Stop Gambling on Hunger

Barclays considers stopping its agricultural speculation

dave — Sat, 01 Dec 2012 14:13:06 +0000

In response to growing public pressure against excessive speculation in food and energy markets, Barclays is considering stopping all of its trading in agricultural products due to “potential reputational damage.” Barclays would join a growing number of European banks and pension funds who have recently stopped trading in agriculture futures due to growing concern that this speculation is driving world food prices higher and making them more volatile.

More recently, investors are pulling out of agriculture speculation not only because of these social concerns, but also because, “commodities trading turnover for the 10 biggest investment banks has tumbled 20 percent in the first nine months of this year, and the profitability of operations could be squeezed further by tougher regulations.” As another article questioning the benefits of agriculture speculation ponders, “if CalPERS, among the most sophisticated institutional investors, cannot make money from an index-based approach to commodity investment, supplemented with an active management overlay, there must be doubts about whether other pension funds will be any more successful.”

Proven model predicts higher food prices if speculation is not reined in

dave — Thu, 16 Aug 2012 13:30:59 +0000

The New England Complex Systems Institute, that has developed a quantitative model able to very closely predicted the FAO’s food price index, released a new report predicting sharply higher food prices due in part to excessive speculation.

Their model, originally released in September 2011 matched the FAO’s index from 2004 to 2011. Since then it has continued to closely follow the real world numbers.

Unfortunately, the model now predicts, “another speculative bubble starting by the end of 2012 and causing food prices to rise even higher than recent peaks”

While the researchers acknowledge that the drought in the Midwest U.S. will cause prices to rise, their model shows that excessive speculative activity will have an even larger effect. Though some key financial reforms passed in 2010 may finally begin to be implemented in early 2013, that may be too late to avoid the coming price bubble.

“We find that through the mechanism of speculative activity, the drought may trigger the third massive price spike to occur earlier than otherwise expected, beginning immediately, and sooner than could be prevented by the anticipated new regulations. This spike may raise prices well beyond an increase justified by the reduced supply caused by the droughts… [w]hile the drought only causes a limited price shock, the impact on prices is amplified by the speculative activity,” write the authors.

Graph showing the dramatic difference that speculation can make in food prices

As NECSI president Bar-Yam said, “We are on the verge of another crisis, the third in five years, and likely to be the worst yet, capable of causing new food riots and turmoil on a par with the Arab Spring, alluding to another study by the NECSI showing that the last two food prices bubbles in 2008 and 2011 correlated with similar increases in violent outbreaks and food riots.

Graph showing the number of violent outbreaks rising and falling with food prices

Perhaps most frustrating is that the principal causes of the rising prices are bad public policy:

“Each of these causes is due to particular acts of government intervention or deregulation. Thus, while the food supply and prices may be vulnerable to global population increases and environmental change, the existing price increases are due to specific governmental policies. In order to prevent further crises in the food market, we recommended the halting of government support for ethanol conversion and the reversal of
commodities market deregulation, which enables unlimited financial speculation.”

Could it be that we are in for another round of unnecessary, destabilizing and dehumanizing violence?

CalPERS fails to make money in commodities

Brennan — Wed, 01 Aug 2012 19:58:05 +0000

(Reuters) – Nearly five years after it began investing in commodities, the biggest public pension fund in the United States has yet to make any money in the asset class — highlighting the difficulty even the largest and most sophisticated institutions encounter in wringing returns from investments in agriculture, metals and energy derivatives.

The California Public Employees’ Retirement System (CalPERS) had assets valued at $236 billion at the end of March 2012, including $3.6 billion linked to commodity prices, according to the latest quarterly performance report presented to CalPERS investment committee in May.

The system began investing in commodities in October 2007. CalPERS’ performance matters because it has been one of the highest-profile institutions to allocate significant funds to the asset class, helping make it more acceptable among traditionally conservative pension funds.

A review of the programme by pension consultants Wilshire Associates in May 2011 noted that the leading investment banks dealing with CalPERS, which included JPMorgan, Societe General, Barclays and UBS, “realise the benefit of having a visible plan sponsor like CalPERS being an active proponent of commodity investment.”

But a careful analysis of the programme’s performance suggests it has actually lost money. Between October 2007 and June 2011, the programme had a negative rate of return of 6.9 percent per year. Between July 2011 and April 2012, the fund achieved a positive return of just 0.1 percent, according to performance reports published on CalPERS’ website.

Detailed data for performance in May and June 2012 is not yet available. By design, however, performance closely tracks the S&P Goldman Sachs Commodity Index Total Return Index , which declined 12 percent over those two months, so it is almost inevitable the programme was down sharply by the end of the second quarter — ensuring it has been loss-making since inception.

This performance analysis is not meant to single out CalPERS. It is meant as a case study that reflects performance problems common across the sector.

DISAPPOINTING RETURNS

Launching the programme, CalPERS stated its objectives were to enhance risk-adjusted returns, diversify the risks in its portfolio, and hedge against inflation (“Statement of Investment Policy for the Inflation Assets” July 2011).

Commodity prices are extremely volatile. From the outset it was understood that the commodity programme would generate extremely variable returns. In one presentation, CalPERS forecast the annual volatility of returns at 21 percent (“Strategic Asset Allocation: Judges’ Retirement System II (JRS II) and Legislators’ Retirement System (LRS)” April 2011).

But it was also expected the programme would add stability to the wider portfolio owing to the low correlation with other asset classes. And it was believed that commodities would add to performance. In the April 2011 presentation on asset allocation, CalPERS assumed a long-term compound return of 5 percent a year from the commodity programme. After five years, the programme is nowhere near delivering that.

The disappointing performance comes amid broader pressure on CalPERS investment portfolio. In the 12 months ending in June, CalPERS achieved an overall return of just 1 percent, far below the fund’s discount rate of 7.5 percent (which has itself been recently reduced).

“The last twelve months were a challenging period for all investors as the ongoing European debt crisis and slowing global economic growth increased market volatility and reduced equity returns,” the fund’s chief investment officer said in a statement released on July 16.

The commodity allocation is too small to have much impact on CalPERS’ overall performance, and the fund is a very long-term investor which can afford to ride out short-term fluctuations.

But the asset class performed below average in 2011/12, despite all the talk of a commodity super-cycle, and dragged down overall returns, at a time when the fund can ill-afford underperforming asset allocations.

The failure to generate consistent positive returns over the last five years suggests something is wrong with the underlying approach.

IF NOT CALPERS, WHO?

CalPERS is among the most sophisticated institutional investors, and as the biggest public pension fund in the United States commands significant attention and expertise from sell-side banks and investment consultants.

If CalPERS cannot make money from an index-based approach to commodity investment, supplemented with an active management overlay, there must be doubts about whether other pension funds will be any more successful.

Part of the problem is staffing. CalPERS has well-known difficulty retaining investment professionals owing to the big difference between compensation in the public and private sectors.

In its May 2011 programme review, Wilshire expressed particular concern about the recent departure of the dedicated fund manager responsible for overseeing the commodity strategy and his replacement by a team that is also responsible for the currency, swaps, sovereign debt and treasury portfolio.

“For internal active management purposes, staff has only one or two investment professionals responsible for researching, implementing and monitoring strategies designed to outperform the broader commodity market. These individuals also cover a number of other asset classes and securities,” the report found.

Overall, though, Wilshire rated the programme favourably.

CalPERS utilises a mixed approach which is in line with the current best practice being recommended to pension funds. Approximately 75 percent of the commodity exposure is indexed to the GSCI Total Return Index while the remainder is devoted to active (alpha-generating) strategies.

Wilshire explained “the majority of commodity exposure is done through inexpensive index swaps. Active strategies are then employed as opportunities are present in the market which are implemented via a swap on a custom index that reflects the positions CalPERS desires”.

Praising the expertise available in-house, even if it is stretched thinly, Wilshire concluded “the portfolio manager has experience in a variety of commodity markets from prior employment and displayed an understanding of how experienced traders and portfolio managers can add value by exploiting inefficiencies in particular markets.”

“Overweighting of commodity sectors which display positive attributes such as positive or less negative roll yield and avoiding those whose value gradually declines as the futures contract ages are at the heart of the commodity programme’s active strategies.” In o ther words, CalPERS seeks to avoid contango markets and look for backwardations.

CalPERS also uses is commanding position to secure advice from the major investment banks active in commodities: “staff has leveraged CalPERS’ unique position within the marketplace and worked with external dealers and asset managers to research potential alpha strategies.”

NOT ENOUGH ALPHA

Alpha generation has helped improve performance, but nowhere near enough to offset the drag on index performance from the cost of storage and other features contributing to widespread contango markets.

Between October 2007 and June 2011, the commodity programme suffered a negative rate of return of 6.9 percent, which was better than the negative rate of return of 7.3 percent in the GSCI Total Return benchmark, but not by much.

The problem is that the fund’s policies deliberately limit the amount of tracking error between its performance and the underlying index benchmark. If the benchmark is consistently loss-making, as the GSCI has been in recent years, there is not much that the portfolio managers can do about it.

CalPERS is stuck somewhere between fully passive and fully active management. The index-based programme was set up to capture systematic returns which have since vanished. The active overlay is not large enough to escape the grinding losses inflicted by the GSCI.

But a shift to mostly or fully active management would be inconsistent with its original objective and might be uncomfortable for a high-profile institutional investor, which would risk being accused of stoking food and fuel prices.

In the meantime, the underperformance of CalPERS’ commodity programme can no longer be dismissed as a blip and must eventually force a rethink — which is likely to be underway at other pension funds as well.

Levin to SEC: Proposed ETFs backed by physical copper should not be allowed

Brennan — Thu, 19 Jul 2012 17:06:09 +0000

Responding to NYSE Arca’s request to list new physically-backed copper ETF created by JPMorgan, Carl Levin (D-MI) urged the SEC to deny the request, arguing the new ETF “would allow speculators to create a squeeze on the market,” and “…undoubtedly affect and increase the price of copper.”

Similar products in precious metals have been successful in recent years, according to the Financial Times. Unlike gold, silver and palladium, though, copper is essential to manufacturing because of its use in electrical wiring.

Not surprisingly, then, several US copper users, including Southwire, Encore Wire, Luvata and AmRod as well as trading house Red Kite, have argued that the new ETF would “wreak havoc” on the global economy.

NYSE, however, does not believe the JPMorgan ETF, which would start trading with 10,185 tonnes–with a capacity to hold up to 61,800 tonnes–would be significant compared to an annual coppper production of 20m tonnes.

“Given the anticipated size of the Trust relative to the size and depth of the physical copper markets… the Sponsor [JPMorgan] has informed the Exchange [NYSE] that it does not expect the Trust to cause a spike in copper prices,” NYSE said.

“The SEC will decide by Thursday whether to permit or reject the product, or to open a further period of consultation and market review.”

“NYSE has filed a separate request to list the BlackRock iShares copper ETF,” which could hold up to 121,200 tonnes.

Read the full article here.

Could oil prices be rigged too?

Brennan — Mon, 16 Jul 2012 18:04:08 +0000

In the wake of the Barclays’ Libor scandal–with internal memos now hinting that the scandal will envelop other banks–some politicians and fuel campaigners are urging regulators to expand its investigations to determine whether oil prices have also been pushed up.

Concerns around the reliability of oil prices–reinvigorated by the huge spike in gas prices earlier this year–continue to grow after a recent G20 report “found the market is wide open to ‘manipulation and distortion.’” Oil retailers use “benchmarks” to determine the price for future supplies. The benchmark rate is calculated by data companies (Platts & Argus) based on submissions from banks, hedge funds, energy companies, and others who trade oil daily. Similar to Libor, the integrity of this process depends on the honesty of firms to submit accurate data–firms that have an interest in manipulating prices.

The report, published last month by the International Organisation of Securities Commissions (IOSCO), noted that whole market is voluntary–that is, banks can choose which trades to make public–meaning “traders have opportunities to influence oil prices for their own profit.”

IOSCO says this “creates opportunity for a trader to submit a partial picture in order to influence the [price] to the trader’s advantage”.

In an earlier report, the regulator concluded: “It is open to companies to report only those deals that are in their own best interests for the rest of the market to see.”

Platts and Argus argue that they are well aware of these possibilities, and that they employ journalists to weed out bad data.

Paul Tucker, the Bank of England’s deputy governor, told MPs that Barclays’ abuse of the Libor system may be only one part of the banks’ dishonesty over crucial financial information.

The growing concern is not limited to the UK:

Further alarm bells are being sounded by US regulators, who have already pointed out the rate-rigging scandal could spread to the oil market.

Scott O’Malia, a top official at the US Commodities Futures Commission, has drawn attention to the “striking similarity” between the potential for manipulating oil and Libor.

Read the full article here.

Contention over CFTC’s Proposed Interpretive Guidance on Cross-Border Application

Brennan — Mon, 09 Jul 2012 18:46:45 +0000

On June 29, the CFTC released its proposed interpretive guidance on cross-border implementation-of financial reforms – essentially, how exactly, if at all, will new CFTC regulations flowing from Dodd-Frank be applied to foreign subsidiaries of U.S. banks and others trading on U.S. markets from another country. Organizations working for strong financial reforms were encouraged to see the CFTC, in the face of objections from Wall Street and abroad, adopt strong interpretive guidelines that would affect a significant portion of traders on U.S. markets.

The response from Wall Street traders left no question that this will be an important battleground for the effective implementation of the regulations called for in Dodd-Frank. Wall Street has relentlessly attempted to undercut strong regulations at every point in the implementation process, and the cross-border application question is no exception. Because derivative markets are global– nearly 70 percent of Wall Street banks’ derivative transactions are already routed through foreign subsidiaries–weak cross-border application of new regulations on transactions involving US subsidiaries could significantly undermine the intention of the Dodd-Frank Act. Without strong cross-border considerations, Wall Street will be able to elude regulations through the shiftiness of regulatory arbitrage – shifting trades to where regulations are the weakest.

Days before the CFTC release, Michael Barnier, the EU commissioner overseeing financial services, warned in a Financial Times op-ed that “The biggest danger to success is that of excessive attempts by regulators to exercise authority beyond their normal boundaries.” Barnier was concerned that U.S. regulators were seriously considering a wide interpretation of who a “US person” is under the Dodd-Frank Act. The danger, in Barnier’s opinion, is that many of the requirements would apply to companies in the EU and to trades between the EU and US clients.

“A narrow definition of what a “US person” is under the Dodd-Frank Act is the first place to start. If not, it will be difficult for the EU to accept US rules as equivalent to ours,” he went on.

This is the same reasoning that Republican commissioners at the CFTC used in their comments to voice disagreement with the interpretive guidelines. While all five commissioners voted in favor of the interpretive guidelines, Republican’s Scott O’Malia and Jill Sommers approved them only to move the process forward, and disagreed with what they see as an “overreach” of US regulatory purview. O’Malia even cited Barnier’s FT comments.

The desperate appeal to standards of international comity in financial regulations would be honorable if it weren’t meant to hide a more dubious intention of weakening cross-border implementation: To give Wall Street a way to avoid the teeth of Dodd-Frank by way of regulatory arbitrage. After all, EU regulations, as currently proposed, are not as strong as those passed in the US.

While we understand that cross-border implementation is a complex task requiring a nuanced approach, we believe the “biggest danger to success” is that of cross-border implementation so weak that it undermines the effectiveness and intention of the regulations as a whole: To protect the integrity of the US economy, and tax-payers from paying for another bailout. The currently proposed interpretive guidelines do take seriously both strong cross-border implementation and international comity, leaving a major role for other countries’ regulations to combine with those of the U.S.

You can find the proposed interpretive guidelines and each CFTC commissioner’s comment here.

Who is writing comments for CFTC’s O’Malia?

Brennan — Fri, 06 Jul 2012 18:37:23 +0000

Is someone ghost-writing Scott O’Malia’s comments on CFTC rules and guidelines? According to John Kemp of Reuters, who recently wrote a very intriguing piece exploring the transformation of O’Malia’s comments into eight thousand word legal briefs, it’s likely.

During O’Malia’s first two years, his statements were–on average, around 1,240 words, with two footnotes–similar to his colleagues. But since October 2011 the average has jumped to 3,020, with 17 footnotes–including two statements of over 8,000 words and around 50 footnotes. Jill Sommers, for example, another Republican commissioner, limited her comments on the same two occasions to 1,500 words and no footnotes. O’Malia’s statements are also written like detailed legal brief, and without legal training and a small staff Kemp thinks it’s likely someone outside the CFTC is writing them.

O’Malia has emerged Wall Street’s staunchest defender at the CFTC, and his comments are of particular interest, because they have been cited numerous times in Wall Street’s case against CFTC rules in court. As Kemp says, “the question is: who exactly is writing these lengthy statements-cum-briefs and with what purpose?

From the looks of it, one might infer that O’Malia’s statements are opening up CFTC rules to challenge from the inside. The question, again, is who?

Find the full article here.

CFTC begins work on high-frequency trading definition

Brennan — Thu, 21 Jun 2012 14:54:35 +0000

The Commodity Futures Trading Commission (CFTC) will take a broad approach to defining high-frequency trading, according to a “working definition” released by a CFTC subcommittee on Wednesday.

High-frequency trading currently makes up roughly half of US equity volume and futures markets. Proponents argue that it adds critical liquidity to these markets, but the dangers of this practice are becoming increasingly clear, particularly after the May 2010 “flash crash” temporarily wiped-out $1 trillion in paper value in the stock market in just a few minutes.

A definition from the CFTC will be a small step forward towards acutally cracking down on this contentious trading practice. Proponents of a broad definition say it’s necessary to cast a wide net to make it hard to game. Some within the CFTC, however, believe such a broad definition could make it hard to enforce and leave it open to challenge in court.

Gensler said the CFTC is aiming to release later this summer a “draft concept release” on potential risk controls and system safeguards for high-frequency trading to help ensure the safety and soundness of the markets.

Find the full articles here:
http://in.reuters.com/article/2012/06/20/cftc-hft-idINL1E8HK2FI20120620
http://online.wsj.com/article/SB10001424052702303379204577477003146372804.html

House Republicans and Wall Street team up to slash budgets of financial regulators

Brennan — Thu, 14 Jun 2012 15:20:06 +0000

Clearly Republican lawmakers have forgotten the fact that unregulated derivative markets would have brought down the entire U.S financial system, save for the massive amounts of (tax-payer backed) government bailouts and free money the Federal Reserved dumped into the laps of Wall Street.

What else could explain the recent spending bill released by house Republicans, which amounts to a budget-slashing party aimed at emasculating the regulatory agencies charged with implementing the Dodd-Frank financial reform bill?

Because Wall Street could only water down–not completely kill the initial legislation–the industry has taken up a long line of strategies to render it dead in the water, as Matt Taibbi detailed in a recent post.

The bill’s biggest losers are the Securities and Exchange commission, the Commodity Futures Trading Commission, and the IRS. The House provided only $50 million of the $245 million increase requested by the president requested for the SEC, but restricted it to technology expenses–meaning there will not be enough staff to actually enforce illegal activity.

The IRS–who already cut 5,000 employess last year–received none of the $945 million increase they requested in order to enforce tax rules and fulfill the agency’s role in implementing the new healthcare law.

The CFTC, charged with regulating commodity derivative markets, has seen its purview increase tremendously over the past few years. Exchange traded futures markets have ballooned in recent years, and, for the first time, the CFTC will be charged with regulating the massive over-the-counter market–formerly unregulated.

As a reward for these new responsibilities, the House bill not only refuses to give any of the $105 million increase requested by the president, but goes so far as to cut the current CFTC budget by 12 percent (over $23 million). As if it could get any worse, the bill also includes a handful of restrictions on how the $180 million can be spent. Specifically the restrictions direct money towards technology and away from rule writing and enforcement. So, analysis but no enforcement.

CFTC Chair Gary Gensler released a statement saying the proposal “put the interests of Wall Street ahead of those of the American public.”

Gensler then put the situation into context in language we should have no trouble understanding:

“Picture the NFL expanding eightfold to play more than 100 football games in a weekend, leaving just one referee per game, and, in some cases, no referee[.] Imagine the mayhem on the field, the resulting injuries to players, and the loss of confidence fans would have in the integrity of the game.”

You can find a good overview of the bills impacts in this NY Times piece.

The bill will go before the full house appropriations committee later in June.

You can find more specific information about the bill’s implications for the CFTC in the Politico or Reuters articles.

Myths and facts about commodity speculation

Brennan — Fri, 01 Jun 2012 20:34:17 +0000

The Commodity Markets Oversight Coalition (CMOC), an alliance of commodity derivatives end-users and consumers, has compiled an excellent list of commonly held myths about speculation in commodity markets and facts that dispel them.

For example, here’s one of my favorites:

MYTH: Restraining financial speculation is against American principles and free market ideals.

FACT: Even America’s Founding Fathers worried about financial speculation and feared its excesses. In a letter to President George Washington on May 23, 1792, Thomas Jefferson wrote that “all the capital employed in paper speculation is barren and useless, producing, like that on a gaming table, no accession to itself” and said that it “nourishes our citizens’ habits of vice and idleness, instead of industry and morality.” He went on to warn of its “corrupting” influence on politics and feared that speculators would control the legislature and render “honest voters” essentially voiceless. His fears may have indeed come to pass (see the next “myth”). Stable, competitive and productive markets are American. Reckless gambling on the backs of American businesses, consumers and the economy is not. History has shown that completely opaque markets encourage fraud, manipulation and disruptive trading practices that endanger consumers, businesses and economic well-being. Furthermore, it is important to note that commodity markets were never meant to be financial markets. They were created as hedging tools for commodity-dependent businesses such as farmers and truckers, not as a playground for Wall Street investors. Speculators may serve a purpose by taking on risk and providing necessary liquidity. But these markets were never created to serve speculators.

Find the full list here.