With the recent Senate hearings and everybody debating the affects of speculation by index funds, we have been inundated with politically motivated noise demonizing everyone from hedge funds to oil companies and those who would both support or oppose offshore drilling. In an effort to go beyond the self-serving blather, here are three unique observations offered to me in the past several days on the subject.
“The typical line of reasoning is that commodity index funds exclusively buy and hold commodities, and this buying represents a permanent increase in demand, which naturally results in higher prices,” says John Joseph of commodity trading advisory SEMA4 Group. “Of course, this buying and holding activity is no different from the buying and holding activity performed by equity index funds. And yet commodity index activity has been branded as a threat to our economy, while equity index funds receive quite the opposite treatment. This is hypocritical at best and disingenuous at worst.”
David Hightower, publisher of the Hightower Report is generally dismissive of the idea that long-only commodity index funds are driving up commodity prices. “If one does a broad commodity view, you find that natural gas prices have went up and that the speculators have been net short the last year. You look at copper prices and it went from 40¢ to $4.30 and the net-spec position was short; so some things don’t wash.”
In the case of crude oil, Hightower says that we are producing 86 million barrels of oil and consuming almost the same amount. “If we are not actually using that commodity, because we have the specs that are in it, it’s going to build up in the end. And another thing, the speculation itself has increased the cost of carry,” he says, therefore the cost of maintaining speculative positions puts the onus on the speculators themselves. “So it’s going to meter itself. I just think that it’s wrong to say, ‘we have decided that prices have got too high. We have had a four, five year bull market in energy, so a speculator does not consume the oil.”
Hightower does allow that on a day-to-day or week-to-week basis, index funds may be able to temporarily sway prices upward, but by extension there would be an equal number of days when they would also artificially depress those prices.
“The vulnerability of the economy puts people’s anxieties even higher,” Hightower says, and offers bottled drinking water as an example of misplaced priorities. “People walk out of a gas station complaining about $3, $4, $5 fuel; but they’ve got a $40 carton of cigarettes and a [$6 per gallon] bottle of water. High prices have a function: to change people. And if we stop that, we are not going to get the true substitution of oil and the changing of habits.”
Todd G. Buchholz, managing partner at the Two Oceans Fund, argues that higher commodity prices are not entirely demand driven. “The U.S. economy was growing at roughly 5% last year. Crude oil fell into the $50 per barrel range. Since then, the U.S. economy skidded to a virtual halt, the world economies economic growth rate fell about 40%, and yet prices doubled in that period. That to me demonstrates that demand is not driving prices,” he says.
Buchholtz acknowledges a slew of different supply constraints in the energy and food markets, but says that supplies are available and that the pace of the increase in demand is difficult to reconcile with the parabolic rise in prices.
However, Buchholtz is not in favor of government intervention, which he says would ultimately worse for consumers. “The world needs to produce more commodities, and the only way to produce more is to let prices rise,” until the bubble pops. “I don’t know if the pop will come in two weeks or six months, but ultimately there needs to be reconciliation between supply and demand and that’s not happening at current prices.”
Tags: crude oil, David Hightower, excessive speculation, Hightower Report, John Joseph, SEMA4 Group, Todd Buchholtz, Two Oceans Funds
