Would pulling the reins in on speculators control volatility in oil prices? The Commodity Futures Trading Commission plans to hold hearings to decide whether position limits should be imposed on the energy futures markets as they are on corn, wheat and other commodities.
Regulators and lawmakers are concerned that Wall Street firms, which trade just to profit from price swings instead of actually supplying fuel, distort prices. Only 2% of oil futures contracts result in physical delivery, says the CFTC. New rules may affect how commodity ETFs operate.
Bob Carey, chief investment officer of First Trust Advisors, explains what he believes really influences commodity prices. His financial advisory firm provides 40 ETFs in addition to closed-end funds, unit investment trusts and other investment products. It has $20 billion in assets under management.
IBD: Do you think speculators are driving the commodities markets?
Carey: No. The best analogy is horse racing. All the folks betting on a horse don't affect the horse's speed around the track.
And likewise there're plenty of examples last year of commodities -- besides metals, oil and natural gas -- that saw spectacular increases. There's no way to speculate, for example, on onion prices. Onion prices went up substantially too.
In the end, these markets are zero-sum propositions. What's happening is there's a lot of political pressure on policymakers in Washington to address these markets. More than anything else, they're bowing to public pressure.
IBD: What do you think drives commodity prices?
Carey: It's a monetary phenomenon. Long-term commodity prices tend to rise when we have accommodative Federal Open Market Committee interest rate policy. When interest rates are held low and the Fed injects more cash into the economy, a lot of that money all of a sudden ends up in the economy in the form of higher prices.
It's a monetary phenomenon. When the economy slowed down, the turnover rate of money began to slow down; you started seeing prices coming down.
It's not just supply but also a factor of how much turnover of money there is in the economy. The prices precipitously fell once the velocity (rate of turnover) of money collapsed like it did in Japan.
IBD: Explain velocity's role.
Carey: How often does a dollar turn over in the economy? The economy and all economic activity is a function of the supply of money multiplied by the rate it turns over in the economy.
And now we're starting to see commodity prices rise. Gold has gone up a fair amount over the last six to eight months. And oil prices are up from their bottom. We're going through the same cycle again. Obviously it's not grabbing attention because the prices are coming from a lot lower level.
I think it's fair to say when the Fed is as accommodative as they are, the bias in the market will be for prices to go higher.
IBD: How do you explain sky-high commodity prices last year that caused worldwide food riots?
Carey: In the end, high prices will often serve to increase the supply of commodities. We went through that huge increase in prices and now there's plenty of supply. Nobody is talking about a shortage of oil or natural gas or corn right now.
It's obviously not good when prices go up as fast as they did. They certainly disrupted the economy and certainly had a negative impact on people who are really struggling to buy food. All these things go in a cycle. I don't think there's a whole lot the government can do to control the cycle. These markets are just too big.
IBD: Is any entity big enough to manipulate prices like oil?
Carey: I don't think so. Oil is just too big. It's got people all over the world participating directly or indirectly.
IBD: Could speculators have any beneficial effects?
Carey: There's no question. The more activity there is in some of these markets, the more folks who are actually in the production and delivery and consumption of these products can hedge away some of the risk to their businesses.
I believe it makes the economy more efficient in the long run if folks have the ability to hedge away exposure, whether they're actual buyers or sellers of commodities. The folks who rely on those contracts need those markets to be as liquid as possible and reliable and transparent.
Limiting the activity in those spaces may not have the desired consequence that policymakers would like. They're looking to blame somebody. And I think, in the end, the blame is misplaced.
