Wednesday, August 19, 2009

Putting the hammer to commodity funds

The CFTC ruled that the DB Powershares commodity funds will no longer be exempt from position limits in soybeans, wheat and corn. They have a total of $5.8 billion in invested funds. DB had a no action letter for position limits that allowed for the tremendous growth. in these funds. Without the position limit exemption, there would have been a large constraint on the growth of these ETF's in the grain markets.

There is no question that allowing for position exemptions creates the potential for an imbalance of longs and shorts in the market. Grains are different form oil. The market is not as big. Imbalances will always be corrected in the simplest way, prices will move. The increase in ETF passive buyers will have potential risks. If prices are moving higher and there is more interest in ETF's, there will be increased buying pressure in up market and when sentiment changes the potential for increased selling pressure on the downside. This will increase overall market volatility which may lead to welfare reducing effects. If there is less certainty about price, there will be less usefulness for futures as a hedging tool. It is in the public's interest that the regulator investigates this issue. However the exact behavior in prices is not clear. Having more buyers in the market also allows for more hedgers to enter the market.

A look at prices shows that we is more than 50% down from its highs and below levels seen two years ago. For soybeans the decline has been less dramatic but also large. Prices have fallen from $15.5 to current levels of $9.78 / bushel. Corn is closing in on the Fall 2006 range. This is happening while ETF's have continued to grow.

Now ETF's like commodity indices will often follow specific rules for rolling contracts and for hold exposures outside the delivery month. Their impact should have clear distortions near rolls and delivery. The evidence on whether this has had a price impact has been mixed. It would seam that that a change in policy should be discussed but only after there is a careful review of the facts in this case. The CTFC should provide the economic evidence on why this makes sense and what will happen when this new exemption takes place.

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