Issue 4: Will position limits help reduce price volatility?

The evidence is overwhelming that position limits are, at best, unnecessary and may, at worst, negatively impact commodity markets and users. Numerous studies have been conducted by government agencies and others into commodity price volatility. Little, if any, support exists for the idea that speculation causes that volatility or that position limits curb speculation.

The Economist

  • “There is good reason to worry that position limits will harm markets more than help them…Investors will become pickier about the contracts they enter into as a result of the limits, which may cause markets to become less liquid, worsening volatility rather than reducing it.”

EDHEC-Risk Institute Paper

  • “…proposals in restricting speculation fall somewhere in the continuum of being a placebo to actually being harmful to the goals to which they aspire.”

IMF Report

  • “…although financialization may have led to increases in co movement between some commodities, particularly gold, no apparent systematic connection is found to either price volatility or price changes. These findings are consistent with recent studies in the area by the CFTC. Thus, there is little evidence to suggest that trading in futures markets has driven the price run-up or has destabilized the commodity markets during the first half of 2008.”

Explorations in Economic History Paper, Simon Fraser University

  • “…futures markets were associated with—and most likely caused—lower commodity price volatility.”
  • “The fundamental result of this paper is that futures markets are systematically associated with lower levels of commodity price volatility.”

The Oxford Institute for Energy Studies Analysis

  • “…even if there is a adverse effect arising from the entry into the market of a class of pure financial investors, limiting the percentage of any one contract that can be held by any one investor would not be an effective response, since multiple investors each holding positions below the percentage limit could, conceivably, still have a large aggregate effect.
  • Nor would it make sense to calibrate a regulatory regime which seeks to limit the participation of one class of investor given that, as we noted earlier, medium-term market expectations affect prices through the position taking of both commercial and financial participants.”
  • “The key focus for public policy makers should be medium-term price trends because of the potentially harmful economic impact these can have. However, we consider the objective of controlling medium-term price movements through financial market regulation alone to be both misaligned and unachievable. This is because the financial regulatory tools currently being considered, such as position management techniques (including position limits), would not have a meaningful impact on this key issue. The overall conclusion is that, if there are policies which can make a difference to the key economic issue they would have to address the fundamental drivers of instability, rather than issues solely related to the operation of the financial markets.”

European Commission Agriculture and Rural Development Markets Brief

  • “There is a general consensus that both higher output and input prices in agriculture are here to stay. Price volatility has increased markedly and is also expected to remain high, at the same time as productivity growth has slowed down. Based on our analysis it is clear that changes to the fundamentals of agricultural markets have contributed to upward pressure on prices and go some way towards explaining the rise in price volatility but they do not give the full picture. The link to developments in other commodity sectors should be explored further.
  • “Since the causes of price volatility are multiple and varied, this does not lend itself to simple solutions. Despite some common factors that appear to be at play across and beyond commodity markets, there are specific factors related to agricultural production (linkage to food security and the environment, dependency on life cycles, weather and seasons, sanitary conditions) which further complicate the potential impact of policy. The scope for agricultural policy measures to address the causes of agricultural price volatility is further constrained by the presence of price co-movement across commodities. In the short term, efforts should be concentrated on improvement in market transparency particularly on public stocks and dissemination of relevant information throughout the food chain, which could play a significant role in reducing price fluctuations. In the longer term, the sustainability and competitiveness of agriculture depend upon innovation and agricultural productivity growth.”

Michael V. Dunn Opening Statement

  • “There has been the suggestion by some that once we set position limits on physical commodity derivatives, the price that we pay for gas, bread, milk and other things would inevitably drop, and that volatility in commodities markets would simply cease to exist. I believe this is a fallacy.”
  • “Price volatility exists in markets that have position limits and in markets that do not have position limits. Price volatility exists in markets that have substantial participation from index funds and markets that do not have any index fund participation whatsoever.”
  • “As Nobel Prize winning economist Paul Krugman pointed out in a recent editorial, price volatility exists in our markets because we live in a “finite world” where there is not, at any given moment in time, an inexhaustible supply of oil, wheat, milk or other physical commodities to meet the global demand for such products. Simply put, sometimes prices are higher because the demand for a product around the globe is greater than the supply.”

OECD Technical Report

  • “The policy implication of the available evidence on the market impact of commodity index funds is straightforward: current regulatory proposals to limit speculation—especially on the part of index funds—are not justified and likely will do more harm than good. In particular, limiting the participation of index fund investors would rob the commodity futures markets of an important source of liquidity and risk-absorption capacity at a time when both are in high demand. More ominously, tighter position limits on speculation in commodity futures markets combined with the removal of hedge exemptions could force commodity index funds into cash markets, where truly chaotic results could follow. The net result is that moves to tighten regulations on index funds are likely to make commodity futures markets less efficient mechanisms for transferring risk from parties who don’t want to bear it to those that do, creating added costs that ultimately are passed back to producers in the form of lower prices and to consumers as higher prices.”

Craig Pirrong, The Wall Street Journal

  • “Restricting these speculators won’t reduce the price of oil — but they are likely to make consumers and investors worse off. Futures and swap markets facilitate the efficient management of price risks, and speculators are an important part of that process. For instance, a producer of oil may want to lock in the price at which he sells his oil in the coming months in order to hedge against fluctuations in its price. He can do so by selling a futures contract at the prevailing market price. Similarly, an airline can protect itself against price increases next summer by buying today a futures contract that locks in a purchase price for next July.”
  • “Restricting speculation would increase the costs that producers, consumers (such as airlines), and marketers (such as heating-oil dealers) pay to manage their price risks by reducing the number of traders able to absorb the risks they want to shed.”
  • “More restrictions and regulations of energy markets, in the vain belief that such actions will bring price relief, are counterproductive. They will make the energy markets less efficient, rather than more so.”

Dwight R. Sanders and Scott H. Irwin, New York Times

  • “Current legislative proposals might similarly curtail speculation by reducing the volume of trade, but it is unlikely that they would cure the “problem” of high prices. The measures, however, are likely to hurt the ability of futures markets to accommodate businesses that need to manage price risks.”
  • “First, recent price increases do not neatly fit a bubble explanation. For example, livestock and meat futures markets did not experience price increases until recently, yet the concentration of speculative buying has been among the highest in these markets for some time. It is difficult to see why speculative buying would have an impact on some markets and not on others.”

Marketing and Outlook Research Report, University of Illinois at Urbana-Champaign

  • “Proposals are once again surfacing to increase margins in an effort to curb “harmful” speculation in futures markets. Such policy decisions aimed at curbing speculation may well be counter-productive in terms of price levels or market volatility. In particular, these policy initiatives could severely compromise the ability of futures markets to accommodate hedgers and facilitate the transfer of risk.”

University of Muenster Working Paper Series

  • “…whether the speculative impact on conditional volatility has increased…with respect to six heavily traded agricultural and energy commodities, we do not find robust evidence that this is the case. We thus conclude that the increasing finanancialization of raw material markets has not made them more volatile.”

OECD Food, Agriculture and Fisheries Working Paper

  • “…While the increased participation of index fund investments in commodity markets represents a significant structural change, this has not generated increased price volatility, implied or realised, in agricultural futures markets. Based on new data and empirical analysis, the study finds that index funds did not cause a bubble in commodity futures prices. There is no statistically significant relationship indicating that changes in index and swap fund positions have increased market volatility.”

Madison Marriage, Financial Times

  • “‘these rulings, in particular on commodity position limits, may cause liquidity to decrease, which could result in increased price volatility [and] increased trading and risk management costs.’”
  • “…position limits would ‘impede the ability for market participants to properly hedge their investments. This risk will ultimately be born by the general public and their public pension plans.’”
  • “…this is a ‘very good example’ of how regulatory uncertainty creates unnecessary financial burdens. ‘[Firms] had to prepare for the implementation of position limits [which] required extensive internal and external resources. This was a huge waste of time and money for managers and dealers.’”