Oil Speculators Outed

Yesterday the Wall Street Journal published a teaser article about oil trading during the speculative bubble of 2008.  The WSJ reveals few details except to note that Goldman Sachs and big hedge funds drove up the price of commodities.  The data was obtained from Senator Bernie Sanders (Socialist - Vermont).

This comes on the heals of the publication by the Commodity Futures Trading Commission (CFTC) of "large trader directional data," as promised by Commissioner Gary Gensler.  The commissioner promised the data a month ago while noting that recent purely speculative positions (people who never take physical delivery of a given commodity) were up to 88% of oil and grain markets.  This of course runs counter to the claims by hedge funds and banks that they either do not speculate, or that it's a small portion of the market and provides "needed liquidity."

My guess is Sanders believed the CFTC publication would be a significant revelation and that Gensler would make a big deal about it.  I found the data on the website - not exactly out front in blinking lights! - and it's useless.  There are no names and it covers a three year period of time where prices fluctuated wildly.  For the most part it evens out.  The report is a total whitewash.

Large trader data is confidential, but once it is produced to congress apparently all bets are off.  Sanders is on the committee that requested the data from CFTC, and the leak is clearly a shot across the bow, threatening that the CFTC should re-think using the Dodd-Frank legislation to put up more smoke and mirrors.

But how sad is it that an outright socialist is - completely on his own - taking this stand?  Where are all the Dems and Repubs who constantly seek out cameras to wax poetic about standing up for the little guy, and against commodity price speculation?

Of Corruption and Indifference

In my last post I discussed the beginning of futures trading enforcement actions under the Dodd-Frank legislation signed into law last year.  This is not a perfect piece of legislation by any means, but it should help to correct for abuses that have occurred since the repeal of Glass-Steagall.

How confident can we be that federal regulators will actually carry out their enforcement duties when we see stories like this one in Rolling Stone?  Apparently (also reported here in a shorter version) the Securities and Exchange Commission (SEC) has been destroying documents.

I doubt that anyone would be surprised that Wall Street banks and hedge funds engaged in lots of shady activity.  Few would be surprised that the SEC clearly fell down on the job during the entire past decade.  But even I am surprised that the SEC is alleged to have engaged in systematic cover-ups.

It's nice that Sen. Grassley is looking into the matter, but as my most recent post notes, he's one of the Republicans actively trying to thwart enforcement of Dodd-Frank.  The expression "smoke and mirrors" comes to mind.

Back to the Beginning

Here we are a little more than a year after the Federal Reserve started interfering in capital markets again. It was quite a run if you owned stocks or invested in fungible commodities. Now that QE2 is over, the U.S. credit rating has been downgraded for the first time in history, and markets around the world are tanking, it's time for a recap.

It was also about a year ago that I started this blog. I have held off on writing very much recently, letting events speak for themselves. Was there really any point in harping on the food price inflation connection to Syria's ongoing repression? Tunisia and Egypt gave us the verdict, we are now in the sentencing phase, with events on the ground providing daily impetus for banishing central bank inflationary policies to the dustbin of history.

In my initial posting, I hi-lighted a terrific article in Bloomberg Businessweek that raised the alarm bell about a new commodities trading tool called ETFs: Idahowheat Blog: A Proper Beginning.

Today, legendary investor Jack Bogle appeared on CNBC and gave his verdict on ETFs (beginning at 2:35) .

To be fair to the Fed, inflationary monetary policies may well have worked in a different era. But one has to wonder if they just did not account for the effects of de-regulation. There is simply no incentive for capital institutions to engage in what your father called investment, when there are so many opportunities to engage in mere speculation instead.

The full Bloomberg article deserves another look. Here are some of the more illuminating passages:

"Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks. 'You walk into a casino, you expect to lose money,' says Greg Forero, former director of commodities trading at UBS (UBS). 'It's the same with these products. You're playing a game with a very high rake, a very high house advantage, and you're not the house."

How did such an incredibly risky and misunderstood financial instrument come about?

"... In 2004, however, Deutsche Bank's Rich devised a commodity ETF that opened the door to retail investors when it launched two years later. There was an obstacle: The U.S. Commodity Futures Trading Commission, a regulatory board created in 1974 after a runup in grain prices, required buyers of certain commodity investments to sign a statement saying they understood the risks. The banks argued that it would be impossible to collect so many thousands of signatures for a product designed to trade like a stock. In 2005, Deutsche Bank lawyer Greg Collett, who had worked at the CFTC from 1998 to 1999, helped persuade the commission to waive the rule and let funds replace it with their prospectus. That would provide adequate warning, the CFTC concluded. Collett says he believed the fund "democratized" commodity investing."

Just as the U.S. federal government eliminated sensible laws and regulations like Glass-Steagall (1999), which were designed to prevent market manipulation, the trend continued all through the last decade. Republican lawmakers did not de-regulate because they are principled capitalists - they reacted to specific lobbying efforts designed to make certain wealthy individuals much wealthier (Glass-Steagall was repealed specifically so that former Clinton administration Treasury secretary Robert Rubin's bank, Citigroup, could operate in the new mortgage backed securities market - woops!).

At this point you may be asking where are the regulators. The Dodd-Frank legislation signed into law by the president last year was specifically designed to address complex financial instruments like ETFs:

"The financial reform bill President Barack Obama signed on July 21 includes a few provisions that may help the CFTC [Commodity Futures Trading Commission] address the commodity ETF mess. The new regulations enhance the CFTC's ability to prosecute trading abuses, and set position limits on over-the-counter swaps, like those UNG has been buying. How much the new law will help remains to be seen, says Jill E. Sommers, one of the agency's five commissioners, because Congress still needs to appropriate funds and write guidelines for implementation and enforcement. 'We'll need additional dollars to carry this out,' she says, adding that it's too early to say whether the CFTC has the authority needed to crack down on pre-rolling. 'We're at the beginning of the rule-writing process, so it's premature to say whether additional authority is going to be needed,' she says."

A few days ago the CFTC finally passed a rule designed to shed light on who was making big bets on commodities, i.e., speculating (you know, that thing speculators insist they don't do). Commissioner Gary Gensler announced there is more to come next month.

If you're under the impression that Republicans or Tea Partiers are standing on principle in order to "put the country back on track" and "stand up for ordinary Americans," think again. Tea Party champion Michelle Bachmann wants to eliminate Dodd-Frank altogether. Republicans will do everything they can to prevent Gensler from either passing new rules or enforcing them.

If you're finding it hard to reconcile rhetoric about protecting the little guy and specific actions designed to let the casino roll on, you're not alone.  The truth is, both parties are on the left, beholden to the wealthy and leaving the "little guy" standing in the middle of a wheat field in Genesee, Idaho, on a day when 1/4 of his wheat kernals are still soft and the wheat market is tanking along with equities, wondering who is really going to stand up for him.

Speculation Drove Wheat Prices Up While Supply Expanded

View this excellent interview of an Indian commodities expert on the Real News Network.

Maseratis in Moline

I could write many words about the current food price commodity slide and provide many links and charts to show that the price action in those markets over the past year was a massive bubble that is now bursting.  Instead I'll just share this segment from CNBC today.  The best part is a trader who has been short the market lately and is making a killing on the slide.  That starts at about 2:20.

Enjoy.

Bring On Normal

Sniping at Federal Reserve Chairman Ben Bernanke is nothing new, but I predict that the generally flattering treatment he has received from Wall Street and its media acolytes will cease pretty much immediately.  As noted today at Forbes.com, at an afternoon presser Bernanke basically said he's clueless as to why flooding the market with free cash made bankers richer, but didn't create jobs for Joe Sixpack.

I don't think that before today the market believed the Fed was really going to withdraw from its unprecedented interference in the economy.  But after today's sober assessment from Bernanke and reiteration that Quantitative Easing II is over, beginning tomorrow Wall Street will sound like a cacophony of jilted lovers.

Meanwhile, the price of wheat is in a free fall, with some folks reporting that demand is not there to support anywhere near the current Quantitative Easing II-inflated price.  Now where have I heard that before?

Farm Aid 2011

The annual Farm Aid concert and event will take place on August 13 at the brand new LIVESTRONG Sporting Park in Kansas City, MO.  The local food movement has strengthened quite a bit in only the last year.  Even more significant than the growth in farmers markets and local produce production is the shift in staple food consumption.  Late last year whole wheat bread product sales surpassed white bread sales for the first time in history.  Dog food is now being advertised as corn and wheat-free.

Farm Aid is obviously about farmers, but it's really about food.  The point is to re-connect farmers to folks.  That is happening, and Farm Aid has been a big part of the movement.  Look for updates here.

Down Goes the Prophet of Jamahiriya

The first thing Muammar Gaddafi did after taking over as ruler of Libya over 40 years ago was to invent a word with which to name the new country: Jamahiriya.  It is based on the Arabic word meaning "state of the masses."  Apparently the state of the masses in Libya, er Jamahiriya, is... angry.  Again Al-Jazeera's coverage of the events is making Western media look foolish, as this time our "gatekeepers" are covering the 1,900 person royal wedding guest list (and speculating about Kate Middleton's gown!).

Here continues the series on the increase in food prices and its consequences.  It is worth noting that in his rambling, threatening communique on state television yesterday, Gaddafi's son perfectly described the economy of the country.  "How will you obtain flour," he asked, "when a civil war comes and the petrol is burned."  My previous post showed that Libya not only imports all of its wheat, but a large amount of wheat flour also.  The country has been so badly mismanaged that there is not even a viable milling industry.  Libya is the most extreme, but not nearly the only example of an absurd oil-for-food trade scheme that was destined for failure.  The rapid food price increase is the tipping point.

I am focusing on wheat in this series even though food price increases are being driven by the rise in all major food commodities except rice.  There are good reasons for this.  Wheat is mostly consumed by humans, and largely in the form of bread, in stark contrast to soybeans and corn, which are both increasingly used in transportation fuels and non-food products, and beef production.  When prices rise as fast as they have in the current period it makes sense to focus on the bare essentials.  This is not only practical; since bread can be stored and transported easily as the food of last resort, access to it is also psychological.  If a country cannot provide a steady and affordable supply of the absolute basics, is there any reason to leave its leaders in place?  We are seeing the answer to that question all across North Africa and the Middle East.

This first chart is the historic wheat price, not adjusted for dollar exchange trade value (that is coming), since 1981 (courtesy World Bank via Index Mundi).

In the chart below I used the historic wheat price and coded the peaks and troughs.  I then divided the negative or positive percent change by the number of months it took to get there.  As you can see from the chart above, the price for wheat in 2008 remains an all-time high.  But the price increase from it's trough in the current bull market has been more rapid.  This chart shows that in the current run-up, the average price increase per month is over 15%.

Many countries across the region had diminished wheat stocks at the end of last year, even though the US wheat stocks were three times larger than in 2007.  They must have believed that prices could not be sustained and were waiting for them to start declining in February (historically the beginning of the seasonal price down-trend).  These countries have recently been buying huge amounts of wheat at or above the current peak price.  At the end of last week the wheat price plummeted as traders noted that there simply were not any buyers.  So much for the "growth-led" exponential demand pressures and bad weather we keep hearing about.  It should be clearer by now, and will be by the end of this series, that wheat prices since the mid-90's have been driven by conditions in the equities, treasuries, and non-food commodity markets, not supply and demand fundamentals. 

We are in unchartered territory here.  When prices rise this fast, hoarding will take place and regimes will soon realize that their chances of remaining in power are better if they withhold food instead of giving it away.  The only prediction we can be confident about is that the increased volatility in the wheat markets since the mid-90's will continue.  As I will show, volatility, not price peaks is the root of the problem, and the culprit is obvious and identifiable.

Here Comes the Bad News

Today we'll look deeper at some numbers to understand why the current unrest in the Middle East and North Africa is food-based.  First, below are two maps from the FAO that present two important features of the food marketplace in the region.

The first titled "Dietary Energy Consumption" shows that per capita daily calorie intake in all of the countries in the region except Yemen is over 3,000.  That is on par with Australia and Spain, for example.  Egypt, specifically, is better off than the other countries in the neighborhood.  This makes sense if you look closer at the table of largest wheat importers from yesterday.  Third on the list was Egypt in dollar value, but in terms of total volume they are first.  They just get a really good per unit price on their wheat (I can't imagine how that happened).  In general, the people in these countries have enough to eat.  The situation is much different throughout the rest of Africa, India, and in parts of South America.

The next map entitled "Net Trade in Food" shows us the balance of food exports and imports divided by  consumption.  The dark green countries consume quite a bit, as the map above shows, but they are the production powerhouses that export huge amounts of food, especially staple commodities.  The orange areas in North Africa indicate a huge negative balance.  If we look at the map above again and recall that those countries have enough food to consume, the negative balance must mean that they are big food importers.  Egypt is better off than others in the region because they export a lot of high value fruit crops.

So we know that the countries in the region have plenty of access to food, but that they are highly reliant on imports to meet those needs.  Why does this matter?  Think about it this way.  Joe lives in a relatively modern country with plenty of access to food even though he is poor and spends a large percentage of his income on it.  Nancy lives in a developing country where food scarcity is common, she is also poor and spends a lot of her income on food.  In both countries wheat prices have led to significant disruption in food distribution and huge retail prices increases.  If you are a dictator, which country would you rather rule?  My answer: the country where technology does not make organizing protests really easy, and where people are accustomed to being hungry.

Below is a chart showing percentage expenditures on food in various countries, sorted by percent expenditure on cereals, like wheat and corn.  This is not a comprehensive list, rather representative countries that illustrate the trade imbalance in staple foods between Western countries and those in the subject region. 

First note the difference in percent food expenditures between countries like Egypt and Morocco, and Germany and Australia.  The yellow hi-lighted countries spend a relatively small percentage of expenditures on food, and we see that the types of food they import are items like wine and cheese, not staple foods.

This data was compiled by the USDA's Economic Research Service, and it is based on a 1996 survey.  I added to it the 2008 top three food imports from the FAO database, and the last column on the right is the percentage of wheat consumption that was produced in the subject country.  Those percentages only appear for countries where wheat was the number one import (also hi-lighted in green).  All of the green hi-lighted countries are in the subject region, wheat is their number one import, and they spend a large percentage of income on both cereals and all foods.  The countries with red hi-lighted text are those that spend over 1/3 of their income on food, and import over 1/2 of their wheat.

Turkey and Iran are very close to that threshold, and Spain and Italy should be on the watch list as all their numbers are creeping up, and they import a lot of soybeans and wheat, respectively.  They are also two of the Mediterranean countries having major financial problems.

All of the countries hi-lighted in green have experienced recent protests or revolutions sparked by sharp increases in food prices.  Algeria, with its very large wheat imports, could be next.  Even if countries subsidize bread and other basic foodstuffs, they can only maintain those emergency measures for so long.  What we saw last year was pure speculation, but what we'll see now will be actual hoarding.  Prices will continue to rise with scarcity, and unrest will continue.  Of course, most of the countries on this list also import large amounts of corn and soybeans.  The prices of those two commodities has risen sharply, but those increases began a few months after wheat.  Just wait until those increases begin to affect retail prices.

Policy makers can wring their hands about who will take over in these countries in the near term, but it won't matter.  Tunisia set off a food-based economic death spiral in the region that will not end with current leaders being deposed.  Anybody who wants to step forward and occupy the palace had better sleep with one eye open.

Suicide's Easy, What Happened to the Revolution?*

As talking heads debate the future political power structure of Egypt, one constant remains as it did before the crisis began (hint: it is not the Muslim Brotherhood).  As I have noted in this blog many times, the staple foods commodity markets are experiencing an artificial bubble (yes, I am disagreeing with Ben Bernanke) that will have serious consequences.

The most stark examples of this are the revolutions in Tunisia and Egypt.  But if this is an economic phenomenon, we need to ask some important questions.  First, what other countries are experiencing problems due to rapidly rising food prices?  Second, where are they?  Third, in the context of their broader economy, does it matter?  Fourth, what are the long-term implications?

In the series of maps and tables I present over the next several days, I will try to answer all of these questions.  Instead of putting myself in the position of arguing an obvious point with a trained economist who is probably a genius, I will present straightforward data from the UN Food & Agriculture Organization (FAO) which both shows how Tunisia and Egypt arrived at this place, and how several other countries in the region are likely to suffer the same fate.

First up, the most recent data (2008) for wheat imports.  Look who's 3rd.

Rank	Area	Quantity (tonnes)	Flag	Value (1000 $)	Flag	Unit value ($/tonne)
1	Japan	5780710		3291570		569
2	Algeria	6913570	R	3055210	R	442
3	Egypt	8327790	R	2461720	R	296
4	Italy	5443040		2277540		418
5	Indonesia	4497190		1975480		439
6	Brazil	6032700		1873590		311
7	Iran (Islamic Republic of)	5197370	R	1801340	R	347
8	Morocco	4083580		1609100		394
9	Turkey	3708000		1483190		400
10	Spain	4655980		1430390		307
11	Netherlands	4304570		1389950		323
12	Republic of Korea	2682310		1274360		475
13	Mexico	3217030		1246900		388
14	Iraq	2963320	R	1242860	R	419
15	Belgium	3114540		1151470		370
16	United States of America	2516500		1080410		429
17	Yemen	2126630		956364		450
18	Philippines	2251970	R	936905	R	416
19	Germany	2582770		910089		352
20	Tunisia	1762440		811114		460

FAO Stat Wheat Imports 2008

*Black Rebel Motorcycle Club

Song: Berlin

Album: Baby 81