Oil commodities hedge fund speculator is anything but “passive”

June 18, 2008

Ross Levin, a NYC hedge fund analyst with Arbiter Partners, who calls himself a “passive speculator in securities” met Lionel Lepine, a member of the Athabaskan Chipewyan First Nation whose family and friends living on the contaminated watershed upriver from the oil sands’ effluence are suffering from unprecedented numbers of cancerous tumours.

read more | digg story

A number of recent stories intersect here: Harper’s apology for past treatment of Canada’s First Nations, the pollution of the Athabaskan River north of the oil sands, the impatient development of nonrenewable resources, the meteoric rise of oil commodities market directly caused by irresponsible speculators playing with volatile, unpredictable hedge funds that play havoc with the market making a fortune for some while destroying economic, social and ecological environments all around them.

In a rapid visit to the local library yesterday I grabbed Jake Bernstein’s How the Futures Markets Work. Although it is quite old for the fast-paced risk management industry, there are certain fundamentals that ring true. He briefly traced the history futures contracts leading to the volatile environment where agricultural futures were replaced by the less predictable currency markets. Of course, his book was written long before the meteoric rise of private equity funds.

My concern remains with the absent ethical component on trading floors. Ethical responsibilities are as elastic as the regulations that govern the centuries old practice of hedging. In the period of late capitalism and the emergence of risk society, the cost of destructive unintended byproducts have created havoc in ways that far exceed the commodities/service value. The road to profits and impatient money, is paved with casualties.

Berstein’s facts of market life are telling. He encourages simple methods and systems which require few decisions and little mental conflict. Too much thought is not conducive to successful trading. Too much analysis costs lost opportunities. Keep systems simple. Control your emotions. Practice caring less so that you remain more objective. Don’t ask why. Knowing why may hinder you more than it will help you. Patterns are the best indicators available (What feeds into a “pattern” however is not a science). Timing is what makes money in the futures market (Bernstein 2000:282-3).

In other words, futures’ gurus encourage young hedge fund analysts to not think too much about factors such as displacement of peoples, the degradation of living conditions and the way in which they unwittingly contribute to making vulnerable ecologies and peoples even more vulnerable. Their gurus tell them to not think about the impact of their actions. They are told to not ask why the prices of essential commodities like fuel and food that they are playing with, are pushing certain groups into unimaginable levels of social exclusion. In the end groups at-risk to health degradation are always those least able to protect themselves. How convenient that the gurus do not factor in these social issues. They are entirely absent from finance reports.

But then a lot of information is purposely not included in financial and business reports. Bernstein argues that the simpler systems that take fewer things into consideration will lead to more profits. Yet when he lists off all the potential factors in operation in even a simple fundamental analysis, it is not at all simple. It begins with the highly complex. The algorithms involved may appear to be simplified through the use of databases that seem to generate accurate, objective hard facts. In reality, the accuracy of any query depends on what was fed into it.

Futures trading, also known as commodities trading, the final frontier of capitalism, became a popular speculative and investment vehicle in the US in the 1960s (Bernstein 2000:1). These financial instruments offer unlimited profit potential with relatively little capital. Speculators are drawn to the possibility of quick money or what I like to call impatient money. The great wealth accumulated from speculative financial instruments has spawned careers in brokerage, market analysis, computerized trading, computer software and hardware, accounting, law, advertising which themselves subdivide into more recent opportunities such as those related to risk-management.

While gurus such as Bernstein argue that gambling is for anyone but speculation is for professionals, the chaos and unpredictability of the current global economy have been linked to a growing culture of gambling in futures trading rather than level-headed professionalism. Gamblers create risk simply by placing a bet; professional speculators “transfer risk from the hedgers to the speculators” and it therefore called risk management instead of gambling.

“It rained last night so the price of soy beans will be down today.” Although the basis of fundamental analysis in economics is supply and demand, the actual fundamental analysis of specific markets that might generate accurate price predictions are complicated as numbers of factors overlap and massive quantities of data need to be considered. The simple equation involves how much of a commodity or service are buyers willing to pay at a given time and place. There used to be a correlation between price and consumption. Factors that impact on price of commodities include the state of the economy (local, regional, national and international – inflationary, recessionary with rising or falling employment), availability of alternate products or services, storage possibilities, weather, seasonality, price cycles, price trends, government subsidies, political influences, protectionist attitudes, international tensions, fear of war, hoarding, stockpiling, demand for raw materials (sugar, petroleum, copper, platinum, coffee, cocoa), currency fluctuations, health of the economy, level of unemployment, housing starts. Most technical systems are not effective in making traders money.

In spite of this there is still a persistent belief that there is an invisible hand that guides market correcting imbalances like a living organism or finely-tuned machine.

“Markets work perfectly as they respond to the multiplicity of forces that act upon them. It is our inability to find, parse, and correctly weight the impact of these factors that limits our results and success of our fundamentally based forecasts (Bernstein 2000:162).”

The bottom line is that wealth disparities continue to intensify and that these inordinate extremes of wealth and poverty destabilizes society. These distorted economic relationships deprive us of any sense of control over economic forces that threaten to disrupt the foundations of our existence. National governments have been either unwilling or unable to deal effectively with this situation in which we live where the deplorable superfluity of great wealth exists alongside the acute suffering of those living in miserable, demoralizing and degrading abject poverty even in countries like Canada.

Social equality is an entirely impracticable chimera. Even if equality could be achieved it could not be sustained. Wages and income should be unequal and should correspond to different efforts, skills and capacities. However, equal justice for all is not only necessary but urgently needed.

As long as those involved in the financial and energy industries remain in denial of their role by hiding behind economic and ideological polemics and simply dismissing concerns from others there can be no productive change. A fresh look at the problem should involve people like Lionel Lepine who are directly involved with decisions, along with experts from a wide spectrum of disciplines. There will not be a voluntary ethical turn so for now we desperately need public policies that will regulate industries.

Selected Timeline of Critical Events

1710 The first modern organized futures exchange began with the Dojima Rice Exchange in Osaka, Japan. The Japanese feudal landowners began to use certificates of receipt against future rice crops. As these futures certificates became financial instruments in the general economy the value of the certificates would rise and fall as the price of rice fluctuated. The Dojima Rice Exchange emerged as the world’s first futures market where speculators traded contracts for the future delivery of rice or “certificates of receipt.” The Japanese government outlawed the practice when futures contracts (where delivery never took place) began to have no relationship to the underlying cash value of the commodity leading to wild and unpredictable fluctuations (Bernstein 2000:30).

1848 The Chicago Board of Trade (CBOT) was formed as a price risk occurred in the grain markets of Chicago.

1865 The Chicago Board of Trade (CBOT) organized trading of futures contracts.

1919 – 1945 The Chicago Mercantile Exchange (CME) traded futures in eggs, butter, apples, poultry and frozen eggs (Bernstein 2000:70).

1960s Futures trading, also known as commodities trading, the final frontier of capitalism, became a popular speculative and investment vehicle in the US in the 1960s (Bernstein 2000:1).

1970s There was increasing volatility in international currency exchange rates as the Bretton Woods agreement began to break down. Business people transferred risk of volatility in international markets by hedging with speculators willing to take the risk. Futures markets began to expand into foreign currencies as fluctuated wildly competing against each other and the US dollar.

1972 The total volume of futures contracts trading was 18 million and the top ten most actively traded future contracts were agricultural futures (Bernstein 2000:71).

1974 The US Congress passed the Commodity Futures Trading Commission Act and established Commodity Futures Trading Commission (CFTC) to protect participants in the futures market from fraud, deceit and abusive practices such as unfair trading practices (price manipulation, prearranged trading, trading ahead of a customer), credit and financial risks, and sales practice abuses (Bernstein 2000:32). Individual nation states have similar regulating bodies.

1982 Futures trading in the US was self-regulating and anyone in the business had to become a member of the National Futures Association (NFA).

1986 The total volume of futures contracts trading was 184 million and the T bonds were among the most actively traded future contracts (Bernstein 2000:71).

1990 The price of crude oil rose dramatically when Hussein invaded Kuwait.

1999 The most actively traded future contracts were interest rates, futures, stock index futures, energy futures, currency futures and agricultural futures (Bernstein 2000:72).

2000 The Chicago Mercantile Exchange (CME) trades futures in livestock futures, currency futures, interest rate futures, stock index futures (Bernstein 2000:70).

2000 More than 90 foreign futures exchanges emerged with the ever-increasing demand for new financial instruments “to hedge against fluctuating interest rates, changing foreign exchange rates and institutional securities portfolios (Bernstein 2000:46).

2008 Calgary has a high percentage of young millionaires with lots of disposable income. There are also c.4000 homeless people in Calgary, the oil capital of Canada. c. 40% of the homeless are working poor who are unable to afford housing.

Webliography and Bibliography

Bernstein, Jake. 2000. How the Futures Markets Work. New York Institute of Finance.

4 Responses to “Oil commodities hedge fund speculator is anything but “passive””


  1. thanks for the positive mention of my book!
    truly
    jake bernstein

  2. Ed L. Says:

    Have you been following the discussion on Paul Krugman’s Blog regarding the fallacy of speculation, and the fundamentals of supply and demand.

    http://krugman.blogs.nytimes.com/

    Krugman has taken several leading economists, and the bulk of Congress, to task arguing that it’s political expediency to blame the speculators (even evasive tactics by the industry), and that current high prices are justified by the fundamentals (basically low spare capacity, declining dollar, geopolitics, and increasing global demand). I disagree with him, and have said so on his blog, and I would be interested to hear what you think?

    I’m currently interested in the relationship between sweet light crude and heavy/sour crude on the exchanges, a matter that directly impacts the development of oil sands in Canada. In the peak oil scenario, it’s sweet light crude that becomes scarce, and over time gets replaced by heavy/sour crude (which is more difficult to refine). Are we seeing a transformation of this sort already … and is Saudi Arabia drawing our attention elsewhere so that we will continue blithely move onward and upward with consumption. Supplies appear to be stable (there are no gas lines anywhere in the world, refineries are at 85% during busy driving season), current high prices are resulting in demand destruction, and yet crude prices for light sweet crude soar (with every tick of the declining dollar).

    I believe it’s excess liquidity in the markets chasing too few commodities: namely investment dollars and sovereign wealth funds looking anywhere for a bull market, and finding few prospects in the U.S. dollar, credit markets, real estate, or elsewhere in the U.S. economy. But this still doesn’t answer Krugman’s basic question why there is no hoarding of supplies by speculators (in a market that is contango). Are we fooled thinking oil is a free market to begin with?


  3. You raise some thought-provoking questions. It is telling that The Bank for International Settlements (BIS) report also raised pivotal questions about regulation of the oil commodities markets as even they are cautious about the role of speculation. Krugman and those who comment create a really robust debate but I usually read them just to find their sources that provide stronger evidence-based research.

    I believe the concept of a “free” market is deceptive. It may be a goal for some distant future but it has never existed and it certainly doesn’t now.

    By the way, I visited your blog and read about your own work. You seem to have found a way to make the beauty you love be what you do.

  4. Ed L. Says:

    Many thanks.

    I found myself archiving info throughout the web, and it helped to provide some reference point and think about what I was finding a little deeper. Links get lost quickly, and I now have stories, insights, programs, issues all in one place. It’s great to know that people are reading, and I’ve enjoyed your blog as well … it’s a heady brew of northern issues, analysis, and the spirit of engagement and critique.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: