Commodity Speculation or Market Power?

After seeing how much Goldman profited from selling MBS that they knew were junk, it's hard to feel sorry for Goldman receiving so much grief for its commodity storage and trading activities.  The worry seems to be that because Goldman has become increasingly involved in commodities markets that they must be manipulating prices for profit, and in the process pushing prices away from their fundamental values---ie., supply and demand.

Do we actually know whether there is a problem here? It's possible that Wall Street is trying to manipulate the market.  But this is a hard thing to do, even for a really big company, especially one that doesn't produce the stuff it's trying to monopolize.  Also bear in mind that anyone can buy and store commodities, so it's not like there are huge barriers to entry.  Those who have tried to corner commodity markets in the past haven't fared well.

My sense is that cornering a commodity market via hoarding is basically impossible once the market realizes what the major player(s) is doing.  And if they're having senate hearings about Goldman's storage and trading activities, I think it's fair to say the cat's out of the bag.

So, what is Goldman doing? If it's not a market power story I'd guess they're trying to buy low and sell high, just like everybody else. They probably believe they have a better handle on market fundamentals than other commodity speculators.  Perhaps they do.  But if this is all they are doing, then they are effectively reducing price volatility and helping to make the market work more efficiently.

On public radio this morning a reporter (sorry, I forget who), asked Omarova whether Goldman's profits just meant that consumers were paying higher prices.  Omarova said "that's absolutely right." But it's absolutely wrong if Goldman's just speculating.  Goldman's profits are coming out of the pockets of speculators who bet prices would fall when they rose, and vice versa.  In fact, that's probably the case if it's a market power issue too.

Anyway, if this is about Goldman trying to corner the storage market, that's a problem and Goldman deserves the grief they're receiving. But that strikes me as unlikely as it would be foolhardy.  My guess is that this is just speculation, which means Goldman's profits translate directly to better allocation of commodities over time, less commodity price volatility, and basically zero influence on average prices.


  1. speculators who step in to assume market risk—as temporary buyers or sellers—in exchange for a profit opportunity. If they did not exist, speculators would need to be invented in order for futures markets to function.

    But the same cannot be said about commodity index traders who, on average, hold eight times the position size of large speculators. Commodity indexers would have you believe that theirs are benign passively-managed positions, which are simply roll forward as futures contracts expire, without affecting prices. The truth, as the chart below illustrates, is that commodity index traders show the same momentum trading pattern as speculators, adding buying pressure to rising prices and selling pressure to declines. Despite the fact that commodity indexers are long-only traders, their trading shows high volatility than speculators. Any commodity price movement or volatility caused by speculators is magnified two-and-a-half-fold by commodity index traders.

    Commodity Index Traders outpaced CTA’s since 2009 commodity bottom

    Who are these outsized traders?
    And how do they circumvent position limits designed to prevent market manipulation. According to International Swaps and Derivatives Association, 70% of commodity index long futures contracts are held by just four large banks (Bank of America, JP Morgan, Goldman Sachs, and Citibank). In 1991 the futures market regulator, The Commodity Futures Trading Commission (CFTC) was convinced to grant these swap dealers trading limit exemptions previously reserved for actual commodity producers and processors who had real inventory to hedge. The four big banks use futures markets hedge commodity index swap agreements made with commodity index, pension, sovereign, and other funds who wish to add a commodity exposure to their portfolios. ...
    [[Should let u know that Goldman is not the only 'bank' which has storage facilities -- There's a decent WSJ article from a few years ago which touches on this, and why [such as shape of forward curve, etc. But u can bet more goes on than simple spec. Deep look into Minneapolis Xchange can be worthwhile.]]

    1. Juan,

      I understand that Wall Street has become a lot more engaged in commodity markets. It make sense for them to do that as it is an excellent diversification strategy, as commodities tend to have little correlation with stocks. Gary Gorton and coauthors pointed this out awhile back and this seem to have some influence. But I don't understand why this growth in commodity trading is a problem.

      (1) I don't understand how commodity index traders can change average price without physically holding commodities.
      (2) If they are holding physical quantities (like Goldman Sachs), I don't see how they can change average price without perpetually growing their hoard, and I don't see any evidence that they are doing this.
      (3) how commodity traders can change price volatility while always holding long positions, and not lose money.
      (4) If commodity traders are making money, they must be buying low and selling high, and this would reduce volatility by making highs and lows a little less extreme.

      So, what am I missing?


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