Tuesday, April 04, 2006
Futures and Volatility
I'm glad to see people responding to the post on the Oil ETF. I see it as one of the more important macro issues to hit the markets in some time.
When the Gold ETFs came out, it took a while before they took off, but then cash market and the ETF began feeding off each other over the past six months or so. Rising gold prices attracted more money to the ETFs, pushing gold prices higher, attracting yet more investment. All the usual indications of a speculative bubble. But I also believe that the ETFs are filling a demand for diversification that is providing an increased level of demand for gold that will put a floor on gold. In other words, some of the money that's came into the market is inelastic and will stay invested even if things get crazy.
Oil on the other hand, not be a store of anything, wouldn't share the same level of inelasticity. But, I also doubt it will be as popular as the GLD has been, because this first Oil ETF offering is being put out by a relatively unknown outfit.
When the big boys get one going (I think Barclays is working on one), then it could really take off.
I have mixed emotions about such ETFs. Investors hypothetically can go long and short most ETFs, but I've heard and read stories about people brokers not lending shares in many ETFs, making them hard to short (though not on the "hard to short" list). And the reality is most of the investors buying such ETFs are long investors. So basically the ETF opens up the NYMEX oil futures contracts to every return chasing average Joe with an Ameritrade or ETrade account.
This will no doubt have negative ramifications, especially initially. Keynes wrote about keeping market costs just to keep average people and their closed-eyed speculative ways out of the markets. The late 90s were the result of costs and barriers falling. There were obvious negative ramifications. But I believe Keynes was wrong andt there have been more overall positives than negatives.
I like the idea of choices for everyone and markets being open to everyone. I suspect that it will get ugly for a while and then over time normalize just as stocks have done after the bull market of the late 90s.
The biggest thing to fear with oil, however, is the trickle down inflation that oil can cause. With gold this is not a concern. Most things made with gold are inessential. Gold is either frivolous jewelry or investment. There's not much in the way of industrial dependency. But oil goes into all kinds of things.
One of the big problems with oil is that a relatively few massive companies control every point on the distribution system. If they can't profit on oil production they make it up on finished products. Companies can absorb a refining squeeze when they're getting rich on the production end. Valero, the biggest refiner, doesn't produce oil, but it owns a big chunk of the country's pumps.
I question whether having a speculative market for oil at all is a good thing. Perhaps the problem is in the ability to close contracts on cash. If all contracts were deliverable, there would be far less speculation.
Steel is one of the most important commodities, though a semi finished product, there is, right up there with oil, and the distribution system did just fine without a speculative market. Steel prices have also risen sharply in recent years, but prices steel prices are heavily influenced by energy prices, coal from which coke comes, India has a futures market that's trading contracts on millions of tonnes, and there's a small cash only market called the Birmingham Futures Exchange. There's some push for a big steel contract. Proponents have pointed to recent price fluctuations as showing a need for a futures market. But it looks to me like the price fluctuation correlates closely with the volatility in other commodities used in the steel production process and those commodity's prices are influenced heavily by the speculative aspect of their futures markets.
posted at 12:48 PM
