Did the government force down oil prices?
Posted
Sep 22 2008, 04:05 AM
by
Anthony Mirhaydari
Rating:
The United States government successfully popped the commodities bubble and brought down oil prices just in time for the election season, according to the latest rumor spreading around Wall Street trading desks.
Market strategist Donald Coxe from Canada's BMO Capital Markets discussed this idea in a note to clients last week. In his words, Ben Bernanke and Hank Paulson, trapped between commodity-fueled inflation and a tumbling financial sector, took "the pressure off the heavily-levered banks by putting pressure on the heavily-levered speculators and hedge funds that were short the banks and the dollar, and long the commodities."
They accomplished this in July by announcing the U.S. Treasury would extend Fannie Mae and Freddie Mac a line of credit while holding open the possibility of equity purchases -- moving the government's implicit guarantee of the GSE freak shows firmly into the explicit column. Coxe dubs it the July 13th Commodity Massacre.
By releasing the news over the weekend, when Asian markets were opening and liquidity was limited, the impact on both trader psychology and price were maximized. Moreover, the announcement was accompanied by a crackdown on short selling of financial stocks and "false rumors" by the SEC, as well as a reclassification of commodity traders by the CTFC.
The high flying hedge funds had flown straight into the G-Man's trap.
The mechanism for action was to force those sinister speculators to rapidly unwind their profitable and massively leveraged short-financials / long-commodities positions -- inflicting as much pain and panic as possible. This would accomplish two important things: 1) Mainly due to lower crude oil prices and a stronger dollar, inflation rates would ease and better represent the decaying global economy while alleviating pressure on the embattled consumer; 2) It would provide a nice boost to the malcontented financial sector desperately trying to raise new capital and offset mounting losses.
While many still debate the degree to which speculators affected commodity prices -- with our own MSN Money blogger Andrew Horowitz chiming in -- Coxe notes that price movements over the summer were a "large deviation from the six-year pattern in the commodity bull market in which professionals and industrial participants had generally been the dominant forces." Since hedge funds can't store crude oil, they bought long-dated futures contracts instead, which drove the future price of oil higher -- a condition called contango.
In comparison, backwardation (when near-month or cash prices are trading at higher levels than long-dated futures contracts) occurs in a normal market as producers sell futures to lock in a price for oil or grain yet to be pumped or harvested. In other words, the hedgers normally outnumber the speculators.
Citigroup equity strategist Tobia Levkovich begs to differ, and thinks the idea of sinister plots in Washington D.C. "might be useful for investment counselors that need a convenient excuse." He notes that commodity prices tend to follow corporate credit availability on a nine-month lag. By this measure, and considering the hedge fund redemptions and associated deleveraging taking place, commodities will likely underperform through mid-2009.
(Disclosure: I don’t control a position in any of the companies mentioned)
Related reading:
Top consumer stocks for cheaper oil
Sky-high Oil: We have been ripped off
Rise in Oil was caused by Manipulative Speculation
Crude will rise again, soon
