HowWealthWorks.com

[Dave]

[Suresh]

TED BUTLER COMMENTARY
MARGIN INCREASES

I would like to comment on the recent round of margin increases for COMEX silver futures. http://www.nymex.com/notice_to_member.aspx?id=ntm235&archive=2006

Long-time readers know that I rarely mention margin changes. That’s because I don’t think that all margin increases are bad and are designed to cause selling by long holders as many claim. Looking at the issue through my former broker’s eyes, I know that margins exist for one reason and one reason only – to protect the broker from unsecured client debits. Margins are increased when it is felt the brokers need more protection and reduced when less protection is needed.

But sometimes margins are used to influence the market. I feel that is the case with the last round of margin increases in silver. What made this last margin increase unusual is that, for the first time in 25 years, the COMEX differentiated margin requirements between the front months in silver (up through the September contract) and the more deferred contract months.

In my opinion, the COMEX has done this for one reason only – they see delivery problems ahead for silver and are attempting to clear out as many hangers-on as possible. This can also be seen in the backwardization that has been developing in the December 2006 and further out contracts of COMEX silver. The COMEX attempted to camouflage their real intent in silver by also making a differentiation in the nearby gold months versus the deferred gold contract months, but any serious market observer knows that is silly in gold, where there is not the hint of a delivery squeeze.

You must understand that all exchanges, including the COMEX, operate and set rule changes for the benefit of their most important members, and not the public at large. In most cases, the most important members are the commercial shorts. These shorts want as little outside pressure on silver deliveries as possible, and that is why they are making it easy and enticing for longs (and maybe even outside shorts) to clear out of the nearbys and migrate to the back months. As a general rule, whenever a financial institution attempts to get you to do something, the prime motive is for the benefit of the institution and not you. Please be guided accordingly.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Reuters: NYMEX to raise margins for crude, related futures
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Margins for the crude oil, crude oil calendar swap, and crude oil financial futures contracts will go up to $7,250 from $6,500 for clearing members, to $7,975 from $7,150 for members and to $9,788 from $8,775 for customers, NYMEX said in a release.

Margins for the NYMEX miNY crude oil futures contract will rise to $3,625 from $3,250 for clearing members, to $3,988 from $3,575 for members and to $4,894 from $4,388 for customers.

Margins for the NYMEX MACI index futures contract will increase to $1,450 from $1,300 for clearing members, to $1,595 from $1,430 for members and to $1,958 from $1,755 for customers.
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No surprise here. Rising crude oil prices raises prices paid by consumers for food and energy. Consumers complain to Congress. Congress and the Fed worry that a rising consumer price inflation rate will crimp overly accommodative fiscal & monetary policies. Congress points the finger at dastardly speculators in the futures market, instead of worry about the supply/demand imbalance and the falling dollar. NYMEX clamps down on speculators by upping the margin requirements.

Too bad no one told Congress that there are commodity exchanges outside the U.S.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

WSJ MarketBeat blog: The Energy Markets’ Circuit Breakers
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The rallies in oil and other energy products have been so furious that they’ve set off rarely used trading limits, or circuit breakers, designed to keep commodity markets from spiraling out of control. As a hybrid market with both a trading floor and an online platform, the energy-focused New York Mercantile Exchange’s circuit breakers are particularly tricky.

In electronic trading, heating oil recently hit its daily limit, trading up 25 cents. That caused a brief halt to trading in all Nymex energy products and, when trading resumed, all limits were doubled. Crude oil’s limit went from $10 to $20 following the halt.

Nymex’s floor, however, is more freewheeling and, in many participants’ eyes, represents the benchmark for crude, heating oil, gasoline and natural gas in the U.S. In that venue, there have not been any limits hit yet and, even if that does happen at some point, trading will only be halted in the specific products that have hit their limits.
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Of course, if there is a single oil trading market anywhere else in the world, for example, in Dubai, then halting trading in the U.S. doesn't really do much to halt the rise in oil prices.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Financial Times: CFTC in talks to plug the 'London loophole'
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The Commodity Futures Trading Commission, the US commodity and futures watchdog, believes speculators are not to blame for current oil prices.

Only weeks ago it unveiled initiatives with the UK's Financial Services Authority to expand the amount and quality of information received from energy traders in London on their trading activities.

A version of the West Texas Intermediate crude oil contract is traded in London on ICE Futures Europe, owned by Atlanta-based InterContinental Exchange, and regulated by the FSA. It is similar to the WTI contract traded on the New York Mercantile Exchange, regulated by the CFTC.

On Tuesday, the CFTC announced the creation of an "inter-agency task force", including the Federal Reserve, Treasury, Securities and Exchange Commission, Department of Energy and Agriculture Department to "study the role of speculators and index traders in the commodity markets".

The CFTC was also on Tuesday holding the first meeting of a recently-formed "energy markets advisory committee". It would "focus on the issue of transparency in the energy markets", including the role of index trading and energy trading on foreign exchanges.

However, the moves do not address a key difference in the way the US and UK oversee energy traders.

The CFTC requires US exchanges to put in place limits on the size of positions taken by traders "to reduce the potential threat of market manipulation".

The FSA has no such rule, meaning there are no position limits in place for traders on ICE in London.
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The dilemma for the CFTC is how to respond to Congressional pressure in the US to address the way US benchmark oil contracts are traded and regulated in London, without laying itself open to criticism that it is attempting to impose US-style regulation abroad.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

naked capitalism: Lieberman Proposes Barring Institutional Investors From Commodities
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Whether it comes to fruition is to be determined, but taken at face value, Connecticut senator Joseph Lieberman's proposal to bar institutional investors such as pension and index funds from investing in commodities is a Nixon-goes-to-China moment, a significant indicator of Wall Street's fallen standing.

Lieberman has been a staunch defender of the securities industry and repeatedly stymied the efforts of the last pro-enforcement SEC chairman, Arthur Levitt. But now he's not simply willing to support legislation that will put a crimp in the financial services money machine, he's leading a charge.
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Now before the wealth-holding class howls that they've just been done a dirty by being deprived of inflation protection, there is an asset class that, unlike commodities, supports productive investment. and provides inflation protection, namely, infrastructure investments. The cash flow from infrastructure projects (toll roads, airports) goes up over time, as do the payouts, so they have fairly secure cash flow that increases over time.
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Overseas. investor allocations to infrastructure are often as high as 10%, while in the US, they are less than 1/5 that level.
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Such measures won't have the intended effect (because of the existence of overseas commodity exchanges) and will have an unintended effect of flooding money into indirect commodity plays (e.g., producers of commodities and companies that service or provide products to producers of commodities). As it is the market for commodity plays is small. Such measures ought to make the available market smaller, causing prices to go even higher as smart money tries to enter it.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Dave]

It's interesting that US legislators stood silently by while bubbles grew up in the bond, stock, and real estate markets from 1995-2006; but one whiff of higher commodity and consumer prices and the witch hunt for the evil "speculator" begins. The massive growth in money supply as a result of the FED serial bubble blowing has finally ended with commodities which directly couple into consumer prices.

Its not speculators that are causing commodity prices to rise, but people seeking safe haven from their money losing purchasing power. Legislators will talk about targeting the speculator to help the little guy, but what they're really interested in is keeping the little guy from protecting themselves from the government tax of inflation. That's why the legislators are targeting institutional investors and index funds. Please note that institutional investors and index funds are not speculators, they're the primary investment vehicle of the little guy.

NY Times: A Bull Market Sees the Worst in Speculators

In Washington, financial speculators have fat targets on their backs. They are being blamed for high gas prices, soaring grocery bills and volatile commodity markets, and lawmakers are lashing out at market regulators for not cracking down on them more vigorously.

Just this week, Senator Joseph I. Lieberman, the Connecticut independent, said he was working on a proposal to ban large institutional investors from the commodity markets entirely. The same day, the Bush administration endorsed another Senate proposal to create a new federal interagency task force to investigate commodity speculation. At least four public hearings have explored the topic in just the last two months, and Senator Lieberman will hold another session on June 24.

Commodities, priced in American dollars, tend to rise in price as the dollar weakens, making commodities a popular haven for investors fearful of inflation.

In a statement this week, Walter Lukken, the C.F.T.C. chairman, said the commission was determined to see that commodity prices were set “by the fundamental forces of supply and demand, rather than by abusive or manipulative practices.”

Mr. Verleger said he strongly disagrees with the view that these new speculators are pushing up the price of oil and other commodities. “In fact, they have at a minimum reduced price volatility and quite possibly contributed to a lower price level than would have been obtained had they been barred from the commodity markets,” he said.
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Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom

[Suresh]

Financial Times: US limits oil trading in London
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The ... [Commodity Futures Trading Commission]'s decision to impose position and accountability limits on one crude oil contract traded on London's ICE Futures Europe exchange - which is linked to the benchmark US West Texas Intermediate contract - would bring oversight of US traders' behaviour on overseas exchanges into line with limits on domestic markets.

Mr Lukken said: "The CFTC will also require other foreign exchanges that seek such direct access to provide the CFTC with comparable large trader reports and to impose comparable position and accountability limits for any products linked with US-regulated futures contracts."
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Mr Lukken acknowledged the widespread concerns about the surge of money flowing into the futures markets from institutional investors via commodity indices. He said there were "concerns that people are trying to evade position limits" through Wall Street "swap" dealers that handle much of this type of investment.

The CFTC is collecting more detailed information on index funds and other transactions being conducted through swap dealers and plans to provide recommendations to lawmakers in September.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Jesse's Cafe Americain: Comex Acts to Curb Speculation (in Gold)
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And After the Bell...

[Suresh]

The Bloomberg article below quotes Gary Dewaal, group general counsel Paris-based futures broker Newedge Group, as saying “The whole thing is political.” He's right.

Regulators want to curb shorting in the equity markets, when it depresses financial corporation stocks and makes them seem even more overleveraged. Regulators want to curb longs in the commodity markets because high input prices squeeze profits, if they can't be passed on to consumers; just as bad, if they can be passed on to consumers, then high input prices are bad because they jack up the consumer price inflation rate. The reality is that regulators want to foster a happy medium price that is beneficial to parties they are interested in helping, just as Mr. Dewaal said.

Admittedly, regulation has its place. But, it must reflect economics as it works in the real world. Economics in the real world comprises the interaction of consumers, workers, capitalists, and entrepreneurs. Capitalists channel savings into investments that reflect mis-alignments of price and value. When something is underpriced, capitalists hoard it; when something is overpriced, capitalists sell it short. At any given time, even with the presence of capitalists, price and value may not be aligned. Capitalists have only as much market information as everyone else, and capitalists are subject to the same fear and greed as everyone else. As such, capitalists may drive a price higher than properly valued or drive a price lower than properly valued. Entrepreneurs observe the market prices of resources that shift in part under the action of capitalists. Successful entrepreneurs anticipate future conditions of the market and organize available and known resources in a way that represents value to the consumer and profit to the entrepreneur.
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Bloomberg: CFTC to Propose New Limits on Energy Speculation to Curb Prices

The Commodity Futures Trading Commission will take another step today in its efforts to rein in energy speculation, proposing hard limits on the number of futures a single investor can hold.
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Commission Chairman Gary Gensler has pushed for tighter rules on energy speculators, calling for strict limits on who is exempt from regulation. He has also asked Congress for authority to regulate over-the-counter markets, where traders can sidestep restrictions by buying unregulated, bilateral contracts.
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CME Group Inc., owner of the New York Mercantile Exchange and the Chicago Board of Trade, proposed rules of its own in September that would have limited traders to 10 percent of the first 25,000 contracts of open interest in a single month, with a 5 percent increase for each 25,000 of open interest thereafter. Investors would have faced an all-months combined limit of 150 percent of the single-month limit.

OTC Markets

The CME said that hard position limits would be ineffective if the CFTC didn’t gain power over the OTC market. Tighter limits would push traders to shift their positions to the over- the-counter market or unregulated exchanges overseas.
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The House of Representatives passed legislation on Dec. 11 designed to shed more light on the $605 trillion over-the- counter derivatives market. The measure would exempt corporate “end-users” such as oil companies and airlines that use derivatives to hedge operational risk.

Narrowing Exemptions

Gensler has pushed Congress to narrow the exemptions and give the commission authority to curb speculation in off- exchange commodity contracts.
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Gensler has said that the exemptions may provide a loophole for financial institutions with end-user clients to circumvent the limits, saying in the Jan. 12 speech that “it is the Wall Street banks that benefit from the so-called ‘end-user exemption’ from transparency, not the businesses that use derivatives.”

Commodity Businesses

Commodity-based businesses such as manufacturers, airlines and energy producers that use derivatives would be exempt from the clearinghouse requirement if they can show they are using the contracts to hedge operational risk. The transactions would have to be reported to regulators.

Gensler has proposed a three-pronged regulatory approach: regulate derivatives dealers, bring transparency to the OTC market, and move standard derivatives to regulated clearinghouses. He cited estimates that half of all commodity and energy derivatives transactions could be standardized.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

FT Alphaville: Digging deeper into the CFTC’s position limits

Energy analyst Olivier Jakob from Petromatrix has crunched through the CFTC’s proposals on position limits released last week.

His findings are worth flagging up because they differ to the consensus view that the proposals, if enforced, would be a benign influence on energy markets.

First, he guesstimates the limits would certainly affect at least one large Wall Street investment bank offering a leading commodity index. And while the bank — which he does not name — could apply for an exemption to a maximum of 130,000 WTI contracts on a single month, they would then be prohibited from holding speculative positions. In other words, would it be worth it?

According to Jakob, therefore, the limits create an uncomfortable situation for some of the larger Wall Street investment banks offering commodity indices — and could force them to choose between operating index and swap businesses versus proprietary books.

Furthermore, there isn’t an easy side-route out of the restrictions, say by starting subsidiary hedge funds or physical operations. That’s because the limits are imposed on an aggregate basis per owner institution — and when exemptions are granted, speculative operations are restricted.
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_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.