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Thread: tongue in cheek commentary on commodity prices ....

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    Default tongue in cheek commentary on commodity prices ....

    ... which tries to make the point that a financial derivative contract for future oil / gas / gold / whatever is (temporarily) being treated as if it were the real thing !

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    Default Re: tongue in cheek commentary on commodity prices ....

    I know it's being sarcastic...

    but I'm failing to see the connection. The entire argument looks like swiss cheese. The fall in the price of oil is observed over a 6 month period but the demand statistics are in decade units! That doesn't prove jack.

    The more likely explanation for the current scenario:

    9-12 months ago:

    instability over supply.
    No impending resolution to war in Iraq.
    Possible escalation of conflict with Korea (remember war uses large amounts of oil)
    Forward price of oil goes up
    Spot price of oil should equal forward price less carrying cost
    Intuitive argument - if we fear oil is gonna get expensive, we better buy more of it now and horde (carry it)
    So the current price of oil adjusts upwards (as at 9-12 months ago)

    0-6 months ago

    situation stablizes for the short-medium term
    forward price of the commodity drops
    so people stop buying oil in advance and hoarding it so short run supply falls and price falls as observed

    if speculators had been taking long positions on oil, many now exit their positions causing more downward pressure. You could say that the price of oil "overshot" due to fear, momentum and speculation. Markets have a tendency to overshoot and correct themselves (like shares)

    And what about the increase in futures contracts? Well, conservative risk averse company sees relatively low forward oil prices and wants to "lock it in" while they can. Could be punters, people like you who think the low price of oil is unsustainable even in the relatively short run

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    Default Re: tongue in cheek commentary on commodity prices ....

    but in reality, the single largest event which took place in the oil markets over the past few months did not involve one barrel of actual oil ... it involved the hedge fund Amaranth being cornered by a fall in oil prices (arguably due to rising oil inventories in the Northeast US stemming from a mild early winter) and being forced to sell 'long position' oil futures / derivatives contracts at a loss with resulting bankruptcy.

    My take on the author's tongue in cheek point is that, in the past couple of years at least, there has been a huge 'disconnect' between the amount of the real live commodity that is available and the amount of the commodity that people (thus market prices) THINK is available. The difference of course stems from the writing of 'naked' options contracts that are not actually backed up by ownership of the commodity, as well as from the writing of more complex derivatives contracts whose notional values are proportional to a commodity price but which have no direct connection to a supply of commodity. Thus while these contracts do move commodity market prices, they arguably do so based on false assumptions i.e. that the counterparty on the 'short' side of the trade can actually cover his 'short' position !

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    Default Re: tongue in cheek commentary on commodity prices ....

    I love your input.

    I don't think a futures contract is created upon a false assumption that the short side can actually cover... because such contracts are 99% cash settled and there's no physical delivery.

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    Default Re: tongue in cheek commentary on commodity prices ....

    ^^^ yes I understand that this is what USUALLY happens, however ...

    (snip)"The irrepressible Ted Butler sees things in stronger terms, likening the silver situation to that with nickel.

    Writing on Silverseek.com, Butler first analyzes the LME’s action of last week by saying that “the heart of this matter … is that the LME just declared that its nickel contract has gone into default. While [the LME] states that the action by the exchange is designed to prevent default, the action taken is nothing but a declaration of default, rendering his statement as absurd. Default is a simple word. Any time you unilaterally violate or negate the terms and conditions of any legal contract, that contract is in default. Period.”

    Butler is outraged at what has transpired: “What the LME has done in nickel is relieve the shorts of having to round up actual metal to deliver against their contractual promise to deliver, and unilaterally transferred the obligation to the longs, the industrial user. These industrial consumer longs (and other longs) entered into their nickel contracts voluntarily and legally, with the option of taking delivery. Now they are told, with no warning, they can’t take delivery and must secure metal elsewhere. The shorts don’t have to scramble for material they promised to deliver, the longs have to scramble for material they were legally promised to receive. Nothing could be more unfair.”

    The ultimate downside is that “the abrogation of the shorts’ delivery obligation is not the end of problem, even though it may lead to the end of the LME itself. That is because legitimate long contract holders, particularly industrial consumers, have been left in a lurch by the deferral of delivery of actual metal,” thereby undermining the legitimacy of the entire contract system.

    Butler then makes the connection with silver, saying it “is also the same thing with the short-side manipulation in COMEX silver. It is a coincidence that this LME nickel disaster has occurred precisely at the same time others and I have been alleging a manipulation in COMEX silver. However, nothing could prove our case more clearly …

    “I think there may still be time for the US regulators to act in silver and avoid a COMEX silver delivery default. But I also have my doubts. That’s because the CFTC and NYMEX/COMEX officials have been dragging their feet on the issue of the concentrated short position. Instead of promptly responding to allegations of manipulation and a looming delivery default, the regulators are stalling. Stalling didn’t benefit the regulators in LME nickel. It only made matters much worse.”(snip)

    from

    In other words, had not the LME and arguably the COMEX 'changed the rules after the game was started', major financial explosions of those entities holding short paper positions that they could not settle by delivering the actual commodity per the terms of their 'derivatives' contracts would have happened overnight.

    Put another way, the LME and arguably the COMEX 'changing the rules after the game was started' was a deliberate market intervention that preserved profits for holders of short paper positions, which also left long paper holders scrambling to obtain the metals they had contracted for on the spot market at whatever asking price (assuming that sufficient metal could be found at all).

    The whole 'derivatives' market was shaken by this blatant effort by the LME to 'f#$k the counterparty' in order to prevent the short speculators from going bankrupt ... but in the grand scheme of things the LME traded instant bankruptcy of the shorts for slow-motion bankruptcy of the longs ! Because of the aftermath of the LME's action, and arguably the huge public backlash which would have resulted from a COMEX oil price manipulation versus an LME/COMEX nickel price manipulation (after all most people don't fill their tanks with nickel three times a week), Amaranth was not so fortunate in terms of their oil futures contracts.

    This of course brings us back to the original tongue in cheek conclusion that, in terms of market prices of commodities, there really isn't any difference today between mining an extra ton/barrel of gold/silver/nickel/oil versus short selling of option paper promising to deliver an extra ton/barrel of gold/silver/nickel/oil that doesn't really exist at some future date. Fiat Commodities ?

    ~
    Last edited by Melonie; 02-03-2007 at 10:56 AM.

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    Default Re: tongue in cheek commentary on commodity prices ....

    Interesting. I don't know anytihng about commodities trading. I thought it was just a matter of buying making a contract to buy nickel at $20, and in a years time if the long holder has to buy the nickel off the market for $30 they get $10 back from the short speculator.

    Are you saying nickel can't be bought off the market for the spot market price? Or there just *is* no market for actual nickel?

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    Default Re: tongue in cheek commentary on commodity prices ....

    what I'm saying is that, at the time of the LME incident, hedge funds and speculators had managed to run down the market price of nickel by 'naked' selling of nickel futures contracts that they didn't have the real nickel commodity to back. When those futures contracts expired, such that the hedge funds and speculators were forced to go to the spot market and buy nickel to meet there futures contract delivery obligations, it quickly became apparent that there wasn't enough real nickel available to meet those contract delivery obligations at any price. Spot market buying to cover contract delivery obligations began to send the spot market price of nickel to the stratosphere ... a classic 'short squeeze' ... which was also creating huge losses for the hedge funds and speculators now being forced to pay stratospheric spot market prices far in excess of the sale price of their futures contracts. At this point the LME 'changed the rules after the game was started' and allowed the hedge funds and speculators to pay cash interest payments in lieu of fulfilling their (defaulted) futures contract obligations. Of course this didn't help the longs and industrials who were at the receiving end, as they were now forced to pay stratospheric spot market prices for the nickel needed in their production processes despite the fact that they had previously contracted with the hedge funds and speculators for nickel delivery at the price set in the futures contracts that they had previously purchased. Arguably, if the trading of nickel futures were linked to actual quantities of nickel available (i.e. real world supply and demand relationship), the spot market price of nickel in previous months would have been much higher than it actually was, thus defaults on nickel futures contracts would have ultimately been avoidable. Of course, hedge fund and speculator profits on the buying and selling of nickel futures contracts would have arguably been greatly reduced as well !

    The point is the same ... that the hedge funds and speculators were able to manipulate the market price of nickel via the buying and selling of nickel 'derivatives' contracts that were totally disconnected from the actual amount of nickel being mined, bought and sold. The difference is that they got 'caught at it' and would have been headed for bankruptcy if the LME had not taken action to 'legalize' their 'derivatives' contract defaults. The hedge funds and speculators were allowed to write futures contracts on more nickel than actually existed, and when called upon to physically deliver even a fraction of the amount of nickel they had contracted for, they were 'caught short'.

    Arguably, the exact same thing takes place in regard to other commodities, stock shares etc. but the hedge funds and speculators involved haven't been 'caught at it' yet. But this may change ... see the new thread on the OverStock.com lawsuit just filed. Like the LME nickel case of 'derivatives' being traded based on quantities of nickel that didn't physically exist, OverStock is suing over the (naked short) selling of more OSTK shares than actually existed by hedge funds and speculators for the same purpose of artificially depressing the price of it's stock shares, thus allowing the hedge funds and speculators to garner handsome profits on naked stock option contract sales !

    Fiat Commodities - hedge funds traded 'counterfeit' contracts not actually backed by nickel

    Fiat Stock Shares - hedge funds traded 'counterfeit' stock shares that didn't actually exist


    ~
    Last edited by Melonie; 02-04-2007 at 08:52 AM.

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