Streetwise Professor

Going through my news clips this morning made me feel like I was in a video game fighting off hordes of zombies. Commodity market critic zombies.

Zombie #1: Gretchen Morgenson, with an article on RINs. It is a farrago of innuendo and idiocy.  Really, it is 9 pages long, and I could write 20 listing all the fundamental flaws.  I don’t have the energy for that (no pun intended), so I’ll limit myself to the greatest hits.  In a nutshell (emphasis on the nut), it is a typical Morgenson piece: if banks are involved it’s bad;  if people are speculating it’s bad; if there are unintended consequences of government policies, it’s not the fault of the stupid government, it’s the fault of those who have to deal with the stupidity, and who figure out ways to make money out of artificial bottlenecks created by the stupidity.

The article is an assemblage of assertions and allegations totally lacking in evidence.  Morgenson alleges JP Morgan has speculated in RINs.  Which it denies.  She insinuates that the market might be manipulated, but provides no evidence.  She mentions a “corner”, but obviously doesn’t understand how a corner works: that would require the accumulation of a long futures/forward position, but she provides no evidence that anyone has accumulated such a position. (CME shows a grand total of a whopping 558 RIN contracts outstanding.)

Morgenson is obviously very suspicious of speculation-kind of funny, since her entire article is completely speculative-and suggests that speculation distorts-i.e., manipulates-prices.

Assume arguendo that Morgan or some other evil bank did figure out that the blend wall would hit and that RINs would become more valuable as a result, and hence accumulated them.  If it is right, it will profit when prices rise.  That doesn’t mean it caused the prices to go up. Prescience isn’t the same as manipulation.

Morgenson should be forced to write on the blackboard, Bart Simpson-like:

Speculation≠Manipulation

Speculation≠Manipulation

Speculation≠Manipulation

Speculation≠Manipulation

Speculation≠Manipulation

. . . .

The real problem here is something that makes only a cameo appearance in Morgenson’s story: the artificial RIN bottleneck created by an idiotic government policy that was adopted based on a forecast of future gasoline consumption (‘cuz yeah, we’re so good about making energy forecasts) and an ignorance of the technological realities of ethanol.  It is inevitable that someone would figure that out, and make money off it.  Inevitable.

Quite honestly, you’ll learn more about the reality of RINs from one of those ubiquitous Hitler videos than the New York Times (h/t @izakaminska):

Speaking of tow-headed troublemakers named Bart . . . that brings us to Zombie #2. Taking a break from edifying us all about the evils of HFT, polymath Bart Chilton went off on the evils of banks in commodities:

Mr. Chilton, in prepared remarks viewed by The Wall Street Journal, said it’s “nearly impossible to figure out exactly what banks own.” He said the CFTC can see what banks are trading in derivatives markets tied to commodities, but doesn’t know what physical assets like oil tankers and aluminum they hold.

“Unless we can see that, we can’t reasonably and responsibly protect against market manipulations,” Mr. Chilton, a Democrat, plans to say in speech to a business association in Michigan Saturday.

The CFTC has been investigating firms that store and deliver aluminum, including Goldman Sachs and J.P. Morgan, after complaints from companies that use the metal. Beer and soda companies, can makers and other end users said firms that warehouse aluminum inflate prices by holding onto it for longer than necessary.

Banks that trade commodities have come under fire from government officials, companies and consumer groups who say they exert too much influence over markets for some raw materials.

Mr. Chilton plans to raise that concern in the speech, saying banks that own commodities and trade in derivatives based on the prices of those commodities have a potential conflict of interest.

“The prices of commodities are supposed to be based upon supply and demand,” Mr. Chilton plans to say. “However, what if you control, or have significant influence upon, the supply or the demand?”

Mr. Chilton also is expected to say the public should be able to “easily locate and click on a link to find out” what physical commodities banks own. He will also call on lawmakers to rein in banks’ role in the buying and selling of physical commodities and not leave the decision to the Federal Reserve.

Click on a link to find out physical positions.  Right, Bart.  Uhm, you can’t even do that for futures positions.  And care to share any evidence demonstrating that any banks exert a “significant influence” on supply and demand in any energy commodity?  Their market shares in physical tend to be very small.  Check out the stat on Morgan Stanley in the Morgenson article-Montaigne markets 2.5 percent of gasoline in the US. Big freaking whoop. JP Morgan serves one piddling refinery on the East Coast.  Sheesh.

Conflict of interest: the classic problem raised by people who don’t have a real argument. Speaking of real arguments, how’s this for a doozy:

“Maybe it’s just me, but I don’t think the American public wants banks owning grain elevators, electric companies, large warehouses or shipping and distribution interests,” Chilton said in the speech.

Wow.  Let no one ever question Bart’s ability to make a substantive economic argument, backed with empirical evidence.

Zombie #3: Lina Khan, in The New Republic. Again, far too much idiocy to deconstruct in detail.  One illustrative example: the insinuations about “inside trading.”  Trading on private information is quite different than inside trading.  The later involves the violation of fiduciary duty or the theft of corporate information that belongs to shareholders.  Trading on private information is the lifeblood of virtually all markets.  It’s called “price discovery.”

The huffing and puffing about Cargill and Trafigura operating hedge funds is another faux controversy.  These funds are regulated just like funds operated by other entities.  Moreover, there are Chinese walls restricting the flow of information between the company-managed funds, and other trading operations.

Furthermore, Khan makes broad allegations of manipulation.  I assure you that yes, manipulation does occur in commodities markets, and that trading firms sometimes execute these manipulations.  But manipulation is subject to regulation (contrary to the statements that these markets are unregulated).  Moreover, the allegations of manipulation in the article are amazingly vague, and unsupported by any evidence.  The article is a classic illustration of the Clayton Definition of Manipulation: Any Practice That Doesn’t Suit the Person Speaking at the Moment.

For instance:

Experts warn that this degree of involvement across the entire production cycle gives a handful of sizable firms even greater unchecked power over our most basic goods. “Clearly if you control the physical stock and stand to gain from managing the release of that stock, it would be foolish to expect companies not to take advantage of that,” said Sophia Murphy, senior adviser at the Institute for Agriculture and Trade Policy and author of “Cereal Secrets,” a report on the major grain traders.

Part of the trouble is that no public body oversees global physical stocks. Andres Missbach, co-author of Commodities: Switzerland’s Most Dangerous Business, said the vast storage capacity these companies have amassed equips them to create artificial shortages in the short-term if they wish. “We have no idea if they are manipulating,” he said. “We can only say they have the capacity to, and that there is no regulator ensuring that they are not.”’

Unchecked power? Seriously?  What fraction of global physical stocks does any firm own?  The article says that Glencore “controls” 50 percent of the trade in some commodities.  If you read Glencore’s statements, they refer to “freely traded” supplies, which are a fraction-and often a small fraction-of total supplies.  For commodities like oil, the biggest trading firms account for 5 percent or less of total supply.

“We have no idea if they are manipulating.”  LOL.  Remember what Judge Easterbrook wrote: “The undetected manipulation is the unsuccessful manipulation.”

I am quoted in the article, but my quotes are rather innocuous. Khan tried to get me to support her trading-firms-are-evil line, which I obviously declined to do: in fact, I disagreed strongly. Those quotes didn’t make the story, naturally. Yeah. No agenda there.

One last thing. All three are rather strange zombies, because they are apparently afraid of the dark.  Each mutters ominously about dark markets, trading in the dark, blah blah blah.

News flash: the “lit” transparent futures markets are the exception that proves the rule.  Virtually all commodity markets are bilateral search markets with little pre- or post-trade transparency.  This makes good economic sense given the heterogeneity of commodities, the idiosyncrasies of and variability in supply and demand for specific varieties, the desire to customize terms, and the low rate of transaction flow in any particular variety or at any particular location.  Commodity trading firms essentially customize commodities by transporting, refining, blending, storing them, etc.  The one size fits all standardization that is necessary to support continuous, centralized markets (like futures markets) is completely maladapted to the trade of actual physical commodities.  Physical markets and futures markets serve vastly different functions, and accordingly operate on vastly different lines.

Zombies that are afraid of the dark.  Too funny. Get a frickin’ night light, Gretchen, Bart, and Lina.

It never ceases to amaze me how commodities bring out the loons, and cause people to lose all ability to reason.  Like zombies.  Like Gretchen, Bart, and Lina.