Streetwise Professor

April 12, 2011

Three Card Bart

Filed under: Uncategorized — The Professor @ 6:31 pm

Bart Chilton has been bolstering his case for position limits by touting a statistic that the amount of speculation in energy markets has increased by 64 percent since 2008. Several people sent me this very interesting deconstruction of Chilton’s number:

Critics say Chilton’s claim is grossly misleading for three reasons. [Emphasis added.]

First, the primary reason for the rise in futures-equivalent holdings was a collapse in natural gas prices, which fell 65% from June 2008 to January 2011 (see pie chart below on contributions to the rise in futures-equivalent index holdings).  Due to the price collapse, for a given notional value of natural gas exposure, more contracts are required now than in 2008.  But the dollar value of holdings did not rise per se.

Second, futures-equivalent does not represent open interest in futures markets, as some of the exposure index players have is netted against internal positions and therefore does not reflect open interest on futures markets.

Third, the notional value of index energy exposure, or the dollar amount on which periodic payments are calculated, shows holdings were 10% lower in January 2011 than in June 2008.  And among the energy contracts, only gasoline showed a notional increase.

Let’s break this down.  Chilton wants to exploit the recent rise in oil and gasoline prices to fuel (pun intended) his campaign for position limits.  He therefore needs to show, somehow, that speculation increased, driving the price increase.  But net long speculation in oil and refined products declined in dollar terms.  Futures equivalents increased somewhat (about 30 percent for crude).   But natural gas futures equivalents rose dramatically–186 percent–even though due to the collapse in gas prices the net dollar investment in natural gas declined 7 percent.  The dollar number doesn’t help to make his point for the crude complex.  The crude complex contract number doesn’t make a big point. So he combines contract positions for natural gas and the crude complex, and ties it to the recent rise in oil prices:

Hemingway said, if you really want to write, start with one true sentence, and from that sentence, you can form your opinion of the truth. Well, here is one true sentence: We have more speculative positions in commodities markets than we have ever had in the past—in fact, they are up 64 percent in the energy complex from June of 2008. You can draw your opinion of the truth, your own conclusions as to whether there is a cause-and-effect—looking at the price trends as these investors enter and exit markets. Read the studies, on both sides of the issue, and draw your own conclusions.

As for the tie:

I’ve said several times that I don’t think these investors are the cruise control of prices, but I do think they tap the gas pedal. I think they can have some effect on driving prices up when they are long in the markets, and I believe they can have some effect on declining prices when they exit.

Note how far Chilton has to stretch to get his headline-grabbing 64 percent number–he has to add in natural gas positions.  Yet he fails to mention that natural gas prices have fallen dramatically–65 percent!–over the period that what he portrays as a speculative splurge has occurred; doing so would completely undercut the “truth” he is trying to reveal.

It makes no sense whatsoever to lump natural gas and crude oil and refined products together.

Well, it makes no sense if you are trying to make a logical argument, and to support the argument by reference to legitimate empirical evidence.  It makes all the sense in the world if the true objective is to confuse the rubes with some sleight of hand.  Where’s the red lady?  (In the day, it was the black lady–maybe that’s not PC any more.)

As for me, I’m still waiting for that “one true sentence.”  That self-righteous reference to Hemingway only adds insult to deception.

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1 Comment »

  1. Can anyone explain something for me?

    If the underlying futures trading undertaken by commercial and physical players in the market stays the same, then any net increase in holdings must come from speculators. There’s nowhere else.

    OK so far.

    Now. A futures position needs a buyer and a seller. We’ve agreed to suppose that commercial trades didn’t rise. So the sellers weren’t commercials. So the speculative buyers must have been buying from…uh…other speculators. Speculative sellers.

    So…even if we accept for argument’s sake that speculation is bad (not that we should; but, for argument’s sake), speculators are betting against…other speculators. Right?

    Wait, maybe the sellers are in fact commercials, abruptly and imponderably doing more selling. Well, that’s no help either because the speculators are then price takers from the commercials. That sounds like they’re providing a helpful service. They’re taking price from people who know what it should be.

    But that can’t be right, because then the grain business (or whatever) would need a pool of spec liquidity to enable it to initiate and dissolve its hedge positions at will. If that existed, it would mean speculators were providing a valuable service as a risk counterparty. To the extent the speculators speculate, they’d either be doing something helpful for the industry or playing a zero sum game with each other.

    No, I give up. It’s too difficult. One day maybe I’ll be smart enough to know why speculation is bad and can only ever move prices the wrong way. Til then I’ll leave to the experts such as Bart to figure it all out for me.

    Comment by Green as Grass — April 13, 2011 @ 4:36 am

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