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The Commodities Futures Trading Commission targets big institutional investors in a bid to curb market distortions
The U.S. Commodities Futures Trading Commission, criticized for its alleged failure to curb 2008's historic runup in oil prices, will soon propose caps on how much any single investor can hold in a set of commodity futures, says an official. In an e-mail answering questions from Bloomberg BusinessWeek, Bart Chilton, one of the CFTC's five commissioners, says the commission will soon propose a rule aimed at preventing any one entity from "controlling too much of a given market." The proposal, which has been anticipated for months, would be subject to a public comment period before implementation, according to CFTC procedures. That means it could take effect as soon as April. "I don't want commodity markets to become a private jungle gym for speculators," Chilton says. The move was set in motion by the sharp public reaction to soaring oil prices. In the summer of 2008, traders bid oil prices up to $147 a barrel on the basis of extremely tight global supplies. By the end of the year, the global economic crisis had reduced demand significantly, investors were fleeing the market, and oil prices had plunged below $33 a barrel. Since then, prices have recovered somewhat—oil traded at just under $80 a barrel on Dec. 31—but are back where they were in the fall of 2007. Do institutions gum up the markets?
In CFTC and congressional hearings over the last year or so, the heads of pension funds, hedge funds, and Wall Street investment banks have argued against trading limits on commodities, saying curbs would hamper their ability to hedge against market volatility. These market players argue that they are not to blame for sharp price swings, saying that they buy and hold commodities as an investment. Critics also say restrictions will simply drive traders to exchanges currently not subject to the CFTC's purview, including those abroad. Analysts say that commodities trading has changed in the last couple of years as institutional investors—pension funds, hedge funds, exchange-traded funds, and the like—have piled into commodities futures in order to diversify their portfolios. The institutions' rationale has been that commodities reduce portfolio volatility because oil, precious metals, and other commodities tend to move in the opposite direction from stocks and bonds. Unlike traditional commodities brokers, who dart in and out of positions in response to the smallest bit of news in far-flung parts of the world, institutional investors tend to buy long, regardless of events. A buy-and-hold strategy usually helps provide stability for a stock or bond, but Chilton argues it's a different case with commodities, where he says the presence of "massive passives"—Chilton's term for institutional investors that go long—hampers the ability of the markets to respond swiftly and accurately to such crucial events as a shift in demand or supply. "These traders like to claim that they add needed liquidity to markets," he says. "But I say it is dead liquidity, because while it comes into the markets, it just sits there, continuing to roll at the expiration of the contract and going long again." Adds Chilton: "I think the [massive passives] have, in several instances, contorted markets in a way that has rendered the historical hedging for business purposes moot." demand for base metals is firming up
The CFTC's action comes as institutional investors are placing more bets on commodities. In 2009, they poured a record $60 billion into oil, gold, cocoa, and other commodity investments, more than a third of it in the final quarter. In a recent survey by Barclays Capital, institutional investors said they expect more than $60 billion to flow into commodities investment in 2010. "Investors haven't lost their taste for commodities despite the turbulence of 2008 and 2009," said Michael Zenker, a commodities analyst at Barclays Capital (BCS). The continued tide of investment could bid up prices for lead, zinc, and copper because it comes when demand for these base metals is firming up in China and elsewhere in the developing world. Some analysts also foresee an additional year of outsized gains for such precious metals as gold and silver, which tend to hold their value in inflationary periods. Lawrence Eagles, a commodities analyst with JPMorgan (JPM), is forecasting a 31% surge in gold prices in 2010, to an average of $1,288. Goldman Sachs (GS), which famously predicted oil's "superspike" above $100 a barrel in 2008, is forecasting an average price of $94 a barrel next year. It remains to be seen whether stiffer regulation on futures trading will rein in prices for these and other commodities.