The Commodity Futures Trading Commission was given broad powers – by last year’s Dodd-Frank Wall Street Reform and Consumer Protection Act – to restructure the futures and over-the-counter derivatives markets. And Gary Gensler, appointed to chair the commission in May of last year, is known to be something of an activist.
So far, however, there has been a lot of talk, a lot of hearings have been held, but little of consequence has been forthcoming.
That will change. We just don’t know when.
One of the key questions the CFTC has been grappling with is the implementation of position limits in futures trading, designed to put the clamps on speculation in agriculture, metals, and energy.
The proposal for new regulations in this area came about largely because of widespread public outcry over the role speculators played in the huge 2008 run-up in oil prices. Or, rather, the role they were perceived to have played. The leading causes of that price spike are by no means settled.
Apart from energy, there has also been a long-standing campaign by the Gold Anti-Trust Action Committee (GATA) and others, to get the CFTC to investigate market manipulation in the gold and silver futures markets by the large bullion banks. (Those interested in this issue can subscribe to our free publication, GATA member Ed Steer’s Gold and Silver Daily.)
GATA maintains that a few banks’ short positions in the precious metals are a naked attempt to keep the price from rising too far, too fast. And, not incidentally, to make a lot of money for the banks when they push prices down. The banks, however, say that they are merely doing necessary hedging.
Whatever the case, there is no question that a very small number of banks are short massive amounts of gold and silver in the futures markets, nor that there is a real lack of transparency here.
Position limits would change that, decisively. Banks, once they exceed the imposed limits, would be required to report exactly what they are doing. If they can show that their activity involves taking legitimate hedge positions, they would be allowed to do so. But if instead it’s entirely speculation, they would be required to unwind those positions in excess of the limit.
Opponents of position regulation, including many commodity traders and investors, have struck back, arguing that limits will never rein in surging commodity prices and could instead have an opposite effect. By restraining volumes, they could make those prices even more volatile.
“Position limits are a dangerous cure for an imagined disease which even its proponents admit has never been diagnosed or detected,” says Michael Cosgrove, a managing director with brokerage GFI Group.
But even the most vociferous of opponents probably realizes he’s fighting a losing battle at this juncture.
At its December 16 meeting, the CFTC introduced its position limit plan. But then, Chairman Gensler abruptly postponed a vote on the proposal. At least three of the five commissioners must vote in favor of issuing the plan for a 60-day public comment period. After that, the measure will be revised accordingly, and a separate vote will be needed to finalize it.
Gensler and fellow commissioner Michael Dunn were known to have favored voting to release the plan, while commissioners Jill Sommers and Scott O'Malia had voiced concerns about the speed of reforms and a lack of information about the proposals, and likely would have opposed.
The swing vote belonged to Bart Chilton, the most outspoken and flamboyant CFTC member. Chilton is a longtime proponent of hard position limits. Nevertheless, he said he would have voted no in December, because the proposal included a two-step approach to allow more time for the agency to gather information on the opaque swaps market. And in Chilton’s opinion, “we need to address excessive speculation in these markets immediately.” Thus Gensler’s decision to terminate the meeting without a vote.
That meant the CFTC would fail to meet the mid-January Dodd-Frank deadline to implement position limits. But that is apparently not a problem, unless the commission is hopelessly stuck. Which it doesn’t appear to be, as Chilton told the media last Tuesday that he has relented and “will now support publishing a position limit proposal for public comment,” while continuing to push for more immediate action.
With three votes in the fold, the CFTC’s way is clear to act at once, which it could do. Or it could wait until the next regularly scheduled rule-making meeting, slated for January 13.
As the process creaks slowly forward, Gensler has agreed to instruct CFTC staff to implement Chilton's suggested "position points" system until a true position limit plan is in place. Under the points system, if a trader’s holdings in a commodity reach a certain threshold, that triggers heightened regulatory scrutiny by the CFTC, and the possibility that commissioners could vote to require the trader to reduce his holding.
Though the points system is intended as an interim measure, many traders feel that it is preferable to a system of fixed limits, and that it could accomplish the desired ends without the negative unintended consequences. Probably won’t happen.
If, as seems highly likely, hard position limits come to commodities futures trading, what are the implications for us as investors?
Of course, we’re opposed on general principles to further marketplace meddling on the part of government. And we recognize that this could be just another clampdown on free trade, one that sets the stage for price controls in the future, if not a complete governmental takeover of commodities markets (on national security grounds, of course), along with the possibility of outlawing private ownership of gold á la 1933.
Ominous, indeed. Yet in the short run, these changes may well prove to be to our benefit. There will be an increase in transparency, at least hopefully. Market transparency is good. We should be able to make better decisions if we can see what other players are doing in the areas we’re investing in.
That should also help demystify commodities markets, especially precious metals, for average investors, and draw them in. The more people participate in our favorite markets, the better for our own investments.
Then there’s the matter of those short positions. If GATA and other critics are right, the bullion banks have built themselves a house of cards that depends on being able to manipulate the market without restriction. Put on limits and the house comes tumbling down. The banks could be forced to unwind positions at whatever price they can get. And that means an appreciation in gold and silver that could be jet-fueled.
No matter what, a change this fundamental is bound to have repercussions of some sort. Stay tuned. It’s gonna be an interesting year.