Tuesday, May 20, former commodity’s trader Michael Masters testified in front of the Senate Committee on Homeland Security about the primary cause of high commodity prices: speculators. You likely won’t see this in the Wall Street Journal.
Here is the link to his testimony: hsgac.senate.govpublic
Good morning and thank you, Mr. Chairman and Members of the Committee, for the invitation to speak to you today. This is a topic that I care deeply about, and I appreciate the chance to share what I have discovered.
I have been successfully managing a long-short equity hedge fund for over 12 years and I have extensive contacts on Wall Street and within the hedge fund community. It’s important that you know that I am not currently involved in trading the commodities futures markets. I am not representing any corporate, financial, or lobby organizations. I am speaking with you today as a concerned citizen whose professional background has given me insight into a situation that I believe is negatively affecting the U.S. economy. While some in my profession might be disappointed that I am presenting this testimony to Congress, I feel that it is the right thing to do.
What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.
In the early part of this decade, some institutional investors who suffered as a result of the severe equity bear market of 2000-2002, began to look to the commodity futures market as a potential new “asset class” suitable for institutional investment. While the commodities markets have always had some speculators, never before had major investment institutions seriously considered the commodities futures markets as viable for larger scale investment programs. Commodities looked attractive because they have historically been “uncorrelated,” meaning they trade inversely to fixed income and equity portfolios. Mainline financial industry consultants, who advised large institutions on portfolio allocations, suggested for the first time that investors could “buy and hold” commodities futures, just like investors previously had done with stocks and bonds.
In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels. Over the same five-year period, Index Speculators’ demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!
In fact, Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years.
One particularly troubling aspect of Index Speculator demand is that it actually increases the more prices increase. This explains the accelerating rate at which commodity futures prices (and actual commodity prices) are increasing. Rising prices attract more Index Speculators, whose tendency is to increase their allocation as prices rise. So their profit-motivated demand for futures is the inverse of what you would expect from price-sensitive consumer behavior.
Index Speculators’ trading strategies amount to virtual hoarding via the commodities futures markets. Institutional Investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits.
Think about it this way: If Wall Street concocted a scheme whereby investors bought large amounts of pharmaceutical drugs and medical devices in order to profit from the resulting increase in prices, making these essential items unaffordable to sick and dying people, society would be justly outraged.
Why is there not outrage over the fact that Americans must pay drastically more to feed their families, fuel their cars, and heat their homes?
Index Speculators provide no benefit to the futures markets and they inflict a tremendous cost upon society. Individually, these participants are not acting with malicious intent; collectively, however, their impact reaches into the wallets of every American consumer.
Congress has closely regulated pension funds, recognizing that they serve a public purpose. Congress should modify ERISA regulations to prohibit commodity index replication strategies as unsuitable pension investments because of the damage that they do to the commodities futures markets and to Americans as a whole.
Just damn.
OK, the next time you bitch and moan about high gas or food prices, will you write a letter to your elected representative?
If you will, thank you.
If you don’t, then shut the hell up.
Michael Masters, commodity, speculator, Wall Street, hedge fund, futures, Congress
1 response so far ↓
1 Sailorcurt // May 31, 2008 at 9:22 am
That’s a new spin on things. I had no idea that pension and retirement funds were dabbling in the highly volatile commodities markets. That’s a recipe for disaster.
All it would take is an unexpected event (new oil reserve discoveries, Congress seeing the light and opening US areas for oil development, a breakthrough in a new energy technology) for the value of those investments to fall dramatically and the involved pension funds to come tumbling down.
That’s, of course, in addition to the impact it has on real-time prices. I’m not much of a supporter in government involvement in free trade, but this is something that bears some looking into.