It is perceived wisdom now that the activity of investors in the commodity market during recent years may have inflated prices, particularly oil, via the inflow of significant investment capital to indexed based long-only commodity funds and ETFs.
Essentially, if the premise is correct, the investment funds swamped physical supply/demand fundamentals pushing up prices, above some undefined ‘appropriate’ level. The view expressed being that commodity markets were under invested and higher prices would result; in fact that higher prices would be required if future supply is to meet potential demand requirements. In truth nobody really knows and that is the nature of risk.
Why this investment activity, often described derogatively in terms of speculation, is considered different to investment flows in to other markets may not be entirely clear; surely investors have as much right to put their money in commodities as equities. Some might say it is no coincidence that most non-professional players in other markets are happy to see higher prices as it benefits the economy and their pensions. Does this make the ‘positive’ benefit of investor speculation in the non-commodity markets more acceptable, whereas increases in commodity prices come straight out of our pockets? The answer should be no, as should any action that unduly influences the price down as well; short sellers should not be vilified for this either as they are really only the messenger expressing nervousness of over valuation.
Interestingly, few commentators have uttered any scepticism about last week’s reasonably significant (>6.5%) drop in the entire oil forward curve. However, one of the strongest rumours in the market is that it was due to the action of a large player, in fact a nameless FED15 bank, who was unwinding a sizeable portion of a long oil position. The talk amongst the trading community is that the bank’s compliance department was concerned about the impending increase in regulatory reporting and a potential knock-on impact on capital requirements.
Currently the market consensus is that fundamentals in the oil market are reasonably supportive. Without any exogenous factors the trend could be back on the ‘up’, though one of the main risks to sharp downside is the uncertainty whether more of the FED15, particularly the larger commodity players, will also feel it necessary to unload their investment in long index strategies and ETFs.
Is this undue influence or an unintended consequence of the regulators’ involvement in the commodity market?