The Smart Profits Report #534
Tuesday, June 24, 2008
by Marc Lichtenfeld, Senior Analyst, Smart Profits Report Contrary to what many people might think, these guys are actually quite intelligent. More than a few of them attended the top schools in the country and were leaders in their professions before joining public life. So why do America’s elected officials do such stupid things? It seems as if at least once per week, I throw down the newspaper in disgust, grumbling out loud, “What are they thinking?!” The latest attempt to pander to an increasingly emotional electorate is the slew of bills in Congress that aim to curb speculation in the energy markets. Among the most prominent proposals is one that would immediately suck $1 billion out of the market from just one source – and could threaten the retirement of millions of people… Institutions… Hedge Funds… Index Funds… Pension Funds… All Banned From The Commodity Markets No wonder comedians love to lampoon our politicians as bumbling idiots. Senators Joseph Lieberman (I-Connecticut) and Susan Collins (R-Maine) have drafted a bill that would ban institutional investors from the commodity markets. Keep in mind that this doesn’t just mean the $100 million-a-year hedge fund manager will be prohibited from the markets. Index funds and pension funds would also not be permitted to invest in commodities. That would freeze out CALPERS (the California Public Employee Retirement System) – the largest pension fund in the United States and which has well over $1 billion invested in commodities. There are various other proposals out there that would curb the amount of speculation allowed, investigate the role of speculators, and tighten regulation of commodity markets. Hey, I’m all for ensuring that the markets aren’t being manipulated and that all trades are performed legally, but the curtailing of free markets is simply a terrible idea. Here’s why… Speculation = Liquidity = Cost-Hedging Ability Have speculators impacted energy prices (most notably, crude oil)? I’m sure they have. But the idea that these markets are simply a fixed game of dice that hedge funds win at the expense of Mr. and Mrs. SUV owner is inaccurate. It’s akin to blaming stock market woes on short sellers. The thing is… institutions and speculators provide the market with liquidity, so companies are able to hedge their supply or product if they need to. For example, by participating in the commodity markets, an airline can lock in its fuel costs at a fixed price for several months. Or a corn producer can sell forward the crop at a fixed price today in order to avoid the risk of falling prices in the future. Don’t Be Scared Of Big, Bad Commodities To some, the mere mention of the volatile commodity markets injects them with a hearty dose of fear and a swift retreat. But while commodities are perceived as a scarier place than the stock market, it’s not necessarily true. My colleague, former NYMEX trader Lee Lowell, has written about trading commodities before. In Fact, Lee's Commodities Corner will show you everything you need to know about the commodities market and how to leverage it for profits. In truth, the commodity markets are similar to the stock market, where some investors may use options to hedge their risk, while others strive for out-of-the-park returns. These investors, speculators and hedgers all coming together is what makes the markets. It doesn’t matter whether we’re talking about shares of General Electric (NYSE: GE) or the price of oil. Buyers and sellers. Supply and demand. Simple as that. The Government May Mean Well… But Its Logic Is Backwards Don’t get me wrong here… I’m not an uber-libertarian who believes the federal government should have no role in our lives. The government should oversee the markets to ensure they are fair and that business is conducted according to the law. But those laws should not be altered just because someone (or even the majority in the case of oil prices) doesn’t like the direction that prices are going. If some of the more radical proposals in front of Congress are pushed through, the confidence in those markets would implode. Sure, it might knock a buck off a gallon of our gasoline in the short-run, but the long-term ramifications of having an impotent financial system probably wouldn’t be worth it. After all, wouldn’t the lower liquidity and perceived lack of confidence in the markets ultimately lead to higher prices, not lower ones? And you can be sure that it wouldn’t end with the commodity markets… Who Do You Trust? A Tried-And-Tested Market Mechanism, Or Meddling Politicians? At some point, other markets would be affected. I can only imagine what Senators Lieberman and Collins’ response would be if there were a major stock market selloff. Ban short sellers? Prohibit institutions from selling stock? Instead of reacting, the Senators should focus their efforts more proactively to craft a responsible and sensible energy policy that addresses supply and demand for the actual commodity, rather than manipulating the financial markets. Perhaps they’ve forgotten that financial markets possess an uncanny corrective mechanism and that throughout history, they usually take care of themselves. When prices are too high, they sell off. When they’re too low, they rebound. It’s merely supply and demand at work in a different area. Other than ensuring they are operated on a level playing field for all, Congress should stick to what it knows best. Alas, if only there were a way of harnessing all that hot air, we could really solve our energy problems… Marc Lichtenfeld Today’s Smart Profits Notes - “But any [stock market] gains Tuesday were being limited by concerns about the impact high prices are having on demand, and worries about Congress’ increasing scrutiny of the oil market.” So said an Associated Press report at 2:38 PM today, noting that Congress’s attempts to reduce oil market speculation might actually be making investors and traders uneasy. Undeterred, however, Congress has introduced no fewer than nine bills over the past few weeks.
- Could oil hit $65 again? According to Michael Masters, it could – but only if excessive market speculation is eliminated. And the AP article also reported that Masters stood up in Congress today and said so on the record. Masters is managing member of the Masters Capital Management hedge fund – but some of his fellow fund managers don’t agree. They also testified that they’re not to blame for high prices, since their funds typically hold small stakes in commodities – usually less than 1% of their assets.
Related Articles Midwest Floods Trigger Corn Crisis… What It Means For Consumers And Commodities Investors Four Reasons Why Commodity Trading Is Better Than Trading Stocks Futures Commodities: How To Invest In The Volatile Commodities Market
| 
