Economy in Crisis
Hedge Funds and Institutional Investors Driving Up Oil and Other Commodity Prices

by Keith Burton - GCN  5/30/08

Federal regulators with the Commodity Futures Trading Commission are investigating whether large institutional funds and hedge funds are behind the sharply rising costs of oil, food and many other commodities in recent months. Investigators are concerned that futures contracts for oil and other commodities may have skewed the market and are behind the price increases.

The Commodity Futures Trading Commission recently held a hearing where testimony was heard from investment experts that indicate that the same forces that were behind the global financial crisis has moved into the commodity market and dumping huge funds into buying commodities that has resulted in the rising prices consumers are seeing at the gas pumps and in grocery stores.

At risk is more than what people pay at gas pumps. There are growing concerns that the commodities markets have been compromised and that if not checked, the result could undermine the national and world economies.

In a May 20, hearing in Congress, Michael Masters, a hedge fund portfolio manager, said the sheer number of investor dollars flowing into the commodities markets had skewed the relationship between oil supply and demand. In his testimony, Masters said that only $13 billion traded in commodities indexes in 2003, compared with $260 billion in March 2008.

Masters testimony is a warning to Congress that serious problems are developing in the futures market regarding the impact of hedge funds and institutional funds pouring money into the commodities market.

"Index speculators provide no benefit to the futures markets and they inflict a tremendous cost upon society," Masters said, according to a copy of his testimony.

In his testimony Masters said:
 

"Commodities prices have increased more in the aggregate over the last five years than at any other time in U.S. history. We have seen commodity price spikes occur in the past as a result of supply crises, such as during the 1973 Arab Oil Embargo. But today, unlike previous episodes, supply is ample: there are no lines at the gas pump and there is plenty of food on the shelves.

If supply is adequate - as has been shown by others who have testified before this committee - and prices are still rising, then demand must be increasing. But how do you explain a continuing increase in demand when commodity prices have doubled or tripled in the last 5 years?

What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant."

At this point, Congress, nor federal regulators have addressed the problem. Some experts believe that the source of the problems stem as far back the Clinton administration when many controls on banking and investments were removed.

What is clear from his testimony is that normal market forces are not behind the sharp rise in prices people are experiencing. There are also indications that news reports that suggest that shortages and future potential shortages are also not the reason for the increases.

GCN has placed Masters' testimony on its servers for readers. It is available HERE. Your computer will need to be able to read .pdf files.

Related Information:
 

Fuel Prices No Longer Market Driven - Star Telegram
Federal Agency Investigation Whether Commodity Investors Driving Up Fuel Costs - LA Times