Growing Speculation Concerns US Regulator
Thursday, March 17, 2011

US Commodities and Futures Trading Commission chief Bart Chilton has spoken of a huge build up of speculative positions in the global commodities markets and argued in support of position limits and more harmonization between national regulators to prevent market imbalances from spilling over into another financial crash.

In a keynote address to the 13th Annual Structured Trade and Finance in the Americas Conference, Chilton said that speculators are generally a positive force in the financial markets, providing essential liquidity. However, he cautioned that the "sheer size of concentrated speculative interests has the potential of moving markets, of influencing true price discovery."

"That can make life difficult for the commercial hedgers who use markets to manage commercial business risks, and for consumers who rely upon them to fairly price just about everything they purchase," Chilton observed. "You don’t have to take it from me, though. Economists at Oxford, Princeton, and Rice universities and many other private researchers say that speculators have had an impact on prices—oil prices and food prices most notably."

According to Chilton, there are now more speculative positions in the commodities markets than ever before. "Between June of 2008 and January of 2011, futures equivalent contracts held by these types of speculators increased 64% in energy contracts. In June of 2008, the number of such contracts totaled 617,000. By September of 2010, they were 923,000. And, by January of this year, they had grown to 1,011,000. In metals and agricultural contracts, those speculative positions increased roughly 20% or more."

Chilton said that the data shows the need for the CFTC to have more tools to prevent such concentrated positions from building up in certain markets. "Our new reform law addresses this by requiring mandatory speculative position limits—to ensure that too much concentration doesn’t exist. We were supposed to implement those limits in January, and I’m disappointed that we have not done so. If we had the desire, we could institute limits for the spot month in over-the-counter (OTC) trading based upon the physical supply. We could put limits in regulated markets. We could have helpful limits in place that could guard against markets being adversely impacted by excessive speculation. We could do that now if we wanted."

"When I make the case for position limits, sometimes opponents say, 'Won’t we see market migration outside the U.S. if limits are in place?' It is a concern. Before the new law, it was common for traders to jump into the dark, OTC pool to hide from regulation. Now that we’re going to be regulating that pool, that won’t be an option. Could traders go to other nations? Yes, if our limits are too restrictive, they could. That is why I have suggested that we err on the high side at first and then re-calibrate as we go forward, and as other nations put rules and regulations in place," he added.

Commodity price inflation, particularly in the oil markets, appears to be an increasing concern for fund managers, who fear for the impact of rising prices on corporate profitability and global economic growth. Almost one quarter of the fund managers who responded to a Bank of America Merrill Lynch survey expect corporate operating margins to decline over the next year, the fastest monthly decline since 2004. With regards the global economic outlook, less than one-third of the respondents (31%) expect the global economy to strengthen in 2011, down from more than one half (51%) who anticipated a stronger economy this year in February's survey. The percentage who expect the US economy to strengthen this year has plummeted from 52% in February to 21% this month.

The prospect of stagflation - lower economic growth coupled with commodity price-driven inflation - has prompted many fund managers to increase their cash holdings, the survey revealed, and the average cash balance rose to 4.1% of portfolios in March from 3.5% in February. Almost one-fifth (18%) of the respondents are now overweight in cash. Fund managers have also reduced their exposure to equities and commodities over the last month, with 45% now saying that they are overweight in equities, down from 67% in February. Just over one-fifth (21%) report being overweight in commodities.