Curb Excess Speculation?
Some proposed 'fixes' could actually boost market volatility.
John Otte
Published: May 8, 2012
The amplitude of recent swings in commodity prices are huge. So are sizes of positions traded by large independent speculators and funds.
Some contend that a speculative tail is wagging the futures dog, to the detriment of market participants who strive to use commodity futures for price discovery and risk management. Such critics call for regulation, legislation, or both, to curb what they view as excess speculation.
Scott Irwin, University of Illinois economist, urges regulators and legislators to act cautiously. "Some proposed 'fixes' could actually boost market volatility," he cautions. He has history and data on his side.
NOT SO SWEET ONIONS: Worries over speculators in the onion market back int the 1950s. Turns out volatility was lower before market limits were imposed. Onion trade outlawed
In the mid 1950s onions represented 20% of U.S. futures trading volume. Demand for onions is highly inelastic. Old-crop onions that have been in extended storage are worthless when new crop becomes available. Harvest delays can create supply shortages. When price volatility skyrocketed, critics blamed speculators. They rallied their legislators. In 1958 Congress outlawed futures trading in onions.
REALITY CHECK: A look at fund ownership versus price in the wheat market shows that prices changes are hard to correlate to 'speculator' activity. At the time Stanford University economist Roger Gray plotted marketing season cash onion price volatility for time periods before, during and after the 1956 to 1958 period when speculators were charged with boosting price volatility.
"Gray's chart shows onion prices actually had less seasonal volatility during the time when critics were blaming futures for creating more volatility than prices had before that time and after futures were banned," says Irwin.
Gray is one economist Irwin credits with helping change the perception of futures markets from mere gambling dens to valuable institutions for discovering market prices and shifting risks.
Are funds villains?
Today commodity funds are taking the rap for muscling prices around to the detriment of physical commodity producers and users.
Irwin plotted holdings of index funds in front-month Chicago soft red winter wheat futures contract and price action of the contract. The funds accumulated positions in 2005 and 2006. Prices really didn't rally until mid-2007. Concluding that fund buying in 2005 and 2006 drove the price rally that occurred two years later is a stretch.
Current outcome uncertain
Will cooler heads prevail and avoid enacting legislation that would be detrimental to allowing futures markets to function effectively as price discovery mechanisms and risk management tools? That question brings to mind a sign once seen in a lobbyist's office. It read, "Those who know politics best, forecast least."
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