futures

Will new rules lead to oil and silver hoarding?

October 19, 2011: 12:33 PM ET

The Commodity Futures Trading Commission approved new limits on commodities traders. Now analysts want to know what will happen next.

FORTUNE -- Is the cure for speculation in the energy markets worse than the illness? Futures industry professionals are up in arms over a vote by regulators Tuesday to introduce position limits on hedge funds and other traders, saying it will lead to commodity hoarding and large price spikes in the futures.

The CFTC decision (the full text is here) places various limits on how much a speculative trader, like a hedge fund or ETF manager, can hold in any of 28 commodity contracts, including energy. The aim is to prevent a run-up like June 2008 when oil hit $140 a barrel which ultimately introduced $4 a gallon gasoline at the pumps. The problem is, according to futures analysts, if speculators aren't allowed to buy the futures, they'll buy the physical commodity instead.

"Eventually you're going to see a shortage, I think it's going to create a disruption in the marketplace. We might get away with it for some time, but if there's a crisis like 2008 you'll see one," Phil Flynn, the energy analyst at PFG Best, a Chicago brokerage, told me this morning (he also lets loose on his morning market commentary). Similarly, if less ominously, CME Group (CME) chairman Terry Duffy told CNBC yesterday ahead of the CFTC vote that passage would "encourage manipulation" of the markets.

Why would they do so? In a financial crisis, large traders will often want to buy futures as a hedge against the dollar plunging or the euro falling apart. Being unable to buy as much as they can on the futures market will just shift them to physicals, exacerbating a crisis and even keeping a lid on contrarian bets that would push prices lower. Hoarding physical oil isn't unheard of: a hedge fund or brokerage big enough has the resources to buy actual oil and sit on it. The infamous Marc Rich was known to do so during the commodities crisis of the late 1970s and early 1980s, and I've heard rumors of large, brand-name Wall Street brokers doing so in more recent years, buying not only oil but the cargo ships that carry oil.

So are we doomed for a superspike of oil prices and $5 a gallon gas if say, Greece sparks a debt market contagion? Maybe not. After all, Wall Street tends not to like any regulation and likes to be dramatic about it. Plus, hoarding hasn't worked out all that well for those who tried it of late, like Anthony "Chocfinger" Ward who appears to have lost a massive 2010 bet on cocoa prices.

But it may be telling that CFTC board member Michael Dunn called the regulations a "sideshow" and that no one has even proved excessive speculation in the future market "even exists." Still, Dunn voted in favor of the measure, saying Congress mandated it.

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