spec, mkts, and oil pricing: new study from the St Louis Fed

[k1f]

This from Jesse's Le Cafe Americain: <<http://jessescrossroadscafe.blogspot.com/


<<19 APRIL 2012

A Study On Speculation in the OIl Market For Those Economists Who Have Apparently Not Seen It


Here is a study from the St. Louis Fed on Speculation in the Oil Market that indicates that speculation contributed about fifteen percent to the increase in prices in the oil market during a recent price increase.

Anyone who trades these markets and follows the real economy does not require such a study to tell them what is plainly visible to their own eyes.

The markets have become deregulated to the point where hot money from big hands can push prices around at will, especially using large positional advantage and High Frequency Trading.

Granted, the larger markets cannot be moved for long against the primary trend, and the trend in oil has been higher for any number of reasons. But traders feed on volatility, both up and down. And they introduce faux inefficiencies to take profits for themselves, adding no value, as a tax on the real economy.

In the smaller commodity markets the scams can go on for longer periods of time creating more substantial damage to fundamentals of the related industry. I would love to show you the CFTC report on the effect of absurdly large positions in the silver market, but it has been sitting on that report for four years.

We have to ask ourselves, what are markets for? Are they fulfilling that function honestly and efficiently? What is the benefit of speculation and what are its limits?

Even Bernanke has seen the effects of speculation in the markets, and this from a man who ordinarily could not find a bubble with both hands.

It is harder to get an answer to this now, because like some periods in history prior to this, the markets and the public are awash in hot money looking for an easy path to enormous returns as quickly as is possible. And that money flows through the avenues of Washington and Wall Street, and the media, and the universities and think tanks, distorting perception and public policy discussions.

And that is the danger of speculative excess, against which we have been warned time and time again.

Now the Fed will likely point to ETFs and blame investors who flocked to commodities to protect themselves from money printing. But that is only part of the story.

If you want to know who is benefiting from this, follow the profits. Look at the big trading desks who are gaming the system, and not at the small fry trying to find some investment haven in the storm of paper games. And the reason they are so desperate is because of the reckless and irresponsible actions of the government in allowing the overturn of Glass-Steagall and the unbelievable growth in the unregulated derivatives market which even now poses a clear and present danger to the financial system.

And if you want to know who is to blame for that, skip the study, and go ask Brooksley Born.

"The increase in [oil] prices has not been driven by supply and demand." — Lord Browne, Group Chief Executive of British Petroleum (2006)

"[...] The sharp increases and extreme volatility of oil prices have led observers to suggest that some part of the rise in prices re‡ects a speculative component arising from the activities of traders in the oil markets. " — Ben S. Bernanke (2004)


The run-up in oil prices since 2004 coincided with growing investment in commodity markets and increased price comovement among different commodities. We assess whether speculation in the oil market played a key role in driving this salient empirical pattern.

We identify oil shocks from a large dataset using a factor-augmented autoregressive (FAVAR) model. This method is motivated by the fact that the small scale VARs are not infomationally sufficient to identify the
shocks.

The main results are as follows:

i) While global demand shocks account for the largest share of oil price ‡uctuations, speculative shocks are the second most important driver.

(ii) The comovement between oil prices and the prices of other commodities is explained by global demand and speculative shocks.

(iii) The increase in oil prices over the last decade is mainly
driven by the strength of global demand. However, speculation played a signi…cant role in the oil price increase between 2004 and 2008 and its subsequent collapse.

Our results support the view that the financialization process of commodity markets explains part of the recent increase in oil prices.

Speculation in the Oil Market - St. Louis Federal Reserve

[dan_s]

No doubt that "speculators" create some big swings in crude oil prices but 15% seems way too high for me. Washington loves to find someone to blame for their short-comings.

The Iranian problem and all the unrest in North African and the Middle East keeps a geopolitical risk premium on crude oil and it should.

[setliff]

speculation = free market

ye pays your money and makes your choice.