Commodities Speculation

Contributed by: Ishwar Chidambaram, CFA

Wall Street banks are back to doing what they do best- hitting Main Street right where it hurts- in the pocketbook. Right from Aluminium and Copper to Oil, Wheat and Gold, rampant price speculation by the big banks has fueled shortages of essential commodities across the globe, affecting millions of people who are reduced to subsistence living below the poverty line. A US Senate report released in 2014 accused major banks like Goldman Sachs, JP Morgan and Morgan Stanley of “being so powerful they were able to influence prices, gain trading advantages and put the broader financial system at risk by entering volatile businesses such as uranium trading and coal production”.

According to the Wall Street Journal, the big banks “built up voluminous inventories of aluminum, copper and other commodities,” which the Senate report found “often exceeded regulatory limits on the size of commodity holdings”. The Senate report cited the example of Morgan Stanley which held 55 million barrels of oil storage capacity, equivalent to nearly 3 days worth of US energy consumption. The report red flagged Goldman Sachs for hoarding 1.5 million metric tonnes of Aluminium, creating shortages in the supply by stockpiling the metal in its Detroit warehouses. The same report pulled up Morgan Stanley for its speculation in jet fuel and JP Morgan for its buying spree of power plants and gaming the electricity markets in California.

The root cause of the problem can be directly traced to the 1999 deregulation of futures markets by the Commodity Futures Trading Commission, as well as the 2003 decision by the Greenspan-led Federal Reserve to allow investment banks to own physical commodities. This enabled bankers to take sizable positions in commodities indexes like the Goldman Sachs Commodities Index (GSCI). This trend actually caught fire post the financial crisis of 2008, when commodities suddenly acquired global recognition as the last safe haven for investments. More than $300 MM entered the commodity markets chasing long only investments like the GSCI, triggering runaway food price inflation.

Any long term solution to these problems must involve a return to greater regulation of the Wall Street banks. The 1999 CFTC decision and the 2003 Greenspan Fed decisions on deregulation must be reversed, if necessary by direct action of the US Senate. This will not be easy, especially in an election year, as Wall Street is a major contributor to the election campaigns of both mainstream parties. However short-term populism and politics of appeasement must never be allowed to predominate over the long term interest of Main Street. Wall Street banks for their part must accept any such increase in regulation as for the greater good. The CFTC must be given greater powers to crackdown on price gouging by the banks.

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