Sunday, October 16, 2011

Squeezes and commodity prices

Good summary article  in the Telegraph on the most celebrated attempts to squeeze different commodity markets. Squeezes have long been a part of the futures market given there has to be convergence of the futures and cash market and there are deliveries of the actual commodities. The potential for ssqueezes is just an another issue that many have with speculation. Speculation is viewed as having a destabilizing effect on price discovery and the effective functioning of markets. Few seem to believe that speculation can provide liquidity and can drive prices to equilibrium levels.

The size of futures trading can outstrip the supply that is available for delivery. This is normal for futures and generally will not cause conditions for a squeeze. Buyers and sellers note that there is the potential for congestion at delivery and therefore roll futures positions away from delivery periods. Squeeze will destroy the market dynamics; therefore the exchanges will monitor market behavior even without government regulation. 

The chance for squeezes is one of the main reasons why the CTFC collects position information and there are position limits. Monitoring position limits is not used to stop speculative activity but to determine whether there will be significant price variations at delivery because there is a bias of buyers or sellers who could manipulate prices. If there are large price divergences at or near delivery, the futures cannot be an effective pricing mechanism. The value of the futures market as a public good dispensing price information will be destroyed. The current monitoring of positions is adequate for controlling the potential for squeezes, but the changing dynamics of speculation may require a dynamic regulatory approach with position limits and monitoring that is more flexible than the current system. A dynamic system will add uncertainty about rules but will provide a safety net for all market users. 

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