Sunday, May 25, 2008

Weekend's Featured: Renewed Manipulation in Commodities

Commodities Are Being Manipulated Again Like in the Past?

In 1980, the Hunt brothers cornered the silver market, causing an epic price spike and then a bust. Crude oil is close to $130 a barrel. Is something similar at work? The US Congress suspects as much and held a hearing on market manipulation in Washington on Tuesday.

Long-term investors in the sector believe that the big institutions that have entered in recent years are "accidental Hunt brothers". Investment in indices based on commodity futures have risen from $13bn five years ago to $260bn now, according to Michael Masters, an investor who testified. The rise in investors' demand for oil futures is almost equal to the increase in demand from China.

Historically, futures markets are naturally short (betting on a fall) as producers tend to buy futures to guard against falls in prices. In 1990, only 13 per cent of open interest in crude oil futures was long. That is now up to 58 per cent - probably thanks to new investors.

Changes to indices have dramatic effects on prices. Crude oil briefly dipped below $50 early last year after a cut in the weighting towards energy in the GSCI index. And there is no shortage of commodities in the US - although many fear there are constraints elsewhere in the supply chain.

There are arguments against this. Big economic factors are at work, notably the weakness of the dollar. Federal Reserve officials note that there is no sign of big increases in inventories of commodities. This would be expected if speculators were betting on prices to rise. Thinly traded metals such as cobalt have also enjoyed sharp run-ups.

These cannot be attributed to speculators. Speculation appears to be changing the way commodity markets work. A debate is needed and changes to regulations may be justified. But speculators cannot take all the blame for the price spike.

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