"Speculators and Commodity Prices"
Opening Remarks of Commissioner Bart Chilton to the Futures Industry Association's Panel Discussion: Financial Investors' Impact on Commodity Prices, Boca Raton, FL
March 16, 2011
When I came to the Commission in 2007, I began to hear rumblings about "new" speculators in commodity markets, and their effects on prices. Now I was quite familiar, as we all were, with the traditional hedger and speculator roles, but as security portfolios began to show weaker returns, folks started to try and figure out how to improve their investments, and many of them looked to the commodities world. This "new" class of investor represented a significant asset class shift from what most of us were familiar. And, as these commodity investments began to pay off, this new class increased in size—in fact, they became massive. In just a few years, by 2008, over $200 billion in "passive" investment (that is, folks who are going long and staying long) came into the commodities markets. The question is: What does this mean? Is it a good thing, a bad thing, or neutral?
Well, we all know what else happened in 2008. Gas prices breached 4 dollars at the pump. Crude touched 147.27 a barrel and we watched the flaming downfall of financial behemoths like AIG, Bear Stearns, and Lehman—paid for by the American taxpayer. So it wasn't an unreasonable question to ask: Is there some linkage, some cause-and-effect between these "new speculators" and the unheard of commodity price increases in 2008?
I asked that question at the time, and you'd think I had questioned whether the earth revolves around the sun. I was bombarded with mischaracterizations of what I had said, what I had asked, what I had questioned. To be clear, the issue was, and is, this: Is it possible that there is some relationship between the presence of "massive passives" in the marketplace (either on the long or short side) and commodity prices?
I've said several times that I don't think these investors are the cruise control of prices, but I do think they tap the gas pedal. I think they can have some effect on driving prices up when they are long in the markets, and I believe they can have some effect on declining prices when they exit.
My primary purpose today, however, is not to tell you what I think. It's to get folks to come to their own conclusions. We've heard so many people say "there's no linkage whatsoever between passive investors and prices" (mostly in an attempt to mischaracterize something I've said). We all know that the easiest way to shoot down an argument is to contort it in such a way as to make it vulnerable to easy refutation. But I'd like to address this in a more sophisticated way. It's simply not the case that "there is no evidence that financial investors affect commodity prices.” In fact, let me give you a few examples from some academic studies, papers and comments over the past few years:
- An MIT study says in 2008, "The Oil Price Really is a Speculative Bubble.” (“The Oil Price Really Is a Speculative Bubble,” R. S. Eckaus, MIT Center for Energy and Environmental Policy Research, June 13, 2008).
- A Rice University Study links financial players like banks, hedge funds and index funds to the steep rise in oil prices in 2008. “So, as the market presence of noncommercial traders increased between 2003 to early 2008, the stance of these noncommercial traders has fairly consistently been to hold bullish, long positions that supported rising prices. And, when their market share was highest, so was their net long position, which again roughly coincided (acting as a slight leading indicator) with the peak in oil prices at $147 a barrel in the middle of 2008.” (“Who Is In the Oil Futures Market and How Has It Changed?” Kenneth B. Medlock III and Amy Myers Jaffe, James A. Baker III Institute for Public Policy, Rice University, August 26, 2009).
- Paul Krugman from Princeton and the London School of Economics said in 2009, "So, this time there's no question: speculation has been driving up prices.” (“Oil speculation,” Paul Krugman, New York Times Editorial Blog, July 8, 2009).
- Jeffrey Sachs from Columbia University said, "The fact that prices soared and then came down so much really does suggest that there was a speculative element to it. (“Corn Futures Spark Riots as Speculators Take Trading to Limit,” Ian Katz and Ari Levy, Bloomberg, December 15, 2008).
- Robert Aliber at the University of Chicago said, "You've got speculation in a lot of commodities and that seems to be driving up the price...." (“Oil Rally Topped Dot-Com Craze in Speculators’ Mania,” Michael Patterson and Elizabeth Stanton, Bloomberg, June 13, 2008).
- Nouriel Roubini of New York University said in 2009, "Another reason to fear a double-dip recession is that oil, energy and food prices are now rising faster than economic fundamentals warrant, and could be driven higher by excessive liquidity chasing assets and by speculative demand.” (“The risk of a double-dip recession is rising,” Nouriel Roubini, Financial Times Opinion, August 23, 2009).
Are you all bored yet? There's more.
- Mohsin Kahn at the Peterson Institute for International Economics said, "...it is fair to conclude by looking at a variety of indicators that speculation drove an oil price bubble in the first half of 2008. Absent speculative activities, the oil price would probably have been in the $80 to $90 a barrel range.” (“The 2008 Oil Price “Bubble”,” Mohsin S. Khan, Peter G. Peterson Institute of International Economics, September 19, 2009).
- A study at Texas A&M University says, "Speculative fund activities in futures markets have led to more money in the markets and more volatility. Increased price volatility has encouraged wider trading limits. The end result has been the loss of the ability to use futures markets for price risk management due to the inability to finance margin requirements.” (“The Effects of Ethanol on Texas Food and Feed,” Agriculture and Food Policy Center, Texas A&M University, April 10, 2008).
- Richard Branson of the Virgin Groups said, "There is strong evidence that speculation exacerbated the last oil and food bubble. Speculation will fuel the next one too, unless meaningful speculative position limits are established.” (Letter to The Economist, July 29, 2010).
- The International Monetary Fund (IMF) said in an Outlook report that, "...it appears that speculation has played a significant role in the run-up in oil prices....” (IMF Regional Economic Outlook: Middle East and Central Asia, May, 2008).
That's ten. I'll stop there, but there are dozens of other examples.
Hemingway said, if you really want to write, start with one true sentence, and from that sentence, you can form your opinion of the truth. Well, here is one true sentence: We have more speculative positions in commodities markets than we have ever had in the past—in fact, they are up 64 percent in the energy complex from June of 2008. You can draw your opinion of the truth, your own conclusions as to whether there is a cause-and-effect—looking at the price trends as these investors enter and exit markets. Read the studies, on both sides of the issue, and draw your own conclusions.
As regulators, our job is to ensure that prices are fair, and that's what I'll be looking at as we proceed to review our proposed rules on speculative position limits and bona fide hedging. I believe that we'll be able to find a balance—to protect consumers and markets—while still allowing these critically important markets to perform their price discovery and risk management functions.
Last Updated: March 16, 2011