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By Staff | Feb 16, 2009

Speculation in markets to some observers equates to manipulation, typically providing them with a convenient scapegoat to blame when markets go somewhere they don’t want them to go.

Some also see public-traded markets as parochial territory that should be limited to participants in those physical markets, excluding investors, i.e. funds.

They would eliminate speculation and its perceived linked partner, manipulation. The unintended consequence is that such limits would depress investment interest, restraining market dynamics and liquidity to non-functional levels, but those facts appear irrelevant to them.

Many suggestions for adding more regulation to public traded markets, in my opinion, are designed to be more manipulative than the manipulation that they are intended to solve.

One such suggestion made by R-Calf USA was a prohibition against speculative short selling. They, of course, are focused on the cattle market, but the principal would be universally applied. They believe that only those that own the physical commodity or have bought futures contracts should be allowed to sell.

I don’t know if they intend to seek the same limits on buyers. The concept of the futures market is to allow producers to establish a value of their product by selling futures contracts to provide the economic basis for them to justify producing the commodity.

In terms of the chicken or egg, the market comes first. Packers are legitimate hedgers. R-Calf USA wants to ensure that the live cattle futures market is heavily dominated by physical hedgers.

In doing so, however, the regulation they suggest would suffocate price discovery and market functionality.

It takes two to tango and several to make a market. Without the speculator to take the opposing position of the hedger, no futures trade will exist. The concept of all trade being conducted between hedgers is non functional. The speculator has historically been long commodity futures providing hedgers someone to sell to. The speculator is the commodity producer’s friend.

The market won’t work without them. Speculators are not going to operate in such a confined space that they can be trapped by market regulation.

R-Calf wants limits set on speculative positions imposed by the physical hedgers. This was an unusual suggestion. I guess that the hedgers get to arbitrarily decide how many others can participate in their market.

They essentially want control in order to “manage” the market. R-Calf has no experience that I’m aware of in manipulating the cattle market so I am surprised that they think they are skilled and competent enough to manage one.

I contrarily am confident that they would screw it up, no offense to R-Calf. Market regulation is somewhat of an art to achieve the balance between letting markets freely derive price discovery or suffocating them to a degree that they become dysfunctionally useless.

This starts with your basic assessment of the job public exchange traded markets are doing. I see problems, but nothing close to justifying the kind of oppressive control that R-Calf suggests.

They want daily limits on cattle futures reduced and cash settlement abandoned reverting to physical delivery.

These suggestions are absurd. Limits are set to allow the markets room to function yet protect the financial integrity of markets. Current limits are appropriate.

Cash settlement eliminated the manipulation that occurred with physical feeder cattle delivery. Cash settlement was a good solution to basis alignment, not the problem, and should be extended to the live cattle contracts. We would be better off if grain markets were cash settled, too.

R-Calf is so obsessed with the possibility that speculators may sell to depress cattle prices that they are willing to concede to oppressive regulation that would ensure too little market participation would exist to support price discovery.

We need funds to balance the commercial short selling. The lack of balance R-Calf suggests exists today is greatly exaggerated. Over regulated, the futures market will not work.

If producers used public exchange traded futures markets instead of feed the packer’s captive supply, the cattle market would improve. Expanded use of the futures market is one of the solutions to captive supply.

Packers use of captive supply to manipulate cash markets far exceeds their ability to use public exchange traded markets to do so. Most of the problems that I see from derivatives have been in the over the counter off exchange trade.

By contrast, exchange traded derivatives, “by setting margin and collateral requirements, would remove risk from the financial system and increase transparency in instruments.”

By establishing limits of OTC traded derivatives thereby pushing them to be transacted through clearing houses, the Commodity Futures Trading Commission gains the ability to oversight the trade.

For those who don’t want commodity prices to go higher and want to limit trade access to those seeking to profit from a market trend, they see regulation as a way to stack the deck.

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

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