JP Morgan Wins: CFTC Position Limits Do Not Apply (To Them)

ChrisMartenson.com ^ | Friday, January 14, 2011 | Chris Martenson

[Attention Surplus Disorder]

Speaking of changing the rules...

Gold and silver are now down hard over the past two days, and the reason may have something to do with the fact that the CFTC utterly caved to JPM in their long-awaited decision on position limits in a 4-1 vote.

While position limits will eventually be set, maybe, someday, the course of action taken by the CFTC grandfathers in JPM's (and HSBC, et al.) current outlandish positions.

Here's the background (emphasis mine):

On July 21, 2010, the Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among other things, the Dodd-Frank Act amended the Commodity Exchange Act to:

•Require the Commission, as appropriate, to limit the amount of positions, other than bona fide hedge positions, that may be held by any person with respect to commodity futures and option contracts in exempt and agricultural commodities traded on or subject to the rules of a designated contract market (DCM). •Require the Commission to establish position limits, including aggregate position limits, for swaps that are economically equivalent to DCM contracts in exempt and agricultural commodities (collectively, economically equivalent swaps). Such limits must be imposed simultaneously with limits on DCM contracts. (Source)

The only wiggle room in the Dodd-Frank bill is for "bona fide" hedge positions, which, I should state, I think is not a good idea because the exact definition of a 'bona fide hedge' is elusive.

For example, you and I could decide to engage in a massive short-hedged position where you short a commodity but buy calls from me. Your 'hedge' is only as good as my credit...........

[Attention Surplus Disorder]

Interesting article about the recent activity in Ag and Au, especially silver.

Chris Martenson is the author of "Crash Course", an utterly superb presentation on things economic (with the exception of its 1% global warming content) which is findable both at the linked location or by searching for 'crash course'. "Crash Course" gets my highest recommendation as a background presentation on our historic, current and likely future economic situation(s).

[phockthis]

big surprise...

[SAJ]

The immediate result? Look for a replay of the quasi-index fund game that was prevalent between 2000 and 2008, and which was, effectively, **solely** responsible for driving the price of WTI crude to $147.

Except this time, look for similar run-ups to occur in food commodities, specifically ANY crop/mkt that seems as if there will be a substandard worldwide crop this year. Wheat may be the principal suspect this year, given Aussie floods. Soybeans are probably second on the list, given Argentina's crop (and governmental) problems.

Good trading to you, m'FRiend!

[proxy_user]

I don’t have technical knowledge of how commodities futures contracts are held - but aren’t many of the contracts that appear to be own by JPMorgan actually owned by their customers, and held in the JPMorgan name only to make it easier to trade?

If you looked at the stock market, it would look like all the stock was owned by Fidelity and Merrill Lynch, but that is really not so.

[djf]

Problem is, if the longs demand physical, JPM gets squeezed. They either deliver or go for a cash settlement.

And it’s the longs who decide how much, not JPM.

[grey_whiskers]

A good question from the discussion of the linked article:

This probably a noob question, but do these position limits (or any pre-existing ones) also limit the speed or rate at which you can purchase or sell your position? In other words, can JPM, HSBC, etc, exit their most or all of their position and pile into another one at a moment's notice? And if there is a limit is it a direct limit, or an indirect one (like all trading stops after X percentage change in a single day)?

I'm just trying to get an idea how quickly this situation can realistically turn around when it eventually happens (whether weeks, months, or years from now).

Your comments, FRiend?

[Attention Surplus Disorder]

"Problem is, if the longs demand physical, JPM gets squeezed. They either deliver or go for a cash settlement.

And it’s the longs who decide how much, not JPM."

I don't agree with that. I consider myself pretty knowledgeable about the silver market but in no way am I claiming I know more than you or anyone else, and that's not the purpose of my reply.

What you say is absolutely true, in an empirical sense in a market that actually works on physical delivery. But it is far from true in a market where probably less than 1% of longs demand delivery. It's also far from true in a market where less than 5% (complete guess) of longs have anything approaching the financial capability to demand delivery. Meaning, even if every long decided to take delivery, only a miniscule pctage of them could do so no matter how much they wanted to, based upon their particular financial capability. OH YES! If all longs wanted delivery, it would create a short squeeze...maybe even a planet-shifting short squeeze...but this is simply not a condition that reality will decide to conform to...because it pretty much can't.

[djf]

But in a sense it’s fake money and doesn’t cost the longs a dime.

Because if they know JPM (or one of the other big bullion banks) are not going to be able to deliver and will be forced to settle the contract for base + say, 10%, then what to stop them? They could hand a check to JPM, say “Where’s my silver?”, then stand there while JPM hands their check back and writes another check as a premium to settle.

[Attention Surplus Disorder]

That’s an interesting “what if” you point out but I seriously doubt that possibility is true. I wish I could give you a detailed explanation of why I think that way but I can’t.

JPM is also said to own 90% of existing copper contracts at the present time.

[SAJ]

Lots of topics there, guy!

First, position limits only ever apply in futures mkts. They do not apply in stock or bond mkts. Second, there are some futures mkts (currencies, e.g.) that do not and never have had position limits. Position limits were established, generally, in physical commodities at the beginning of the last century as a (very effective) means of preventing 'corners', which were quite a scandal at the time. See Frank Norris' book "The Pit" for a fictional but decently accurate description of the cornering process.

Now, regarding rapidity of trading. The big players DO have a speed advantage in futures mkt, but this advantage is somewhat diminished by the increasing popularity of e-trading. Assuming only the existence of a sufficient number of players in a particular market at a given moment, in theory JPM or whoever could liquidate a limit position in, say, crude (20,000 1000-bbl contracts) and turn around and put on a limit-size position in, say, coffee (used to be 10,000 37,500 lb contracts, don't know what it is now) in about a minute. Might be less by now, likely is. Ordinarily, however, a big player would NOT trade in this fashion, and would strongly prefer to "scale in" and "scale out" the orders, i.e. do a chunk at a time, X number of times so as not to move the market a lot.

The problem of tracking intra-day violations of position limits is and has been a tricky one for years. I knew several belly traders who, in the heyday of the belly pit, late '70s or so, routinely violated position limits during the day, but did get their positions back within limits by the close.

The 'situation', as you call it, will only ever turn around when position limits are enforced on everyone who is not a legitimate hedger. The notion that JPM and Goldman are legitimate hedgers because they run self-created "index" funds is a self-serving crock, no more and no less. CFTC should be disbanded for making this ruling.

Hope that answers your questions. If not, fire away, and I'll have another go.

FReegards!

[Attention Surplus Disorder]

You are implying that a civilian can win a game of chicken with JPM! Man oh man, I wouldn’t take that bet.

I have never done it, but from what I hear, taking actual physical delivery from an actual COMEX warehouse is not especially cost effective. You have to hire vault managers and Brinks armored cars and things like that versus taking your profit and going and buying your silver elsewhere. So...this idea that a universe of silver “bugs” could somehow just unite against JPM in sprit and intention, but furthermore agree to a few hundred add’l bucks in various “frictions” for the purpose of taking delivery of the same item that they can buy over here, for less...seems far fetched. I suppose it’s possible.

[djf]

I think the way it is going to play out is a disconnect from the quoted price and the real, true, man-on-the-street price.

At the end of the day, the papers might tell you “Silver costs x$”, but you won’t find anybody willing to sell you physical for X$

[grey_whiskers]

Ordinarily, however, a big player would NOT trade in this fashion, and would strongly prefer to "scale in" and "scale out" the orders, i.e. do a chunk at a time, X number of times so as not to move the market a lot.

I believe I've read in the last couple of years, that the big players were working on algorithms to "stealthily" sell of large lots (in such a way that the very high frequency trading system algorithms were not triggered). Secondly, I have read of talk of "dark pools" at least for stocks -- do you know if there are such for commodities?

Thanks again for your insight.

Full Disclosure: Long silver, mainly 'cuz I think fiat currencies are going to inflate over the next couple of years. If it looks like Sarah and / or Bachmann will win the White House in 2012, along with the GOP taking the Senate, I may go long on US stocks, particularly defense contractors.

Cheers!

[SAJ]

JPM and Goldman, et al., create "index products". Why? Because some people aren't allowed, by law, to trade futures but ARE allowed to trade indicies such as DJIA, SP500, and so forth.

Who are these people, you ask? Oh, some nobodies such as the Harvard University Endowment, CalPERS, and numerous pension funds, among others. But, they decide they want to get into commodities, and approach (say) Goldman Sachs.

Goldman says, "No problem, gents. Here's what we'll do." and creates -- like as not for that one client, but that's another story -- the "Goldman Harvard Index", or some such name. Usually, to avoid regulatory problems, this "index" will consist of several commodities. The number-crunchers do their thing, and pretty soon Harvard owns 200,000 units of this "index". Note that HArvard and CalPERS and these chaps play from the long side ONLY...typically but not always because they are required by law to do so, no shorting allowed.

Goldman, being a bunch of very sharp chaps, of course hedges their sale of this "index" product by buying the requisite number of futures contracts in the various mkts represented in their "index". Harvard gets to play in the futures mkts, Goldman makes a nice, fat fee, what's not to like, eh?

What's not to like is this: by this type of sleight-of-hand, Goldman has introduced a WHOLE LOT of speculative capital into one or more futures markets. Worse still, from a fair-market standpoint, all this capital is on the long side of the mkt(s) in question, which is just another way of saying that this transaction, when accompanied by lots of similar transactions from JPM, MS, Barclay's, HSBC, and the boys, invariably and artificially forces prices higher in the affected mkts. Might be good for Goldman, but this is simply terrible for citizens and nations around the world.

Goldman and the boys allege that they should be able to do these transactions WITHOUT LIMIT, because they are in fact 'hedging' their risk. This is crap, because, unlike the farmer who hedges his wheat or corn against adverse price moves over which the farmer has no control whatever, Goldman has ABSSOLUTE control over their level of risk --- THEY CREATE IT THEMSELVES via these "indes" transactions. The problem here lies in the fact that, relative to the amount of capital being thrown around, physical commodities mkts just simply aren't very big in dollar terms, and thus subject to the price-inflation effects I mention above.

The process above is the heart of the position-limits arguments, ok? Also, pls do not confuse futures with stocks (as your post seems to do at the end). While there are stock futures, very popular mkts, too, the position-limits flap is only about physical commodities.

Hope this is of some use to you. For more, see my post to grey_whiskers elsewhere in this thread.

FReegards!

[SAJ]

We have a little confusion here. HFTs are not part of this discussion; they are relevant to stocks ONLY, never to physical commodity futures. Maybe in SP500 index futures, maybe, but the HFT algos would have some difficulty working in that mkt. Also, SP futures don't have the position limits problem, afair.

Same for "dark pools"; they wouldn't be useful in futures mkts as long as every trade must be settled by the end of the trading day. There can be no possibility of staying "dark" in a regime of daily settlement.

[grey_whiskers]

Hmm, that's what I wanted to know, if there were things analogous to the stock world within commodities options.

Apparently not: so *some* of my concerns are alleviated.

Thanks for the info!

[Attention Surplus Disorder]

YES, I quite agree with you there. We saw that about 8 months ago (?) when premia for silver eagles were $3 and $4 (over a spot price of $17) There will be shortages of 1, 10, and 100 oz bars and RETAIL forms of nearly every description.

BUT: I believe that the conditions underlying that squeeze will dissipate in a matter of days or weeks. Maybe I’m wrong. A short squeeze may well have the capability of goosing the market dramatically, but if previous experience is a guide, they also furnish the means of their own extinction: The higher prices bring out sellers.

Don’t forget that as for precious metals, there is a very strong bias towards a net market-short condition because the miners are almost always selling production forward to meet current expenses.

So; either a universe of retail buyers will not be able to buy & take delivery of more silver without paying silly premia; and the market does not care about retail buyers....OR, the market will take a $5 pump and miners will sell the blazes into it and the $5 will slowly bleed off, but bleed off it will. It’s a matter of record, IMHO, that these dramatic short squeezes do not persist, and, very few holders are able to take advantage.

I sent about 3.5 kilos of sterling scrap into a refiner last week hoping to catch a “$29” handle, maybe even $29.50. I had no expectation of being able to catch over $30, never mind $31. The thing about selling to a refiner is: They have your materials for about a week. And what is remarkable is that they will finish with your materials, weigh them and settle them at just about the lowest spot price experienced during that week, even if that week-low is a 45-minute DUMP. Anyway, now I am concerned about being settled out closer to $27. On 90 oz tr, a $2.50 delta is $225, which is not life changing, but it is not nothing.