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Financial Times: Sights trained on the usual suspect

Sights trained on the usual suspectBy Kevin Morrison and Christopher Brown-Humes
Published: May 6 2006 03:00 | Last updated: May 6 2006 03:00

The speculator is back as the market bogeyman.


He has long been blamed as the agent of boom and bust, whether in Dutch tulips or dotcom shares.

Precisely who or what he is, is seldom made clear. But everyone, it seems, agrees on where he is: the speculator is in the wrong.

This time, speculators are being blamed for driving up oil and commodity prices to the detriment of honest companies and consumers.

“We can see more than $100bn (£53.8bn) of basically what is called speculative money in the oil market,” said Jeroen van der Veer, chief executive of Royal Dutch Shell this week. “Those are the orders of magnitude. They certainly play a role on the price of oil.''

Similarly, last week, Lord Browne, BP's chief executive, said: “Over the past few weeks, the price of oil has been going up in spite of the fact that inventories have been pretty robust compared with historical averages.

“You have to look elsewhere other than inventories and supply and demand for an explanation – there is also speculation.”

It is not just in the oil market that speculators have come under attack.

Thierry Centner, chairman of the International Wrought Copper Council, an industry group for companies that make copper products, told the London Metal Exchange last week: “We recognise that the London Metal Exchange's price of copper is what it is but this market, where speculators can buy what does not exist, is doing serious damage to ourindustry.”

The speculators that the likes of Mr Centner seem to have in mind are hedge funds.

But just how active hedge funds are in the commodity markets is hard to say.

The only guide is a weekly report on the commitment of traders by the Commodity Futures Trading Commission, the US regulator of futures markets. But this is far from perfect.

The last CFTC report shows that “non-commercial participants” – longhand for hedge funds and investment groups such as commodity trading advisers (CTAs) – accounted for 31 per cent of the contracts outstanding in West Texas Intermediate, the US oil futures benchmark, on April 25.

However, hedge funds and CTAs are not the only speculators or non-trade investors in commodities.

The CFTC data do not include the activities of the proprietary trading desks of large investment banks such as Goldman Sachs andMorgan Stanley.

Neither does it include the flow of funds that track the Goldman Sachs Commodity Index and the AIG-Dow Jones Commodity Index, which account for the bulk of the $85bn that is estimated to track commodity indices.

Nor does it include the retail investors that are now able to gain access to commodities markets through the growing number of exchange-traded funds.

“There's been a rapid proliferation of fast money investors who really accentuate certain market moves,” says David Rosenberg, North American economist at Merrill Lynch in New York. “Sometimes it feels as though every one is turning themselves into a hedge fund.”

But not everybody believes speculators deserve the bad press they are receiving.

“It's an easy way out to blame it on speculators,” said Kevin Norrish, energy analyst at Barclays Capital.

He said that for companies to say instead that they have not been investing enough in production and exploration “doesn't sound quite as good”.

Robert Shiller, professor of economics at Yale University, agreed that speculators are an easy target.

“Speculation is a dirty word and when a group of people are called speculators, it usually implies that they are doing bad things,” he says. “If something has happened in financial markets that cannot be easily explained, the quick and easy option is to blame it on speculators. They don't have any defamation league, so they are unlikely to sue.”

Mr Shiller said the complaining chief executives are just playing politics. “They should know better, particularly given that they are also in the business of speculation as they have to take risks with their businesses, which is the same as speculation.”

He added: “They [corporations] are in the business of profit-maximisation, they look to the futures markets to give them a guide on whether they should lift production or not.”

Ironically, the corporate critics of speculators happen to be among the world's biggest traders in the energy markets.

BP reported a profit of $2.97bn before tax and interest costs from trading in oil, natural gas and power last year. Traders said that is more money than any other company has made from the commodity markets.

Royal Dutch Shell does not disclose its energy trading earnings but it is known to be as active as BP in energy market trading.

David Mooney, portfolio manager at NewFinance Capital, a fund of funds group, said it is disingenuous to categorise all financial players in commodity markets as greedy speculators.

“You cannot lump all the investors in commodity markets under one banner because they each have different agendas,” said Mr Mooney, noting the differing role played by hedge funds, commodity index funds, pension funds and investment banks in the sector.

Diego Hernandez, president of BHP Billiton base metals, went further. He said speculators do have a role to play in commodity markets. They provide liquidity to producers and consumers when they hedge.

“They [speculators] have an effect on the market in the short term but what determines prices in the long term are the fundamentals, the supply and demand,” said Mr Hernandez.

Mr Norrish at Barclays Capital made a similar point. “If producers and consumers were the only participants, the market would be much less liquid. Speculators increase volumes and spread risk between different users.”

So far, it is in commodities and metals that speculators' role has been highlighted.

But with markets booming everywhere – from art investment to emerging markets – it may not be long before speculators are being blamed in other arenas.

They have been spared any criticism for fuelling the rapid rise of the UK stock market. But it could come if the FTSE 100 continues the spectacular progress that has seen it rise more than 80 per cent in the past three years. It is especially likely if the investors suffer sharp losses in a steep correction.

Last month, Merrill's Mr Rosenberg took a wry look at what the next speculative market might be “now that real estate, art, base metals, and gold/silver have soared”. His conclusion: orchids.

“Imagine what happens when the hedge funds catch on that there was an orchid mania in the late 19th century that saw one particular genus sell for $600,000 in today's dollars,” he wrote.

Today, orchids are hot again: they are the second most popular potted plant behind poinsettias, up from number seven a decade ago.

In that time, said Mr Rosenberg, sales have doubled to more than 17m a year.

A orchid derivative for speculators to trade surely cannot be far away.

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