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Disruptions in Financial Markets. A critical analysis of speculation. “It is generally agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges.” - John Maynard Keynes. 1. Market behaviour. The client’s behaviour
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Disruptions in Financial Markets • A critical analysis of speculation
“It is generally agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges.”- John Maynard Keynes
The client’s behaviour • The market-maker’s behaviour • The arbitrageur’s behaviour • The speculator’s behaviour
« For example, if I'm long one thousand S&P contracts and it's 11:30 Chicago time, I'm probably going to want to put in some sort of scale-down buy orders, like buying ten lots every tick down, to hold the market in my direction. It doesn't cost me that many contracts at that time of day to support the market, because there are not a lot of contracts trading. The longer you can keep the market up, the better off you're going to be. » Monroe Trout in The New Market Wizards: Conversations with America's Top Traders, by Jack D. Schwager
CFTC (Commodity Futures Trading Commission): « a trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements. » • Speculation is a directional bet engaged to profit from fluctuations in the market value of a tradable good • Lord Adair Turner (former head of the FSA) regards it as entirely socially useless as a financial activity
The successful campaign to allow speculation (1850-1890): • The articles of law that prohibited speculation in France were repealed or amended by the Government of Jules Ferry in 1885, the same year he launched the French colonial empire. • Article 421 of the Criminal Code stated that: “Wagers made on the rise or drop of securities are liable of penalties listed under a. 419” • Article 1965 of the Civil code stated that: « The law provides no remedy against a gambling debt or for the payment of a wager ».
Short selling • Credit Default Swaps (CDS) • Carry trade • High Frequency Trading (HFT)
« You have asked the question “Are Institutional Investors contributing to food and energy price inflation?” And my unequivocal answer is “YES.” In this testimony I will explain that Institutional Investors are one of, if not the primary, factors affecting commodities prices today. Clearly, there are many factors that contribute to price determination in the commodities markets; I am here to expose a fast-growing yet virtually unnoticed factor, and one that presents a problem that can be expediently corrected through legislative policy action. » Michael W. Masters Managing Member / Portfolio Manager Masters Capital Management, LLC - 20th May 2008
« No one has been able to accurately and consistently forecast oil prices, not oil companies, government, or people on Wall Street. However, this lack of reliable oil price forecasting has created a vacuum that has been filled, in my view, by financial players with very short investment horizon, which significantly increased the price volatility. Globalization of the financial market, ease of trading, rapid movement of large sums of capital, information overflow, and increased global tension have created an ideal environment for excessive speculation in the world market. » TESTIMONY OF FADEL GHEIT, MANAGING DIRECTOR AND SENIOR OIL ANALYST, OPPENHEIMER & CO. COMMITTEE ON ENERGY AND NATURAL RESOURCES - 11th December 2007
« Oil price volatility has attracted a large and growing number of speculators seeking the highest profit in the shortest time. Vola- tility, however, has an adverse impact on the oil industry because it increases uncertainty and distorts market fundamentals, which could result in poor investment decisions in securing adequate sup- ply to meet world growing demand for oil. » Fadel Gheit, ibid
The measures proposed by Fadel Gheit to regulate oil trading by financial players: • setting limits on the number of oil contracts by each account; • establishing a minimum holding period to hold these contracts; • preventing conflicts of interest by financial institutions; • imposing stiff penalties on violators, including minimum jail sentences.
Hedging to offset or reduce the risk of price fluctuations • Exchange-traded versus Over-the-counter (OTC) • Bypassing quotas of speculators: the Swaps loophole / Wolf in sheep’s clothing
Speculation is justified by the fact it provides "liquidity". What do we mean by « liquidity" and does speculation provide it? • Protection against slippage • The trend following strategy
2/ Increased volumes and prices on futures markets for commodities.
3/ Crude oil prices on the futures market and volume of swap positions on the commodity futures index
4/ Amount of investments in commodity futures indexes superimposed on oil futures prices.
« Investment in agricultural R&D was slashed: it grew at 2 per cent per year through the 1980s, but since 1990 has shrunk by 0.6 per cent per year. {…} Another change was that research was increasingly privatised. Companies prioritised research that would boost profits, whether or not it improved yields. For example, they developed hybrid maize, but not wheat, because the flowering mechanism of maize makes it easier for companies to exert patent control over its seeds.» Debora MacKenzie, « What price more food » New Scientist, June 2008
