By Rowena Mason
Published: 8:00AM GMT 18 Jan 2010
The neverending dance is illustrated perfectly by events following the bankruptcy of the billionaire Hunt brothers in 1980, who stockpiled silver, causing its price to quadruple and then collapse.
The scandal prompted an irate US Commodities and Futures Trading Commission (CFTC) to impose position limits on how many contracts each market player may own.
This would supposedly spell an end to speculation by those who were not end users (like natural resources companies and airlines) of the physical assets.
Just one year later, the regulator granted its first “bona fide hedging” exemption – to the physical commodities arm of Goldman Sachs, the bank that also happens to be a major speculative trader.
The concessions continued until President Bill Clinton signed the de-regulation bill that gave rise to the so-called “Enron loophole”, enabling fraudulent commodity market manipulation activities at the turn of the century.
It is hardly surprising given the CFTC’s light-touch history that its new limits on positions in oil, natural gas, heating oil and gasoline this week provoked scarcely a murmur from the markets.
“Position limits are so generous that we do not expect any direct market impact,” analysts from Commerzbank said dismissively after the long-awaited announcement.
The CFTC’s unexpected retreat, despite forceful rhetoric, is good news for most market participants, grateful that it has not overly vilified speculators – who do, after all, provide liquidity and better price discovery on the exchanges.
The proposals will grant exemptions to the companies that need physical commodities for their daily operations and be lenient towards the banks that hedge risk for them. Hedge and index funds will be the main losers, but there have been suggestions that breaking up into smaller funds could circumvent the new measures.
The main source of worry for observers is some of those funds hit by regulation will migrate to the “dark” side of the market known as “over-the-counter” – fundamentally less transparent and harder to monitor. Michael Dunn, CFTC commissioner, even believes that the new rules may, overall, “result in less transparency in the futures markets”.
After all, funds have been anticipating them for a good six months and already taken preparatory measures.
The CFTC noted that only 10 market players will have to rein back their holdings, out of 200-plus active in the energy futures market. It is here that the most obscurity – of much more concern than speculation in itself – is to be found, both among paper and physical commodity traders. These derivatives are traded directly between parties, without the cost and interference of a clearing house or regulated exchange. They are more complex and risky, with US observers such as Brooksley Born blaming them for uncertainty about junk assets lurking on balance sheets in the credit crisis. Nobody – not the regulators nor the funds themselves – could see who had built up the riskiest positions, adding to the seizure of the markets.
It appears that some of the funds usually trading on the regulated exchanges have already swapped to trading over-the-counter futures.
Since the CFTC and European regulators began sabre-rattling about an end to speculation, the US Natural Gas Fund, the world’s biggest exchange trader in its field, started to reduce its positions on the exchanges and began to build up over-the-counter positions. More than $2.4bn (£1.4bn) in assets out of its $4.5bn fund are traded on dark markets.
More monitoring of over-the-counter trades could be on its way. New legislation in the US and Europe looks set to force as many contracts through clearing houses and official platforms as possible. The key benefit of this is more data on the activity of traders rather than limiting any transactions they make.
Those against these laws have argued that business could migrate from the West to other financial centres if the rules were too draconian. With 80pc of commodities traded in the US and Europe, it would be a major and unlikely shift for traders to seek loopholes in the looser markets of Asia and the Middle East.
The jury is still out on whether speculation had any part to play in the oil price spikes of 2008, with most analysts and academics arguing that speculation, in itself, was not a big factor.
Given that opacity is the enemy of free markets, better information about both physical and paper traders who work in this corner of the market is surely the best way to find out.
If, as so many argue, speculation is not responsible for commodity spikes, then traders can have nothing to hide.