Anyone catch his testimony before Congress regarding the commodities futures markets? He contends that about 30% of the increase in commodities prices is due to institutional investors getting into this market through “index speculation”. 2 Questions: (1) He contends (without much explanation except a short footnote) that demand for long contracts is pushing the futures price of commodities (obviously), but it is also pushing the spot price regardless of physical availability of the commodity. He mentions that commodity users use the futures market for “price discovery”, but I still don’t see how this can continue to lead spot prices given physical supply/demand. Help anyone? (2) He says that index speculators use “calender spreads” to roll over their long positions in the index, thereby continually only taking the long position and not closing out contracts with an offsetting short. Can someone explain this? Very interesting topic IMO, his testimony can be found here: http://hsgac.senate.gov/public/_files/052008Masters.pdf
jbaldyga Wrote: ------------------------------------------------------- > Anyone catch his testimony before Congress > regarding the commodities futures markets? He > contends that about 30% of the increase in > commodities prices is due to institutional > investors getting into this market through “index > speculation”. > > 2 Questions: > > (1) He contends (without much explanation except a > short footnote) that demand for long contracts is > pushing the futures price of commodities > (obviously), but it is also pushing the spot price > regardless of physical availability of the > commodity. He mentions that commodity users use > the futures market for “price discovery”, but I > still don’t see how this can continue to lead spot > prices given physical supply/demand. Help > anyone? > Where does the price of oil come from? The price is not negotiated for each barrel sold, but is negotiated in the futures market. If the futures market has it priced at $150/barrel, that’s about what you will be paying for it in the spot market. > (2) He says that index speculators use “calender > spreads” to roll over their long positions in the > index, thereby continually only taking the long > position and not closing out contracts with an > offsetting short. Can someone explain this? > Suppose that a huge pension fund that was known for taking long-only positions in oil always rolled on (say) the tenth day of the expiration month. That would create a market opportunity because you would know exactly what they were trading out of, what they were trading into, and when and you could make some money on the basis gap by front-running them a little. They are wise to that so to roll their position forward, the just enter into calendar spreads during the month where they short the current month and go long some forward month. The short offsets their current long. > Very interesting topic IMO, his testimony can be > found here: > > http://hsgac.senate.gov/public/_files/052008Master > s.pdf
"I still don’t see how this can continue to lead spot prices given physical supply/demand. " I see your point, but I think you need to consider the notion that supply/demand for oil is fairly price inelastic. In markets where both supply and demand are price inelastic, the market will be cleared at a wide range of prices, and general conventions such as an expected “market clearing price” could have an appreciable impact within that range. That theory falls apart when US gasoline demand goes down 5% though, FWIW.
So how does this unwind? Would any of you characterize this as a speculative bubble? It seems to me that fundamentals support a price that’s 30% lower; the only thing holding it up to these levels is the money pouring into the sector. Once institutional allocations are reached, does the price correct or just settle at a higher equilibrium? Should regulators prohibit these investments by institutions? I think Masters makes a good argument that these types of speculators don’t fulfill the traditional role of providing liquidity and they are distorting the market…