Round Up the Usual Suspects
In the frenzy over (nearly) $100 oil, everybody–be they politicians or spokesmen for supermajors or OPEC–are desperate to deflect blame. OPEC representatives make risible statements that an increase in OPEC output would not cause prices to fall. (Who knew?) Oil industry folks say that fundamentals can’t justify current prices. Politicians bloviate (well, more than usual), mutter darkly about manipulation, and propose various whacked-out policy nostrums. But all agree on one thing: Speculators Are to Blame. Like the Claude Rains character in Casablanca who orders his gendarmes to “round up the usual suspects” after Humphrey Bogart shoots the Gestapo agent in front of his eyes, whenever energy prices spike, the hue and cry goes up to round up the speculators.
Of late, Exhibit A in case against energy speculation is based on the CFTC’s Large Trader Reports. These reports show that long “non-commercial” positions have been increasing along with prices. “Aha!” go the anti-speculators: “See, those speculators are buying, and driving up prices. If we curtail ‘excess’ speculation, we’ll get oil prices back down.”
Err, not exactly. Leaving aside the myriad deficiencies in the large trader reports–they are a very imprecise measure of actual speculative and hedging activity because there is no reliable mapping between “non-commercial” and “speculation” or “commercial” and “hedging” (commercials speculate too, you see)–there is a serious conceptual problem here. Rather than relying on some abstract, academic analysis to try to make this point, I think this problem can be illustrated best with a contrast.
Believe it or not in this age of record nominal gold prices, but in the 1990s and early-2000s, many gold market participants claimed that gold producer hedging–forward sales of gold–was depressing gold prices. Now let’s work through this. If gold hedgers were net short, since derivative contracts are in zero net supply, that means that gold speculators were net long–just like the current situation in oil. And similarly, if oil speculators are net long today, that means that oil hedgers are net short. So riddle me this: how is it possible that a short hedging imbalance caused gold prices to be too low but is causing oil prices to be too high, and how is it possible that a long speculative imbalance is causing oil prices to be too high, but caused gold prices to be too low?
In other words, if I applied the gold bug theory about low gold prices (short hedging imbalance causes prices to be too low) I would conclude that current oil prices are too low, and if I applied the current theory about high oil prices (long speculation causes prices to be too high) I would conclude that gold prices in the 90s were too high. Does this mean that for prices to make Goldilocks happy (i.e., for prices to be “just right”), net hedging is zero and net speculation is zero? Put differently, the same theory can be used to reach the exact opposite conclusions about whether prices are too high or too low; I can use the exact same data on the composition of open interest to support either conclusion depending on my political/rhetorical/economic purposes. In other words, this “theory” provides no practical guidance whatsoever as to whether prices are higher or lower than they “should be.” It is, to be blunt, pure garbage.
The contrast between the gold and oil markets illustrates the pitfalls of overinterpreting accounting identities. Speculative and hedging positions have to add up to zero, and whether one number is positive and the other negative, or vice versa, is of no use in evaluating which is driving prices.
