Nothing is more antithetical to the principles of free enterprise than price fixing. Rigged prices undermine the efficient functioning of markets and defeat their ability to maximize economic welfare. Sadly, we've had an epidemic of price fixing in the financial markets, frequently involving the largest and most important banks.
The London Interbank Offered Rate has been the subject of governmental investigations in Europe and the U.S. for alleged years-long collusion. Billions of dollars of fines, penalties and other payments have been assessed on various big banks, and the investigation of other major banks continues. Trillions of dollars of loans and contracts were priced based on Libor, and the potential impact of this price fixing is massive.
Foreign exchange rates have been investigated for rigged prices, and billions of dollars of fines, penalties, etc. have been paid in government and private civil lawsuits. Again, some of the largest banks are implicated.
Now, word comes that the market for interest rate swaps has been under investigation for price fixing via the alleged collusive manipulation of the ISDAfix, a benchmark swap rate that is used in the pricing of a variety of financial products. The interest rate swaps market, although obscure to the general public, involves hundreds of trillions of dollars of financial products (in notional value) sold to corporations and other commercial customers to offset interest rate risk. Big banks are reportedly involved this collusion and the fines, penalties, etc. could total perhaps billions.
There are also reports of investigations of price manipulation by big banks in the metals markets. These might involve restricting supply and other maneuvers to rig prices. If wrongdoing is uncovered, more large fines, penalties, etc, can be expected.
Many of the banks involved in these matters are likely to be too big to fail. In other words, while conspiring against the public in very large and important markets, these banks enjoyed the explicit and/or implicit backing of the taxpayers. This backing helped them attain Brobdingnagian size, which in turn probably facilitated their ability to rig markets.
The financial markets are the central venue of the capitalist system, being the place where holders of capital and borrowers of capital meet to determine the allocation of society's financial resources. The largest banks are at the center of the financial markets, and their conduct ripples through the financial markets and the entire free enterprise system. That such crucially important players are so regularly conspiring against the public and the public interest presents a galling spectacle that damages the credibility of the capitalist system. Are markets truly socially beneficial or are they simply a means by which the rich and powerful fleece others?
The world's largest banks have the legal and social responsibility to refrain from such reprehensible conduct. However, their sad record of massive, multi-market price fixing seems to tell us that their chances of upholding these responsibilities aren't very high. Their collusive activities often arise in markets that have a bi-level structure: an inner inter-dealer market where the big banks and other financial firms trade among themselves, and an outer market where the dealers trade with the public at usually marked up prices. The inside inter-dealer market is a perfect venue for price-fixing, as the dealers have to talk and trade with each other every business day. As Adam Smith put it in The Wealth of Nations, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices."
Thus, the challenge falls on regulators and law enforcement authorities to be vigilant and firm. The sheer magnitude of the wrongdoing, as demonstrated by the billions that have been paid out to date, is astonishing. Those who may seem paranoid about the financial markets have it right--way too often, the markets are rigged.
Showing posts with label commodities. Show all posts
Showing posts with label commodities. Show all posts
Friday, June 19, 2015
Friday, September 23, 2011
Why Gold Isn't A Safe Haven
In the past couple of days, gold has dropped close to 10%, and is now trading around $1650 per ounce. That's 15% down from its recent peak price of around $1920. Why the belly flop? The answer is that, contrary to pronouncements of bug-eyed gold fanatics who drool from the sides of their mouths, gold is not a safe haven from fiat currencies or the financial system. Instead, it is joined at the hip with the financial system.
Among the most active traders in gold are hedge funds and other financial firms. These market players mainline leverage. And when they can't find a vein, they smoke the stuff. Consider the nature of leverage. It's a loan denominated in fiat currencies like the dollar and the euro. Leverage must be repaid in fiat currencies. Banks extending margin loans don't want to speculate in gold themselves, so they require repayment in dollars, euros or some other fiat currency.
Leverage financed the great gold rush of 2008-2011. This time, prospectors didn't search for yellow metal in stream beds or under the ground. They sought riches in the trading platforms of exchanges. The ones that got into the market two or three years ago hit the motherlode. But as gold bubbled up, smart players began to wonder when the party would run out of punch. The financial crisis of 2008 taught us that bubbles will burst at some point. Stocks and real estate both bubbled up and burst, and gold isn't different. Part of today's selling is to lock in profits while the getting is good. Locking in profits involves converting gold holdings to a fiat currency. That's the only way to take your gold profits and use them to repay margin loans, and buy cars, food, housing, and so on. So when money managers think the gold bubble, as valued by fiat currencies, has peaked, they will sell gold in order to obtain fiat currencies.
Other hedge fund managers may be selling gold because their investors, seeing the world go hinky in recent months, are making redemption requests to cash out. Investors may be worried about stocks, oil, or other assets besides gold that the hedge funds invested in and are now falling in value. But gold is easier to sell than some assets because it has a highly liquid market. So investor redemption requests, in effect, hit the gold market. Investors want payments in fiat currencies, not distributions of gold. That means the gold has to be sold to convert it into fiat currencies.
The players who dove into gold also traded on a leveraged basis in stocks, other commodities and maybe derivatives that no one can easily learn about because the derivatives market, three years after the financial debacle of 2008, remains opaque. Part of the selling of gold is due to speculators having to raise cash to meet margin calls resulting from falling prices for stocks, commodities other than gold (such as oil, which has lost some of its sheen) and, perhaps, derivatives contracts. In this way, leverage used to invest broadly on a diversified basis can have an interlinked downward impact when some markets go wobbly.
The recent woes of the euro add to the problem. A fall by the euro has pushed up the comparative value of the dollar. Since gold tends to trade inversely to the dollar, a good day for the dollar means a bad day for gold. That's another reason for gold investors to bail before they sustain more losses. The inverse correlation between the dollar and gold reveals a vulnerability of gold to a fiat currency.
With the financial markets and world getting hinkier by the trading minute, the selling has accelerated in the past two days. The ship seems to be sinking, and you know who is scrambling to get off first. Leverage dramatically pushed up the price of gold, and now deleveraging and other financial factors are driving it down.
Today's gold market is a creature of the financial system, and is subject to the same pressures and constraints as other assets. Gold isn't a safe haven. What is? That's the question people have been asking since they sharpened long sticks for protection and sought shelter in caves. When you have the answer, please clue in the rest of us.
Among the most active traders in gold are hedge funds and other financial firms. These market players mainline leverage. And when they can't find a vein, they smoke the stuff. Consider the nature of leverage. It's a loan denominated in fiat currencies like the dollar and the euro. Leverage must be repaid in fiat currencies. Banks extending margin loans don't want to speculate in gold themselves, so they require repayment in dollars, euros or some other fiat currency.
Leverage financed the great gold rush of 2008-2011. This time, prospectors didn't search for yellow metal in stream beds or under the ground. They sought riches in the trading platforms of exchanges. The ones that got into the market two or three years ago hit the motherlode. But as gold bubbled up, smart players began to wonder when the party would run out of punch. The financial crisis of 2008 taught us that bubbles will burst at some point. Stocks and real estate both bubbled up and burst, and gold isn't different. Part of today's selling is to lock in profits while the getting is good. Locking in profits involves converting gold holdings to a fiat currency. That's the only way to take your gold profits and use them to repay margin loans, and buy cars, food, housing, and so on. So when money managers think the gold bubble, as valued by fiat currencies, has peaked, they will sell gold in order to obtain fiat currencies.
Other hedge fund managers may be selling gold because their investors, seeing the world go hinky in recent months, are making redemption requests to cash out. Investors may be worried about stocks, oil, or other assets besides gold that the hedge funds invested in and are now falling in value. But gold is easier to sell than some assets because it has a highly liquid market. So investor redemption requests, in effect, hit the gold market. Investors want payments in fiat currencies, not distributions of gold. That means the gold has to be sold to convert it into fiat currencies.
The players who dove into gold also traded on a leveraged basis in stocks, other commodities and maybe derivatives that no one can easily learn about because the derivatives market, three years after the financial debacle of 2008, remains opaque. Part of the selling of gold is due to speculators having to raise cash to meet margin calls resulting from falling prices for stocks, commodities other than gold (such as oil, which has lost some of its sheen) and, perhaps, derivatives contracts. In this way, leverage used to invest broadly on a diversified basis can have an interlinked downward impact when some markets go wobbly.
The recent woes of the euro add to the problem. A fall by the euro has pushed up the comparative value of the dollar. Since gold tends to trade inversely to the dollar, a good day for the dollar means a bad day for gold. That's another reason for gold investors to bail before they sustain more losses. The inverse correlation between the dollar and gold reveals a vulnerability of gold to a fiat currency.
With the financial markets and world getting hinkier by the trading minute, the selling has accelerated in the past two days. The ship seems to be sinking, and you know who is scrambling to get off first. Leverage dramatically pushed up the price of gold, and now deleveraging and other financial factors are driving it down.
Today's gold market is a creature of the financial system, and is subject to the same pressures and constraints as other assets. Gold isn't a safe haven. What is? That's the question people have been asking since they sharpened long sticks for protection and sought shelter in caves. When you have the answer, please clue in the rest of us.
Wednesday, December 22, 2010
Will the Fed's Easy Money Slow the Economy--Again?
It is widely believed (albeit not at the Fed) that easy money policies by the central bank have contributed substantially to the asset bubbles and busts of the past decade. Tech stocks, real estate, consumer credit (remember the days when anyone with a pulse and a signature could get a loan?), and commodities (especially oil) all boomed and busted partly because of low interest rates fostered by the Fed. Each cycle enriched financial markets insiders, but weakened consumers and the broader economy. Nevertheless, the Fed is at it again with quantitative easing (i.e., buying Treasury securities in the open market) and history may be repeating itself.
Oil prices have risen above $90 a barrel, and predictions for $100 oil are becoming fashionable. Regular gas is more than $3.00 a gallon. Metals prices have been rising, and today's Wall Street Journal (P. C1) reports that holdings of metals have become concentrated, suggesting a flare-up of speculative buying. With the economy still struggling to climb out of the septic tank, the liquidity the Fed has been pouring into the financial system apparently isn't being used to build factories or develop software, or for badly needed repairs of bridges and highways. It evidently is going into short term financial market plays, the same kind of stuff that's bedeviled the economy for the past decade.
The Fed wants inflation to stimulate consumer spending. It may well get a dose of inflation this year, if oil and other commodities prices keep rising. But that isn't beneficial inflation. As gasoline, heating oil, diesel and aviation fuel go up, consumers spend more on energy and less on everything else. Oil producers get wealthier (perhaps increasing funding for Iran's nuclear weapons program), while American businesses struggle to keep sales up. Hiring may slow, retarding the recovery of employment levels. The economy could stumble. This is what happened in 2008 and it could easily happen again.
Just when everyone thought fiscal stimulus was dead, the Republicans ignored the mandate from voters in the recent mid-term elections and agreed to a tax deal with President Obama that increased the federal deficit. Okay, so the increase was necessary to give tax relief to the wealthiest Americans, who are major targets of campaign fundraisers now that the Supreme Court has ruled that political sugar daddyism is a Constitutional right. But it demonstrates that fiscal expansiveness lives. John Maynard Keynes' legacy may yet be vindicated by the GOP.
The Fed has powerful monetary tools. These tools, however, can have powerful unintended consequences. Need the Fed pile on with more easy money?
As a bank regulator, the Fed has appropriately been leaning on its regulatees to be more prudent. Perhaps, just perhaps, it ought to consider whether prudence might not be a weapon in its monetary arsenal as well.
Oil prices have risen above $90 a barrel, and predictions for $100 oil are becoming fashionable. Regular gas is more than $3.00 a gallon. Metals prices have been rising, and today's Wall Street Journal (P. C1) reports that holdings of metals have become concentrated, suggesting a flare-up of speculative buying. With the economy still struggling to climb out of the septic tank, the liquidity the Fed has been pouring into the financial system apparently isn't being used to build factories or develop software, or for badly needed repairs of bridges and highways. It evidently is going into short term financial market plays, the same kind of stuff that's bedeviled the economy for the past decade.
The Fed wants inflation to stimulate consumer spending. It may well get a dose of inflation this year, if oil and other commodities prices keep rising. But that isn't beneficial inflation. As gasoline, heating oil, diesel and aviation fuel go up, consumers spend more on energy and less on everything else. Oil producers get wealthier (perhaps increasing funding for Iran's nuclear weapons program), while American businesses struggle to keep sales up. Hiring may slow, retarding the recovery of employment levels. The economy could stumble. This is what happened in 2008 and it could easily happen again.
Just when everyone thought fiscal stimulus was dead, the Republicans ignored the mandate from voters in the recent mid-term elections and agreed to a tax deal with President Obama that increased the federal deficit. Okay, so the increase was necessary to give tax relief to the wealthiest Americans, who are major targets of campaign fundraisers now that the Supreme Court has ruled that political sugar daddyism is a Constitutional right. But it demonstrates that fiscal expansiveness lives. John Maynard Keynes' legacy may yet be vindicated by the GOP.
The Fed has powerful monetary tools. These tools, however, can have powerful unintended consequences. Need the Fed pile on with more easy money?
As a bank regulator, the Fed has appropriately been leaning on its regulatees to be more prudent. Perhaps, just perhaps, it ought to consider whether prudence might not be a weapon in its monetary arsenal as well.
Thursday, May 13, 2010
Still Searching for the Seven Cities of Gold
Suddenly, gold has become the hot new investment, reaching over $1,200 an ounce (in dollar terms) for the first time. Does this make gold a good investment? Consider history.
For the Spain of the 1500s, the New World was a fantastic tale of unimaginable wealth come true. In 1519, Hernan Cortes conquered the Aztecs, securing astonishing amounts of gold and silver, as well as vast territories. Next, Francisco Pizarro and his brothers conquered the larger Inca Empire with even fewer men than accompanied Cortes. Unfathomable amounts of gold and silver flowed to Spain, which had grown in the space of 50 years from a medium sized European kingdom to the enormous Spanish Empire.
As vast fleets of galleons transported gold and other wealth to Spain, inflation set in on the Iberian peninsula. Gold wasn't a magical store of value and wealth. Nevertheless, the Spanish Empire dedicated itself to obtaining as much gold and silver as possible, through conquest and then mining. Latin America, a region with tremendous amounts of natural resources, wasn't developed in the way of North America. By the end of the 19th Century, North America was an industrial powerhouse. The Spanish Empire was bankrupt.
Gold isn't a productive asset. Its only value lies in what it can be exchanged for--i.e., what other people think it's worth. In times of distress, it has value. With the Euro in decline from the sovereign debt crisis in Western Europe, the dollar wavering because of the financial crisis and recession in the United States, and the absence of any strong currency in wide circulation in Asia, gold has by default become popular.
Gold doesn't produce prosperity. It can be a good short term trading play, if your timing is right. But the value of gold is affected by innumerable variables--economic, political, cultural, commercial and industrial (there are a few industrial uses for gold)--and its price trends are notoriously difficult to predict. Gold has done poorly as a long term investment--adjusted for inflation, today's prices are not gold's all time peak (that would be the 1981 price of almost $600 an ounce, which translates to about $1,400 an ounce today). In the last 35 years, the stock market has done about twice as well as gold.
People become wealthy by working, earning, saving and investing, not by speculating in gold. Countries become prosperous by industrializing and strengthening their manufacturing abilities. The Spaniards who searched for the legendary Seven Cities of Gold (or Seven Cities of Cibola) roamed through vast areas of what are now the plains of the United States. They didn't find any gold, and they didn't recognize that the dry grasslands through which they marched would some day become part of the wealthiest nation in the world. They were searching for the wrong thing, and so are today's investors who think they've found a panacea in gold.
For the Spain of the 1500s, the New World was a fantastic tale of unimaginable wealth come true. In 1519, Hernan Cortes conquered the Aztecs, securing astonishing amounts of gold and silver, as well as vast territories. Next, Francisco Pizarro and his brothers conquered the larger Inca Empire with even fewer men than accompanied Cortes. Unfathomable amounts of gold and silver flowed to Spain, which had grown in the space of 50 years from a medium sized European kingdom to the enormous Spanish Empire.
As vast fleets of galleons transported gold and other wealth to Spain, inflation set in on the Iberian peninsula. Gold wasn't a magical store of value and wealth. Nevertheless, the Spanish Empire dedicated itself to obtaining as much gold and silver as possible, through conquest and then mining. Latin America, a region with tremendous amounts of natural resources, wasn't developed in the way of North America. By the end of the 19th Century, North America was an industrial powerhouse. The Spanish Empire was bankrupt.
Gold isn't a productive asset. Its only value lies in what it can be exchanged for--i.e., what other people think it's worth. In times of distress, it has value. With the Euro in decline from the sovereign debt crisis in Western Europe, the dollar wavering because of the financial crisis and recession in the United States, and the absence of any strong currency in wide circulation in Asia, gold has by default become popular.
Gold doesn't produce prosperity. It can be a good short term trading play, if your timing is right. But the value of gold is affected by innumerable variables--economic, political, cultural, commercial and industrial (there are a few industrial uses for gold)--and its price trends are notoriously difficult to predict. Gold has done poorly as a long term investment--adjusted for inflation, today's prices are not gold's all time peak (that would be the 1981 price of almost $600 an ounce, which translates to about $1,400 an ounce today). In the last 35 years, the stock market has done about twice as well as gold.
People become wealthy by working, earning, saving and investing, not by speculating in gold. Countries become prosperous by industrializing and strengthening their manufacturing abilities. The Spaniards who searched for the legendary Seven Cities of Gold (or Seven Cities of Cibola) roamed through vast areas of what are now the plains of the United States. They didn't find any gold, and they didn't recognize that the dry grasslands through which they marched would some day become part of the wealthiest nation in the world. They were searching for the wrong thing, and so are today's investors who think they've found a panacea in gold.
Friday, July 20, 2007
Commodities for Individual Investors
The global economy has grown vigorously in recent years, and the prices of commodities have risen sharply. We all know about oil and gasoline prices. Gold, uranium, silver, corn, cattle, and soybeans have also seen significant price rises. Rising prices attract investors the way shiny objects attract magpies. Nowadays, some people see commodities as the next hot thing. Are they a good idea?
1. Commodities Futures Contracts. The traditional way of investing in commodities is to buy a futures contract. Some view these contracts as a way to make fast money because you can buy one for only a 10% downpayment, or maybe even less. If the contract rises 10% in value, you have a 100% return on your investment. But the reverse is also true: if the contract drops 10% in value, you just lost everything you invested. Further, it's important to understand the nature of futures contracts. You either commit to buy a fixed amount of the commodity at a predetermined price, or to sell a fixed amount of the commodity at a predetermined price. The contract will specify a date on which you have to fulfill this obligation to either buy or sell, called the settlement date. You are locked into the contract--you must buy or sell at the specified price on the settlement date. There is no exit. This is the kicker in commodities futures contracts. If you are in a losing position on the settlement date, you have to take the loss (which could mean forking over more cash in addition to your downpayment if the contract has dropped by more than the value of your downpayment). When a stock drops, you can hold onto it in the hope that it will rise again. When a commodities futures contract is a loser on settlement date, you are stuck with the loss.
Big players in the financial markets can have a hard time figuring out which direction commodities prices will move. Remember the hedge fund called Amaranth, which collapsed because it guessed wrong on the direction of natural gas prices? Individual investors have an even harder time figuring out where commodities prices will go. Some individuals have lost $1 million or more playing with commodities futures contracts. You should avoid them.
2. Stocks with commodities exposure. A safer way to invest in commodities is to buy stocks of companies that have significant interests in commodities. The oil companies are obvious examples. Their stocks have generally done well with the rise in oil prices. Of course, part of the return from investing in oil companies comes from the skill (or lack of skill) of its management and other factors. But if you're looking for a commodities play, oil companies and other natural resources companies are a much safer way to make that bet than a futures contract.
3. Mutual Funds and ETFs. There are mutual funds and ETFs that specialize in providing investors with a chance to profit from commodities by investing in a portfolio of companies with interests in commodities. Since these funds are diversified to some degree, they may be less risky than the stocks of individual companies. They are certainly safer than futures contracts. Of course, you must consider their fees and expenses, as you always would with any mutual fund or ETF.
4. Mattress Stuffers. If you flirt with survivalist tendencies, you can buy gold coins. The 1 ounce 24 carat coins issued by some nations provide a convenient way to own gold--there's the American Eagle, the Canadian Maple Leaf, the South African Krugerrand, and the Australian Nugget. All can be purchased for a little more than the spot (i.e., cash) price of gold in the wholesale market. Owning gold coins presents problems of storage and insurance. And you should buy from a reputable dealer because most people can't tell gold from a bunch of other substances. But if you think the end of civilization is near--or you just want the fun of having some gold to stare at--you can buy gold coins and stick them in your mattress, or in the closet along with your freeze-dried food, bottled water, portable generator, camping gear, compass, flint and steel, tomahawk, coonskin cap, and Pennsylvania long rifle.
Is it a good idea to invest in commodities? If you put a small portion of your portfolio (5% or maybe even 10%) into commodities, you might acheive a degree of diversification that could pay off. Remember, however, that commodities prices are notoriously difficult to predict, and the financial markets have seen long stretches of time when commodities were not winners. Numerous investors have done just fine without investing in commodities.
Crime News: hot dog vendor arrested for parking meter scam. http://www.nbc4.com/news/13716705/detail.html?dl=headlineclick
1. Commodities Futures Contracts. The traditional way of investing in commodities is to buy a futures contract. Some view these contracts as a way to make fast money because you can buy one for only a 10% downpayment, or maybe even less. If the contract rises 10% in value, you have a 100% return on your investment. But the reverse is also true: if the contract drops 10% in value, you just lost everything you invested. Further, it's important to understand the nature of futures contracts. You either commit to buy a fixed amount of the commodity at a predetermined price, or to sell a fixed amount of the commodity at a predetermined price. The contract will specify a date on which you have to fulfill this obligation to either buy or sell, called the settlement date. You are locked into the contract--you must buy or sell at the specified price on the settlement date. There is no exit. This is the kicker in commodities futures contracts. If you are in a losing position on the settlement date, you have to take the loss (which could mean forking over more cash in addition to your downpayment if the contract has dropped by more than the value of your downpayment). When a stock drops, you can hold onto it in the hope that it will rise again. When a commodities futures contract is a loser on settlement date, you are stuck with the loss.
Big players in the financial markets can have a hard time figuring out which direction commodities prices will move. Remember the hedge fund called Amaranth, which collapsed because it guessed wrong on the direction of natural gas prices? Individual investors have an even harder time figuring out where commodities prices will go. Some individuals have lost $1 million or more playing with commodities futures contracts. You should avoid them.
2. Stocks with commodities exposure. A safer way to invest in commodities is to buy stocks of companies that have significant interests in commodities. The oil companies are obvious examples. Their stocks have generally done well with the rise in oil prices. Of course, part of the return from investing in oil companies comes from the skill (or lack of skill) of its management and other factors. But if you're looking for a commodities play, oil companies and other natural resources companies are a much safer way to make that bet than a futures contract.
3. Mutual Funds and ETFs. There are mutual funds and ETFs that specialize in providing investors with a chance to profit from commodities by investing in a portfolio of companies with interests in commodities. Since these funds are diversified to some degree, they may be less risky than the stocks of individual companies. They are certainly safer than futures contracts. Of course, you must consider their fees and expenses, as you always would with any mutual fund or ETF.
4. Mattress Stuffers. If you flirt with survivalist tendencies, you can buy gold coins. The 1 ounce 24 carat coins issued by some nations provide a convenient way to own gold--there's the American Eagle, the Canadian Maple Leaf, the South African Krugerrand, and the Australian Nugget. All can be purchased for a little more than the spot (i.e., cash) price of gold in the wholesale market. Owning gold coins presents problems of storage and insurance. And you should buy from a reputable dealer because most people can't tell gold from a bunch of other substances. But if you think the end of civilization is near--or you just want the fun of having some gold to stare at--you can buy gold coins and stick them in your mattress, or in the closet along with your freeze-dried food, bottled water, portable generator, camping gear, compass, flint and steel, tomahawk, coonskin cap, and Pennsylvania long rifle.
Is it a good idea to invest in commodities? If you put a small portion of your portfolio (5% or maybe even 10%) into commodities, you might acheive a degree of diversification that could pay off. Remember, however, that commodities prices are notoriously difficult to predict, and the financial markets have seen long stretches of time when commodities were not winners. Numerous investors have done just fine without investing in commodities.
Crime News: hot dog vendor arrested for parking meter scam. http://www.nbc4.com/news/13716705/detail.html?dl=headlineclick
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