Monday, June 30, 2008

Oil Speculation

I like the idea of testing the speculative element in oil futures markets by requiring everyone to go all the way to liquidation, instead of just rolling their futures contracts. I didn't realize that it had ever been implemented, so this story about the silver market is interesting.
In one instance, however, the speculation premium was "successfully" tested - in the silver markets in 1980 when the Hunt brothers attempted to corner the market. As silver approached $50 an ounce in January 1980, the commercial participants asked for relief from the enormous margin calls from ever-rising prices. The CFTC and the Comex (the predecessor to the Nymex) responded effectively by imposing "liquidation-only" trading -- traders were allowed only to close existing positions and not permitted to initiate new positions.

This forced purely speculative positions to be closed rapidly, as they could no longer be "rolled" into future months at expiration. This caused the price of silver to drop by $12 the day after it was imposed, a decrease of over 20%! Over the course of the next three months, as contract months expired, the price dropped over 50%.

While I do not advocate such a move,...I believe that in an election year this will inevitably be suggested and implemented. The effects would be astonishing and immediate. Energy funds would be buried, and commodity-biased portfolios hurt badly...

One thing is for sure: A "liquidation-only" market would settle finally and for all time the argument about speculation premium in the oil markets

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