I’m sure Sens. Carl Levin and Dianne Feinstein think they’re enlightened types, far beyond any sort of “ugly American” mentality. But that’s exactly what they betray with their notion of closing the “London loophole.”

Says Levin, “The [Commodity Futures Trading Commission] didn’t have good information about who was trading how much US oil when, and whether traders subject to US speculation limits were circumventing them by trading in London. That’s why I and my colleagues have repeatedly introduced legislation to close the London loophole.”

The Levin-Feinstein bill would order the CFTC “to ensure that energy commodities traded on foreign exchanges using trading terminals located within the US are subject to the same speculative trading limits and reporting requirements as energy commodities traded on US exchanges,” reports the Financial Times.

Of course, not only is there a London loophole, there’s also now potentially a Dubai loophole. And in time, perhaps a St. Petersburg loophole. And if the Iranians can ever get their heads out of their posteriors, a Tehran loophole, and if Hugo Chavez can do likewise, a Caracas loophole. Soon there will be a big bold world of people outside the United States, trading in exchanges outside the United States, perhaps using currencies other than that of the United States.

And as oil prices rise all the while to $150 and $200 and even higher, Sens. Levin and Feinstein will still be fussing and fuming about transactions through U.S. terminals that will account for less and less of the world’s oil trade. What will they do then? Maybe they’ll sue the operators of the international bourses, to go along with their suits against OPEC. Yeah, that’ll bring back $2.00-a-gallon gas.

Source: The Ugly Americans

For those not familiar with the concept of limits, it basically works like this. No trader or fund is allowed to own more than a specific amount of a commodity traded on the futures exchange. This limit varies from commodity to commodity and exchange to exchange. The point is to keep one group from manipulating the price of a commodity, as the Hunts did with silver in the early 80s.

The loophole is one where large investment banks can sell a “swap” for a specific commodity like corn and then hedge their position in the futures markets. There is no limit on the amount of the commodity that can be hedged. So, a fund can accumulate sizeable positions far in excess of what they could do directly by working with an investment bank. In essence, the swap is a derivative issued by a bank which acts just like a futures trade, but it is with the bank as guarantor and not an exchange. Swaps are not regulated as such. And up until now, the banks were seen as legitimate hedgers so there were no limits on what they could buy in the futures markets.

This works for very large commodity index funds which try to mirror a particular commodity index and need to be able to buy very large positions in excess of the normal limits (and there are scores of them), and for the banks that make the commissions and profits on the swaps. Remember, the fund gets a management fee, so growing the size of the fund grows their fees.

These indexes typically have about 26 commodities, with the largest allocation to oil, but almost anything that is traded has some small portion of the allocation. As I noted last week, there are some who believe this is working to drive up the price of commodities beyond the simply supply and demand principles. Whether or not you believe this to be the case, the CFTC is looking at the loophole.

The key word in the announcement yesterday was the word “classification.” Right now the banks are classified as hedgers and as such have no limits. But they are not really hedging the actual physical commodity as a farmer or General Mills might do, but the hedge is their financial position.

If the CFTC decides to look through them to the funds, and they did use the word transparency in their announcement, they could decide to change the classification of the banks from hedgers to speculators. While I do no think that might make a difference in the long run, in the short run it could make commodities volatile in the extreme, and exert downward pressure up and down the price curve, depending on how they would decide to unwind the commodity index funds.

For what its worth, I advised my daughter to get out of the commodity fund she was in for the time being. When the regulators are in the room, anything could happen. And they are getting intense pressure from Congress to change the rules. My bet is that the train has left the station and it is but a matter of time until position limits are put in place for commodity funds, including commodity ETFs. Is that a good thing? I think not, but that matters not one whit. The hand writing is on he wall.

Does this mean I am not a long term commodity bull? No, I remain bullish on a host of commodities over the long term from a supply and demand perspective. It is just that you might want to consider whether to stand aside for a time while the congressional elephant is stampeding around the room. Maybe it is a non-event and someone figures out a way to unwind the positions slowly and over time. Maybe the grandfather the current funds at the size they are today. Who knows? As I said, when the regulators are under pressure to do something, I want to know what the new rules will be before I play in the game.

Source: Swapping out Commodities 

A desperate Democratic Senator, Claire McCaskill, warned during a Senate hearing on commodities speculators that “the American people are about to take out pitchforks” because of the cost of groceries and gasoline.

McCaskill then told an official from the U.S. Commodity Futures Trading Commission: “If you don’t do something, Congress will,” according to a report in the LA Times.

Of course, it doesn’t appear to have struck the outraged Senator to consider mere market forces such as supply and demand or, in the case of oil prices, increased demand from emerging markets and decreased supply because of bad weather or geopolitical events.

To learn more about what is pushing up the price of oil, read on at the ContrarianProfits.com peak oil primer, Peak Oil Facts: How to Survive the Coming Crisis.

“Farmers and food executives appealed fruitlessly to federal officials yesterday for regulatory steps to limit speculative buying that is helping to drive food prices higher,” according to the Washington Times.

In other words, the Commodity Futures Trading Commission is coming under pressure to “do something.”

While farmers here and abroad generally are benefiting from the high prices, even they have been burned by a tidal wave of investors and speculators pouring into the futures markets for corn, wheat, rice and other commodities and who are driving up prices in a way that makes it difficult for farmers to run their businesses.

“Something is wrong,” said National Farmers Union President Tom Buis, adding that the CFTC’s refusal to rein in speculators will force farmers and consumers to take their case to Congress.

“It may warrant congressional intervention,” he said. “The public is all too aware of the recent credit crisis on Wall Street. We don’t want a lack of oversight and regulation to lead to a similar crisis in rural America.”

In other words, if the CFTC doesn’t “do something,” Congresscritters will. And the CFTC seems disinclined to act.
Regulators said high prices are mostly the result of soaring world demand for grains combined with high fuel prices and drought-induced shortages in many countries…

“During such turbulent times, it is tempting to shoot first and ask questions later,” [CFTC Chairman Walter] Lukken said, but he contended the commission should be “cautious” about doing anything to curb speculation. He and other regulators argued that speculators add volume and liquidity to the markets, which makes them operate more efficiently and helps farmers and other players.

Left unspoken at the hearing, at least judging by this account, is the role of the falling dollar, something even middling UN bureaucrats are able to recognize. Of course, it’s an impolitic time for members of the CFTC to bring up the devaluation of the dollar, given how the people responsible for it could end up being their new masters.