For the last several years, the trading behavior of the commodity market conforms to a carefully manipulated market with large capital pools overwhelming the natural market. The reason I say this is that volatility has been absorbed. Also the price movements that took place fits that of a well organized exploitation of leverage through the creation of a secret corner.
It was operated primarily on the copper market and then spun out to exploit most of the other traded commodities. Even the natural laggards were mopped up and brought into play.
Here is how it works. You prepare the target market by getting control of some part of the supply so that you have at least that much ability to manage supply. One shipload on anything will create a scramble in the market to replace shortfalls.
Then you buy as many open contracts in the market as possible to draw down the trading inventory. The cash needed is around ten cents on the dollar of commodity. In the case of copper that would have been about ten cents per pound of copper. Once the entire known inventory is ordered, you jam the price up to a double. In the case of copper this is $2.00 per pound. Your holdings are now sitting on a one dollar profit which allows you to buy additional contracts using twenty cents worth of this newly acquired equity. You should be able to expand your holdings at least five fold. Most importantly, you are been supplied by mostly short sellers at this level who know this price is not sustainable in the real world. At this point, your only exposure is the initial equity.
However, you have access to State capital that is huge. You let the markets sort themselves out for a while and you encourage as much short selling as you can. This part is a lot of fun except it is a good way to go to jail if you are participating in a regulated market.
Once the short side hook is properly set, you spring the trap and jam the market through $4.00 per pound and you protect that market for as long as you can. In copper’s case this went on for at least two years. What happens is the short side of the market is also operating on ten percent margin and they must put up massive amounts of money. You are putting up huge money, but your huge profits make it far less onerous. Over two years, most short positions will collapse and be closed out releasing huge amounts of money back to the operator of the corner.
The surplus margin created allows you to conduct the same operation on the other available markets and lulling the bankers back to sleep because of the apparent diversification.
The commodity cornering operation produced massive cash while strangely enough having a modest impact on the respective demand for the product. A lot of this is because most commodities are on long term contracts and are hedged to begin with so losses take a long time to materialize. More importantly, metal content has been progressively minimized in all manufacturing over the past thirty years in exchange for organics. Thus the economic impact of all this was acceptable to the economy. Our economy can pay more for all this.
Of course the surplus margin helped set of runs in other commodities such as grains were a real long term corner is impractical.
In order to execute such a program it is necessary to have an army of minions who take your trading instructions and are able to operate throughout the globe accessing banks and trading facilities everywhere. There can be no possibility of disloyalty.
It is my conjecture that this was put in place and reached maximum control of cash and credit in the spring of 2008. This obviously makes it the greatest commodity corner in history and just as obviously illegal as hell.
Since they promoted such a huge amount of credit to start with, it is a good bet that they were substantial buyers of high yielding securities that can be carried on even five percent margin. At least that is what AAA used to mean. In other words they could have their cake and eat it while believing that their money was both secure and earning huge returns. Someone has a trillion dollars of former AAA paper somewhere and the global collapse got to someone somewhere. It cannot be all in offshore insurance schemes that are all lying to us.
I think though that hubris, or the need for another major lift, finally led them to take on the oil market. They were strong enough to do it so long as their calculation on demand was correct. Oil had to be sustainable at $200 per barrel or four times base as was copper and all other commodities. If buying collapsed then they were on their own and they would inevitably be overwhelmed.
Quite simply, they made their move and as the price made its way through $125 per barrel, it is a certainty that every end buyer diverted their product into the market to grab the cash. Their worst case was a spell of shortages and rationing. Best case, they would get to replenish at much cheaper prices. It is an industry that must have huge amounts in the pipeline at all times and short term diversion is much more feasible than it initially appears.
And then it all rolled over. The last of the displaced oil was liquidated in the $30 to $50 range and recent price recovery tells us that the last of the distortion is now fully resolved. Apportioning the losses is probably another matter. A lot of the cash likely was placed in illiquid securities that cannot be presently recovered, which means that the institutions cannot release funds.
There have been other great commodity corners in financial history and we always see the same pattern at work. When they break, all participants are wreaked.
If we then ask the further question of who could have orchestrated such a maneuver, we have only one possible prospect on the globe. The KGB has access to the oil production, financial reserves and far more importantly, they command the loyal operatives who can be printed as almost instant Billionaires and sent out into the world to await trading instructions. Without a large group of such minions it would be impossible to access foreign credit and trading capacity.
Of course, there is no evidence at all that this is what happened. It is merely a conjecture. It is also a great conspiracy theory that everyone can play with.
Russia was a major beneficiary of the run up in oil prices and a modest bit of prudence would have them in a strong financial position for a long time. So why are we hearing stories that they are in trouble? Did they really blow it? Did they really imbibe of the Koolaid? Why is it that they suddenly have deep pockets and short arms?
Posted July 8, 2008 03:40 PM (EST)
OPEC, speculation in commodities market, hedge funds, the falling dollar, peak oil theorists, all play a part in the current run up in oil prices. Yet one of the major players has escaped both scrutiny and careful analysis. Consider two items that were news this past month:
- Russia's new president Dimitri A. Medvedev, speaking to a group of foreign journalists made clear his and Russia's posture that the " United States is in no shape to give advice". He then went on to categorically declare that America is "essentially in a depression."
- A few weeks before Alexei Miller, chief executive officer of Gazprom made an eye opening forecast. Mr. Miller predicted on June 10th that oil prices would rise to $250 a barrel in the near future. Gazprom is Russia's largest company. It controls 16 percent of the world's gas reserves and 116 billion in oil and oil equivalent ranking it only behind Saudi Arabia and Iran as the world largest holder of oil reserves.
Now why would the head of Russia's largest and most prestigious company put his reputation and his company's reputation on the line by making such a seemingly rash prediction. Certainly predictions of ever higher prices serve the interests of oil producers but usually they are left to friendly analysts in the field. Could it be that Mr. Miller is absolutely sanguine about the issue, knowing the price game is cooked.
And President Medvedev making comments about an America in depression whose advice is no longer welcome by an ascendant Russia, itself having become the largest energy exporter in the world, stoking an economy that is now the fastest growing by far among the G-8. This, by a nation that still views America with grave suspicion as succinctly expressed only recently in an interview (May 30, Paris "le Monde") with Vladamir Putin the former President of Russia and KGB colonel and Medvedev's sponsor and mentor, as a "frightening monster".
For Russia this moment verges on the triumphal. A nation ascendant in benefiting handsomely from the fortuitous rise of energy prices. An America sinking into recession if not depression, the cost of energy, especially oil, strangling its economy and in turn its influence on the world stage. The shifts in world order are so profound, so unexpected one needs wonder whether the word fortuitous is appropriate relating to the price of oil. In essence the price of oil has done for Russia what the cold war Kremlin was unable to achieve given all its missiles, tanks and mind numbing divisions of men and armor. Could it be that the Russians through Russia's vast $500 billion in foreign currency reserves, or Gazprom itself, or perhaps even the KGB ,or any combination or variation thereof is gaming the oil futures market to Russia's great advantage and to America's and all oil importing nation's great detriment given the vast expenditures in armaments it would have taken to achieve an analogous result. Gaming the oil futures market would be chicken feed by comparison to the armaments cost needed to achieve the same relative status.
Unconvinced it could/does happen? Let me cite some examples and commentary. In a post here in entitled
In another post ("Oil at $111 a Barrel: We Are Being Sovereignly Screwed!", 3.17.08),The Sovereign Wealth Funds of the UAE, Kuwait, Qatar,Libyia, Algeria and of course Saudi Arabia were cited as having enormous wealth tied up in their sovereign funds with the means and certainly the incentive to game the futures markets of virtual paper barrels on commodities exchanges to support the price of wet barrels being produced in their home market. The Brazilian Sovereign Wealth Fund was cited because it has openly declared it will use its Sovereign Wealth Fund to support an ideal valuation of its currency the "real," given Brazil's export oriented economy. Here, clearly and candidly is a wealth fund declaring that its currency holdings would be used to pursue a policy in its specific national interest. This in glaring contrast to other wealth funds who are submerged in murky opaqueness without the slightest inclination toward transparency.
Are the Russians gaming the futures markets for oil? They are not innocents nor incompetent. When it comes to using elbows powered by their resources they will do what is necessary. Ask the Ukranians, ask the Europeans. Gaming the futures markets on the London or Singapore commodity exchanges or through electronic trading (please remember the markets offshore have a direct immediate impact on other markets throughout the world) would be a simple matter for the Russians as long as no one catches them out. Here one needs to remember that the Russian leadership is formed by KGB veterans.
What can be done? Given the evolution of pricing on our commodity exchanges and the paucity of oversight by our CFTC this is a job well beyond the CFTC's capabilities. It is Congress that must act. This administration, so in the thrall of the oil industry, whose modus operandi on matters of manipulation of oil prices is to do little or nothing whether it is confronting OPEC or putting teeth into the CFTC. It is Congress, in the interests of national security and rational markets, that must insist we engage the resources of the CIA to put a clear and bright light on this issue. Anything less would be a dereliction of responsibility.
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