Comment Text:
March 28, 2011
Mr. David Stawick
Secretary, Commodity Futures Trading Commission
Three Lafayette Center
1155 21st Street NW
Washington, DC 20581
Re: Position limits
We are submitting the following comments on the Commission’s Notice of Proposed Rulemaking (NOPR) for Position Limits in Derivatives issued on 13 January, 2011. We have jointly and separately published dozens of academic studies on commodity futures markets. In particular, we have conducted several studies in recent years on the possible impact of speculation, and index funds in particular, on commodity futures prices. A complete listing of these studies can be found in the bibliography of our paper recently published in the academic journal Applied Economics Perspectives and Policy. This paper is available for free download at the following website: http://aepp.oxfordjournals.org/cgi/reprint/ppq032?
ijkey=IB45HstyS3UlRq8&keytype=ref .
We begin by referring to comments made by Commissioner Dunn at a hearing on 13 January 2011. These remarks are indispensible in clarifying the most pertinent questions regarding the NOPR:
With the passage of the Dodd-Frank Act the CFTC now clearly has a mandate to set position limits on commodity markets and the OTC markets, as appropriate, to diminish, eliminate, or prevent excessive speculation. To date, CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the markets we regulate or that position limits will prevent excessive speculation. The task then is for the CFTC staff to determine whether position limits are appropriate. With such a lack of concrete economic evidence, my fear is that, at best, position limits are a cure for a disease that does not exist or at worst, a placebo for one that does.
If there is more than anecdotal evidence that there is excessive speculation distorting the prices in our markets, we need to see it. If there is statistical or economic analysis that shows that excessive speculation exists and that position limits will diminish, eliminate, prevent it, we need to see it. If there is evidence that position limits will lower the price that we pay for gas, milk and steak while simultaneously insuring the integrity of our markets and the price discovery process, we need to see it. Only after all these questions have been answered will I be able to determine whether or not position limits are appropriate.
As Commissioner Dunn so clearly states, the key question is whether the empirical evidence does or does not support a conclusion that speculation in the recent commodity price boom was excessive and led to distorted prices. There is no doubt that “speculation” in the form of investment in long-only commodity index funds soared over the last decade. Those who believe index funds were responsible for a bubble in commodity futures prices argue that the sheer size of index investment overwhelmed the normal functioning of these markets. Those who do not believe index funds were behind the run-up in commodity futures prices in recent years point out logical inconsistencies in the bubble argument, as well as several contradictory facts.
A number of academic studies have been completed recently in an attempt to sort out which side of the debate is correct. We review and summarize the results of these studies in the aforementioned paper published in Applied Economics Perspectives and Policy. Our review found one group of studies containing empirical evidence that commodity index investment directly or indirectly had an impact on commodity futures prices. However, the data and methods used in these studies are subject to a number of important criticisms that limit the degree of confidence one can place in their results. Another and larger group of studies fails to find systematic empirical evidence of a relationship (statistically or economically) between positions of index funds and the level of commodity futures prices. These results are robust across combined on- and off-exchange index fund positions, netted or non-netted swap dealer positions, and individual exchange-traded fund (ETF) positions, as well as a variety of statistical tests, sample periods, and time horizons.
Even if one ignores the data and methodological concerns with the first group of empirical studies, the weight of the evidence is not consistent with the argument that index funds created a bubble in commodity futures prices. Whether the wave of index fund investment simply overwhelmed normal supply and demand functions, channeled investors’ views about commodity price directions, or integrated financial and commodity markets, the linkage between the level of commodity futures prices and market positions of index funds should be clearly detectable in the data. Very limited traces of this linkage are visible, however. To date, no “smoking gun” has been found. Moreover, results of studies that test for a bubble component in commodity futures prices – regardless of the cause – are decidedly mixed. Therefore, it is unclear if there was a bubble in commodity futures prices in recent years, and even less clear whether one was caused by speculative index fund investment.
In sum, the available empirical evidence does not support a conclusion that speculation in the recent commodity price boom was excessive and led to distorted prices. Consequently, new limits on speculation are not grounded in well-established empirical findings and could impede the price discovery and risk-shifting functions of these markets. In particular, limiting the participation of index fund investors would diminish an important source of risk-bearing capacity at a time when such capacity is in high demand. Commodity futures markets would become less efficient mechanisms for transferring risk from parties who don’t want to bear it to those that do, creating added costs that ultimately get passed back to producers in the form of lower prices and back to consumers as higher prices. Moreover, new speculative position limits in futures may simply push index fund investors into physical commodity markets, where index investments would not be subject to speculative futures position limits. Index fund positions in physical (cash) markets would provide a much more direct means by which financial investors could impact price discovery and stockholding in commodity markets; seemingly not the desired outcome of the regulatory drive to limit futures speculation.
We appreciate the opportunity to comment on the proposed NOPR. If we can provide further information or feedback to the Commission, please don’t hesitate to contact either one of us.
Sincerely,
Scott H. Irwin Dwight R. Sanders
Laurence J. Norton Chair of Agricultural Marketing Professor
University of Illinois at Urbana-Champaign Southern Illinois University
