I have just spent the last six of hours investigating a question:
Why did Heating Oil, Copper, and Cocoa miss the boat?
If you look at open interest for these three commodities over the last ten years, it seems fairly normal. The 50 percent increase in open interest over ten years may be a little high, but nothing out of this world.
Now look at open interest for other major commodities over the same period. It increases nearly 350 percent! Why the huge difference?
The only way to explain this strange behavior is that there must have been some big entity (a fund of some type) who somehow channeled money into most commodities (Coffee, Soybean Oil, Sugar, Cotton, Live Cattle, Lean Hogs, Corn, Wheat, Soybeans, Crude Oil, Natural Gas, etc) while at the same time counterfeiting a large number of those same futures (no way was there physical to back up a 350 percent spike in open interest). However, for some reason, this big entity forgot to include Heating Oil, Copper, and Cocoa.
Were commodity ETFs responcible? (No)
My first reaction was to check if commodities ETFs were responsible for this strange behavior in open interest. Maybe a bunch of EFTs were launced and Heating Oil, Copper, and Cocoa were underrepresented.
Below, The Mess That Greenspan Made surveys commodity funds.
A survey of commodity funds
Monday, February 11, 2008
For anyone thinking about adding some commodities to their investment portfolio in 2008, there is a growing selection from which to choose. Here are the top performers:
[Time Frame of ETF launch dates doesn't fit. Open interest spike in late 2006, so none of these ETFs could have had anything to do with it.]
Please don't ask me about that MacroMarkets Oil Down fund - I have no idea what's going on with it. It came out as number one, so it's in the top spot. Numbers two and five above, however, I like a lot.
Mutual funds, exchange traded funds, and exchange traded notes based on a commodity indexes are shown below. All of the remaining tables are ordered oldest first, newest last.
The Dow Jones AIG Commodity Index [do not invest in the AIG Commodity Index], the basis for both the Pimco PCRCX fund and the iPath DJP ETF [or any funds based on it], has been the top performing commodity index so far in 2008, though it is not clear how the Pimco fund has outperformed its index by such a wide margin. Bill Gross must be up to something.
Energy funds are shown below. Again, don't ask me about the Macromarkets products. I don't think I want to know how they work.
Note how the "early bird gets the worm" above with the Victoria Bay USO oil ETF and the streetTRACKS GLD gold ETF below.
The streetTRACKS gold ETF beat the iShares IAU gold ETF to market by only a month or so back in late-2004/early-2005, yet GLD has 11 times the net assets and more than 33 times the trading volume.
Of course in the metals, copper and silver are the stories so far in 2008. Copper?? Isn't Dr. Copper supposed to be predicting the future of the global economy? Apparently Dr. Copper doesn't read the financial papers, otherwise he (or she) would be be predicting a recession by lowering his price.
Well, actually, agricultural products are the real story so far in 2008 as shown below. All these funds are up double-digits so far except the livestock ETF. Hmmm...
Azuki beans? Yes, they are in Jim Rogers' commodity index along with both bean oil and bean meal.
If anyone knows of any other offerings, please send me mail. I think the above list is complete save for the very old Oppenheimer fund (QRAAX) that has some ridiculously high loads.
Full Disclosure: Long PCRCX, DBE, DBA, GLD, SLV
So who was responsible?
I decided to try a new approach. I googled "largest commodity funds", and this is the first entry which came up.
dity Funds- Who Are They & How To Profit From Them?
July 11, 2007 · By Lindsay · Filed Under Guest Bloggers
A Lesson From...
WHO ARE THEY?
HOW DO THESE FUNDS WORK?
Long-Only Commodity Funds (LOCF) and ETFs are the 800 pound gorilla in the room that can no longer be ignored. These funds are big, slow, and powerful. By understanding how they function an investor can profit from the inherent predictability of these funds.
Long-Only Commodity Funds invest in a variety of futures contracts, creating a basket of commodities. Energy related commodities comprise the largest percentage of the contracts held totaling 50-75% of the total portfolio. This is due to the significance of the products both domestically and globally. Energy contracts included in the "basket" are Crude oil, heating oil, and natural gas [was Heating Oil underepresented?]. Other commodities included in these funds are precious and base metals [did "base metals" not include copper?], grains, meats, sugar, and coffee [but no Cocoa?]. The largest of these Funds is the Goldman Sach's Commodities Index (GSCI) with approximately $55 Bil dollars invested [Nooo, why is the answer to "what is wrong with our financial system" ALWAYS Goldman?]. Other notable LOCFs include the Dow Jones AIG Commodity Index, the Deutsche Bank Liquid Commodity Index (DBLCI) and the Rogers Commodity Index.
To understand how these funds operate, let's look at the GSCI. This Fund holds long positions in the nearby futures contract for every commodity in it's portfolio. As expiration of the futures contracts approaches, the fund will liquidate (sell) it's entire position in the current month and establish a new position (buy) in the next active month. This action of selling the nearby futures contract and buying the next contract month is called "the Goldman Roll" and is done between the 5th and the 9th of every month. [Huh, why am I convinced that "the Goldman Roll" is directly involved in the commodity open interest spike?]
CAN THE COMMODITY BULL MARKET CONTINUE?
CAN THESE FUND HOLDERS CONTINUE TO MAKE MONEY?
In the author's opinion, these Funds are a terrible investment and you should stay away from them. Yes, commodity prices may continue their rise in the future. However, it's inevitable that prices will get too high and the weight of higher production, will force prices back down. The commodity bull market is very much like the bull market in stocks in the late 1990s. During that time, money was pouring into Mutual Funds at an unprecedented rate. This caused stock markets to move higher and higher until they greatly exceeded any reasonable fundamental valuation. The same is true for commodity prices. Investor demand rather than true supply/demand fundamentals are constantly driving prices higher. Eventually, commodity producers will dramatically increase production to profit from higher prices and prices will violently correct downward.
THE GOLDMAN SACHS COMMODITY INDEX MONTHLY CHART: AS MONEY HAS FLOODED INTO THIS INDEX, PRICES HAVE CONTINUED HIGHER [despite the inflating supply of commodity futures]. HOW LONG CAN THIS TREND CONTINUE?
A better alternative is to stick to a profitable trading program, or a Commodity Trading Advisor (CTA) that can profit from large moves but will liquidate their position in the commodity before the price crashes back down. The best alternative is to find an experienced CTA that will go short the market and profit from a price crash.
HOW TO PROFIT FROM LOCF!
When trying to profit from LOCF, it is important to know the characteristics of these funds. First, these funds make up a large percentage of the open interest in many commodity futures contracts but they rarely adjust their position sizes. ... [yep these funds were the ones to blame.]
Why is it always Goldman responcible?
Seeking Alphareports that Goldman Sold GSCI to S&P; Following 'Lucky' Coincidences.
Seeking Alphareports that Goldman Sold GSCI to S&P; Following 'Lucky' Coincidences.
Goldman Sells GSCI to S&P; Following 'Lucky' Coincidences
February 13, 2007
We've mentioned the role Goldman Sachs (GS) has played in energy prices last year.
They have been accused of manipulating GSCI (GSG) for trading gains, political advantage, etc. When Oil first dropped, I doubted there was any political manipulation until I could see a market mechanism. It turns out the GSCI was that mechanism.
Now, GS has decided to get rid of the index. From an S&P; Press Release:
Standard & Poor's will acquire the market leading Goldman Sachs Commodity Index ("GSCI") and two equity index families from the Goldman Sachs, the two companies announced today. Terms of the transaction were not disclosed.
The GSCI, created in 1991, currently includes 24 commodities and is designed to provide investors with a reliable and publicly available benchmark for investment performance in the commodity markets.
The clear commodity index leader, the GSCI has an estimated $60 billion in institutional investor funds tracking it, the majority of that coming through over-the-counter derivatives transactions.
After a brief transition period, the index will be renamed the S&P; GSCI Commodity Index. (emphasis added)
Hmmm, I wonder when the honchos over at GS decided "we no longer have a need for that index?"
I guess Goldman Sachs snaked attempts at manipulating commodity prices, indirectly the equity markets, and possibly even the mid-term elections is now past its < span style="FONT-WEIGHT: normal;font-family:'Arial','sans-serif';color:red;">"Sell-By" date. I cannot say there was much of a public relations backlash - a smallish NYTimes article, and the slings and arrows from a few outraged bloggers. But that was pretty much it.
The suspect timing of the unscheduled GSCI rebalancing last July left one to consider to possibilities: that GS is either a collective of naive dolts, or they were blatantly attempting to manipulate the outcome of the mid-term elections. The public clearly thought there was price manipulation going on [By clicking this link, I found the answer to my question]; they weren't fooled. And the appointment of their Chairman Hank Paulson to Treasury Secretary just before these changes must have been just one of those serendipitous coincidences.
The changes in the GSCI led to a subsequent sell off in the gasoline futures market. After a 5 year run in energy prices, there was a 30% drop in the price of oil after their rebalancing - and during the 2 months prior to the election. Another lucky coincidence!
Another fortuitous coincidence: GS had a blockbuster quarter following the ramp of the markets.
There were enough conflicts of interest in place that the markets -- and maybe even GS itself -- are better off with the index in the hands of a more neutral 3rd party . . .
The Big Picturereports that Friends in High Places.
The Big Picturereports that Friends in High Places.
Friends in High Places?
Life is always much more fun when there's a good conspiracy theory to kick around. When the New York Times starts kicking it around too, then it can really be enjoyable.
Such is the case with the recent plunge in the price paid for gasoline by formerly dour consumers leading up to an election where the party in power is clearly having difficulty wooing the electorate. It just so happens that the newly appointed Treasury Secretary used to run the investment bank that controls the world's most important commodity index, which seven weeks ago cut the weighting of unleaded gasoline by nearly 75 percent, causing all commodity investments based on this index to sell their unleaded gasoline futures.
For the same number of buyers, a glut of sellers means lower prices, and voila! Prices at the pump drop precipitously, consumer confidence rebounds, and the electorate develops a new spring in their step.
Or at least, that's what some would have you believe. . .
A recent poll revealed that 42 percent of the respondents thought the White House had somehow manipulated the price of gasoline so that it would decrease before this fall's elections. They were only slightly outnumbered by the 53 percent who believed there to be no trickery involved.
Still, there are a few too many events that have lined up so precisely over the last few months that it's hard not to take notice. A recent New York Times story observed the changes made to the Goldman Sachs Commodity Index back on August 9th, particularly its fortuitous timing. Heather Timmons writes:
Wholesale prices for New York Harbor unleaded gasoline, the major gasoline contract traded on the New York Mercantile Exchange, dropped 18 cents a gallon on Aug. 10, to $1.9889 a gallon, a decline of more than 8 percent, and they have dropped further since then. In New York on Friday, gasoline futures for October delivery rose 4.81 cents, or 3.2 percent, to $1.5492 a gallon. Prices have fallen 9.4 percent this year.
The August announcement by Goldman Sachs caught some traders by surprise. The firm said in early June that it planned to roll its positions in the harbor contract into another futures contract, the reformulated gasoline blendstock, which is replacing the harbor contract at the end of the year because of changes to laws about gasoline additives.
Later in June, Goldman said it had rolled a third of its gasoline holdings into the reformulated contracts but would make further announcements as to whether the remainder would be rolled over. Then in August, the bank said it would not roll over any more positions into gasoline and would redistribute the weighting into other petroleum products.
Not surprisingly, Goldman Sachs had no comment on the recent change.
Having looked at this commodity index some time ago as part of the work done for the Iacono Research website, the weightings from late June were already available in spreadsheet form. A comparison between the composition from a few months ago to the most recent data available at the GSCI page of Goldman's website shows the following changes.
[Below is the answer to my question about open interest. Next time I investigate some financial wrongdoing, I will same myself some trouble by investigating Goldman first]
[Composition of Goldman Sachs's index only has a .19% weighting for Cocoa. This explains why Cocoa's open interest remains the most normal out of all commodities.]
The Times article states that the adjustment prompted the sell-off of some $6 billion in unleaded gasoline futures contracts, some of these being replaced by Reformulated Gasoline Blendstock for Oxygen Blending ("RBOB") futures and, as shown in the chart above, the rest being distributed to other commodities. Note that there was a hefty decline in the natural gas weighting as well.
There have been many other factors at work contributing to plunging energy prices over the last two months - the calming of tensions in the Middle East, a mild hurricane season, and improving energy production around the world - but the August 9th date serves as the peak for nearly all energy products.
The plunge of unleaded gasoline prices around this time is clear in the chart below.
So, indulging some conspiratorial inklings just a bit further, a reasonable question to ask is whether there might be a relationship between falling gasoline prices and other energy prices. Were plunging gasoline prices just part of a broad energy price deline or did it serve as a catalyst?
The price of heating oil, for example is often affected by the price of crude oil, and gasoline prices can impact how much traders will pay for other commodities.
As it turns out, the end of the first week in August marks a peak for almost all energy commodities - crude oil, heating oil, gasoline, and more. But one look at the chart below and it becomes clear which energy commodity led the others down.
With the exception of a brief exchange with always-volatile natural gas shortly after August 9th, other energy prices appear to have been led down by the falling price of unleaded gasoline. It looks like a contagion in the graphic above, spread by unleaded gasoline and picked up by other energy commodities that were unable to fight off its effects.
Not until ten days before Aramanth Advisors fessed up to their bad energy bets on the weekend of September 17th and 18th did the plunge in natural gas prices surpass that of unleaded gas. Of course, owning near ten percent of all natural gas contracts just prior to that fateful weekend, the actions of Aramanth traders leading up to their confessional likely exacerbated this decline.
So, as far as conspiracy theories go, this is quite a good one. The motivation for the commodity index change and the impact on other energy prices will likely never be confirmed or corroborated, but it makes for an interesting story.
Make a little change that causes $6 billion in unleaded gasoline futures to be dumped onto the NYMEX, then watch prices tumble. Stand clear, watching for traders like Aramanth to implode, and get ready to mop up any other messes that arise during the process - all to relieve a little pain at the pump, prior to the polls opening.
Some at the White House may be patting themselves on the back figuring that the best thing they've done in years was to get Hank Paulson to take the job at Treasury. [So this was how Goldman recaptured the US treasury?]
It's good to have friends in high places.
My reaction: Again, why is it always Goldman Sach?