A new report from Michael Masters, scourge of the commodity index speculators, provides some startling numbers that, on their face, suggest strongly that the recent rise and subsequent fall of oil prices was not just a reflection of supply and demand.
- From January to May, institutional investors "poured more than $60 billion into the major commodity indices." The price of West Texas Intermediate (WTI) crude oil rose $33 per barrel during that time span.
- Starting on July 15, the same investors "began a mass stampede for the exits of the S&P Goldman Sachs Commodity Index." They pulled out about $39 billion. The price of WTI fell $29 per barrel.
Ipso facto, speculation was the main driver in the run-up, not supply-and-demand.
When index speculators pour large amounts of money into the commodities markets and buy large amounts of futures contracts, prices go up. When they pull large amounts of money out and sell large amounts of futures contracts, prices go down. These large financial players have become the primary source of the recent dramatic and damaging volatility seen in oil prices.
The report is titled "The Accidental Hunt Brothers" -- a reference to the infamous attempt by Nelson and William Hunt to corner the silver market in the late 1970s. You can find it at the Accidental Hunt Brothers blog, set up by Masters and his co-author, Adam White, as "a blog dedicated to the topic of discussing index speculation."
Masters has a horse in this race -- he manages a hedge fund heavily invested in the airline industry, which has been absolutely pounded by oil prices this year. That's one reason to take with a grain of salt his contention that the speculators only changed their tune and started unloading their positions when Congress began to talk tough on cracking down on speculation. But there's another obvious explanation. Speculators started selling when their perception of what was going on in the marketplace changed. Prices rose because traders looked at the trend lines of demand in places like China and India and Brazil, compared them to the essentially flat growth in supply, and figured that prices would have to go up even higher in the future.
Prices began to drop once it began to be clear that the cost of oil had risen so high that demand was collapsing. That changed the narrative, at least for the short term. Congressional blustering may have played some role, but the global economy is also in a very different place than it was at the beginning of this year. Countries are heading toward recession, growth rates, particularly in India, are falling off dramatically, and everyone, everywhere, is looking for ways to conserve.
There is a bit of a chicken-and-egg problem here -- would global economic growth rates have started slowing down if speculators hadn't pushed the price of oil so high? Untangling the cause-and-effect there gets tricky, and would involve figuring out how much of the worldwide slowdown is the fault of the credit crunch and how much is directly attributable to commodity prices. I predict that many books will be written exploring this question and we'll still be arguing about it a hundred years from now.
However, there was one data point I missed when Masters first presented his index speculator thesis in congressional testimony earlier this year. When institutional investors pour their money into commodity indexes, they aren't just picking and choosing which commodities they buy -- they are getting a piece of 25 different commodities in one big basket. So if the point comes when they decide they've got to get out of, say, oil, they've got to get out of everything. Masters points out in his report that once the price of oil started dropping, so too did the price of 22 out of the other 24 commodities in the index.
Perhaps that too could be explained by a slowing global economy -- but it's still interesting.