16 June 2008

Cost of Speculation

An excellent article on speculation in the commodities markets from the German newspaper Spiegel:

The Attack on Prosperity: How Speculators Are Causing the Cost of Living to Skyrocket

I don't think there's any doubt there's been huge run-ups in commodities starting in August 2007 and another bump in February 2008. To my mind, this is another bubble being blown by investment bankers desperate to mitigate or avoid realizing their losses in the sub-mortgage crisis. There's clearly no willingness to shine any light onto the books of the big banks, since probably 50 % of the top ten would be insolvent if they had to truly account for the value of their highly-leveraged mortgage-based instruments of financial suicide.

Like all bubbles, this one will probably go on for longer than seems possible in spite of the clearly unsustainable nature of the beast. The investment losses, in the end, will only be that much bigger as a result. That said, I think this bubble will burst a little faster than the housing one. For one, turnover is much faster than housing. The price of commodities is rising much faster than housing did so we'll reach the tipping point that much faster.


rks said...

We both think entropy production is a crucial concept, but I have a very different idea on speculation. See http://www.theoildrum.com/node/4154#comment-361912.

rks said...

Hmmm, it didn't make that url a link. Let me try http://www.theoildrum.com/node/4154#comment-361912.

Anonymous said...

Have to agree with rks. The risk adjusted returns of commodity indexes have been more appealing now that short term rates are low and all sorts of fixed income instruments are suspect. Higher interest rates would solve the 'speculation.' Look at the Fed, not money managers.

Krassen Dimitrov said...

I see no contradiction to what Robert is saying. Your post assumes "informed, educated speculation by experts". What Robert is alluding to is incompetent, negligent sloshing around of money by inept financial managers. These are different. The former is good, the latter is bad.

Anonymous said...

Jobs. That's the dirty word that was driven out of the vocabulary by Ronald Reagan. For him, and his plutocrat gangster pals, people don't deserve to work.

Okay, the problem is that the employment picture in the industrialized/capitalist world is turning to shit.

And it's turning fastest in the US.

The commodity bubble will burst.

Robert McLeod said...

Basically, in addition to drastically lowering interest rates to the point they are negative on a real-basis, the US Fed has loaned out $500 billion from their new auction facilities, or about half of what they have. Other central banks also lowered to come to the Feds aid. As Krassen says, that's a lot of money sloshing around.

In a cyclic economy, the benefit of a downturn is that it introduces change. It kills off the old deadwood and creates new opportunities for others to fill the voids left behind. That's not really being allowed to happen here. Instead we're slowly pulling off the band-aid one hair at a time, all so that some mental stillborns can keep their undeserved yachts.

I don't really think this speculation is really helping us to transition away from fossil fuels any more than the oil shocks of the 1970s did so. For one thing, people are hesitant to invest in new production in such an environment. This is what speculation is supposed to accomplish, is it not? But the bubble is so obvious that no sensible person will stick their neck out least the guillotine comes flashing down. So yes, maybe we'll get smaller cars faster by this method, but it's going to come at the expense of a lot of jobs in a big nasty clump.

I would agree that commodities are probably a safe investment, at least until the US receives a new executive. If you can't beat them, join them, just keep your eyes wide open. Oil will continue to rise, until it doesn't.

Frank said...

Very interesting letter from reader George Abert on oil and its relation to the finance fiasco

You may recall that a few weeks ago I wrote regarding my theory that a substantial chunk of the increase in the price of oil was due to speculation to offset bad debt portfolios by the larger east coast investment houses. What puzzled me was how this worked: because once the futures are bid up and the margins made, then the price of crude at the head assumes the previous month’s futures price! The short answer is that a kind of ratcheting mechanism is at work: once the price is bid up, it stays there until it is bid up again the following month.
It’s reported that the level of oil futures market activity by these investment houses is significant, with at least 10 percent of the futures market controlled in any one month. With each market manipulation, their margin per barrel is probably around $5.00. So if you take 10 percent of 85,000,000 barrels a day times 30 days in an average month times $5.00 you get a total of $1,275,000,000 in margin. With each month of these shenanigans, these banks can offset upwards of 12,000 subprime mortgages. Not a lot given that there may be upwards of 2,000,000 of these ticking time bombs, and considerably more if the banks fail to walk the razor’s edge they’ve defined for themselves. At this rate, it will take over ten years to offset the bad debt portfolios and only if few of those who have investment accounts make withdrawals. At the rate of +$5.00 a month, the price for a barrel of oil in 2018 would probably be over $900. It will never get there!
So each month, the investment houses pay out cash to those with account holders who demand it, offset bad paper and then go back to work the futures market with what’s left and what they borrow for 30 days from the Fed. As long as they work quickly, they can keep ahead of the game, at least until the price of oil destroys the underlying economic base. It’s reported that with Americans now paying around 11 percent of their income on energy, we are getting pretty darn close to the end of these shenanigans: in the 1973-74 time frame, the tipping point was reached when Americans had to pay more than 12 percent of their income for energy. When oil gets to $150/barrel in two to three months we’ll be past that point.
Another thing to note: a fair amount of funds in the investment accounts are withdrawn annually in the July-August time frame so that middle class parents can pay college tuition. This is one of the reasons why the market always drops in value in the late summer.
If you consider the combined effects of both the limits to oil futures manipulation and the annual July-August tuition dip and you have some of the makings of a perfect storm.
I think that we very well could be witness the effects of gravity on some very big shoes within the next two months.
It is a pity that potatoes do not have planting instructions written on them like Burpee seed packets do.

Anonymous said...

commodities are spiking mainly because inflation is being realised. there is a run from anything which is not tangible. the main problem is the dollar, and the federal reserve creates these bubbles, not investment banks.