed on Dec 15, 2000 just before that congress adjurned for their Christmas break.

from the article linked to in first comment:

"Michael Greenberger, Testimony before the U.S. Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs regarding Excessive Speculation in the Natural Gas Futures Market, June 25, 2007, at 5 (referring to the “Enron Loophole” discussed below in Section 4, “The loophole was added at the last minute to a 262 page bill, which was itself belatedly and quite suddenly attached in a lame duck session on the Senate floor by then Senate Finance Chairman Gramm to an 11,000 page consolidated appropriations bill for FY 2001.”)"

note that the CFMA also prohibited CFTC form monitoring regulating trading of derivatives by banks, which played a critical role in the housing bubble and the Credit Catastrophe 2008.

[Bill USA]

2. Extremely important information. Will anything be done about this?

This IS the reason petroleum (and food prices in tandem) have been spiking over the last few years.

recommended!