A New Look at the Commercial Traders
Commitment of Traders Charts for 10 Futures Contracts:
01 August 2005
In the past few years, have seen much discussion concerning the activities of the commercial traders in the gold and silver futures markets. There exists a feeling of injury by many investors in precious metal produces, including myself, because we believe the gold and silver industry's commercials are manipulating the price of gold and silver down to a point where it is harming our company's business.
Hoping to bring something new to the discussion, I thought I would examine the activities of the commercial traders in the gold and silver markets with what I think is a new look at the data provided by the Commodity and Futures Trading Commission (CFTC) of the gold and silver commercials trading patterns. To produce a serious inquiry of what commodity futures market commercials in general do with their trading, I have also examined the trading patterns of the commercial traders for eight other futures markets from which we can compare the gold and silver commercials with.
I recognize time as a precious thing to people and their reading my article in its entirety will be a significant commitment of time. So I actually encourage everyone to now go to the end of this article and:
- Read my "Closing Observations and Comments" found just before the charts
- spend a good hour, more or less, looking at my 21 charts
before they read any further. For most people, after reading my brief comments and observations may be all they want, to read.
From this point on in my article I will explain some fundamentals in the commodity markets and the methods I used in deriving the data I charted. This article is broken down into the following sections.
Section 1: Review of who Trades Futures Contracts - Speculators and Commercials Traders.
Section 2: Manipulation Means What?
Section 3: Table 1 Rules of all Commodity Trading
Section 4: Explanation of my Data and Methodology
Section 5: Charts
Readers not familiar with commodity trading will want to read all the following, while more experienced people might want to take a look at Section 2 before they go to Section 4 which explains the methodology used in my charting.
I also use General Mills and Wheaties as examples in my article. I use them because most people know of this fine company and my favorite breakfast food, General Mills, Wheaties. Any use of General Mills or Wheaties in this article suggesting wrongful practices is completely fictional. My data on the grain markets proved to my satisfaction that the grain commercials, including General Mills are ethical businessmen and prudent commercial traders.
Section 1: Review of who Trades Futures Contracts - Speculators and Commercials Traders.
The CFTC has divided traders of commodity futures contracts into three distinct classes of traders:
- Speculators Small or Retail Speculators
- Speculators Large or Professional Speculators
- Commercial Traders
Speculators are best understood as commodity futures contract traders who buy what they don't want and sell what doesn't exist in the futures markets. This is true because speculators are traders who will never produce or process the commodities they buy or sell. The speculator's sole intention in trading futures contracts is to make money on price swings in the commodities they trade. Speculators usually buy and sell contracts in a highly leveraged manner by having a dollar of their capital controlling more than a dollar in the value of the contracts they buy. In other words, speculators will use $1,000 of their capital to control $10,000 in a commodity futures contract. Speculators usually lose money on the futures contracts they buy and sell.
There are two classifications for speculators - Small and Large.
The small speculators are considered retail speculators or people who typically have a day job not related to trading futures contracts but who want to make money in the commodity markets. Small speculators have limited means (capital) and trade only a few contracts at a time. The large speculators are considered professional speculators who trade futures contracts for a living - these professional traders have the capital to trade many contracts in many futures markets.
I do not examine the speculators in this article.
Commercials are people or companies that actually produce or process the commodities being traded in the futures markets. Looking at a futures contract for wheat, the farmer who grows the wheat and General Mills who makes Wheaties breakfast cereal for retail consumption from the wheat the farmers grow are both classified as "Commercials" in the wheat commodity market. This makes sense as producing or processing wheat is the business of farmers and General Mills. Commercials use the futures markets to hedge uncontrollable price swings in the commodity they produce or process in their business operations.
The speculators and commercials futures contract traders need each other - there can be no commodity futures market without both types of traders because:
- The Commercials need the commodities but not the price swings
- The Speculators need the price swings but not the commodities
And from the chaos of the trading pits where the Speculators and Commercials cross their foils comes a stream of valuable commodities at the lowest prices the market can provide.
Anything we buy, anything man-made we can physically place our hands on, is either grown or mined and very likely sold on the wholesale level in a commodity market somewhere. In other words people consume the commodities speculators and commercials trade between themselves. A world without these very important markets is a world where farmers, miners and other important producers / processors of vital commodities would go out of business for lack of the means to hedge profits and controlling loses during times of uncontrollable adverse price swings due to changes in the weather or economic situations. To allow the commodities future markets to become a private market for connected individuals to fleece the producers or processors of vital commodities is an economic perversion of these public markets that will at some future point produce dire consequences.
Prices are important. A true free market price for items consumers buy represents a price where everyone who produced, processed, transported or marketed the item gets a fair return for their efforts in providing this product to the world for consumption. I think it fair to say today only socialist economists would argue the point that one of the reasons the Soviet Union failed was because the pricing structure in its command economy were based upon the wrong prices - prices determined by political needs as opposed to prices left to rise and fall to the demands of the markets themselves. Karl Marx saw benefits in constant prices not affected by changes in supply and demand He was wrong.
If the prices we see in today's commodity markets are not based upon supply and demand of producers and consumers, but rather based upon the desires of people whose concerns for the markets are exogenous to the markets themselves, there is reason for concern.
Section 2: Manipulation Means What?
So the question in everyone's mind by this point is - does Mark J. Lundeen believe the commodity markets are "manipulated?" Well before I say if the markets are or are not manipulated, it is very important for me to define exactly what manipulation means to me. To my mind, for any large commercial trader to cause a large movement up or down in the market due solely to their contract trading * is not * necessarily "market manipulation" by the commercials. Remember, it is the speculators who want the big moves up or down in prices. Commercials want dependable supplies of commodities at predictable prices because that is what is good for their businesses on a long term basis.
The commercial traders of General Mills watching the weather channel see Kansas is going to be the end point of a category 5 hurricane that dropped 50 inches of rain on Texas and Oklahoma. You better believe General Mills is going to be buying wheat contracts ASAP on the Chicago Board of Trade until the price of wheat doubles or triples in a day or two. In my opinion, for General Mills to allow their traders to move the wheat market upwards in this way for this reason is not a matter of manipulation of the wheat futures market by a commercial - rather this is the means by which General Mills survives the destruction of the Kansas wheat crop this particular year. But never doubt that cries of "manipulation" will result from what General Mills is doing in the wheat market. For all too many people whose lives are lived far away from the toil and labor of producing and processing wheat, any large price increase in a box of Wheaties will be seen as manipulation.
It seems to me, one key issue separating legitimate trading from manipulative trading pivots on the point of acceptance or rejection of market risk. What if the hurricane stopped at the Oklahoma, Kansas state line leaving the Kansas wheat crop to become the best in the last 100 years resulting in a drastic wheat price collapse? If General Mills, or any other commercial trader has to deal with the consequences of their futures trading using only their own resources, and those of their customers who now must now pay much higher prices for their General Mills products, well then for General Mills to have started a whipsaw in the wheat market is not manipulation in anyway, shape or form.
However, in my opinion, manipulation even fraud has occurred where associations have been formed for the purpose of concocting a "head we can't lose - tails you can't win" situation. It is hard to see how such a situation could successfully exist without the cooperation of the authorities who are charged with preventing such a situation.
Going back to General Mills and the wheat market example, had General Mills made sure all of their wheat contracts counterparties were from Canada and North Dakota during a good year for the wheat crop where lower prices are to be expected, then they went very long in the market (bought many additional wheat contracts in Chicago's Board of Trade) and then sent out secret agents to burn the Kansas wheat crop to manufacture a wheat shortage, and much higher prices in the wheat market - I would call this a clear case of manipulating the wheat market. Heads, General Mills can't lose - tails, General Mills short side counterparties and Kansas wheat framers can't win, just as planned in this fictional situation.
When the manipulation of one market is likely to cause financial and economic seizures to other markets as experienced in the 1930's I would call such manipulation a "Grand Mal Manipulation." When one considers the relationship silver has to gold prices, and then when one considers the relationship gold has with interest rates, as explained to us by former US Treasury Secretary, Lawrence Summers in his paper "The Gibson Paradox" there is legitimate concern for what would happen to the multi-trillion dollars debt markets, the over 100 trillion dollar derivative market and the world we live in, if the price of silver and gold were to rise above a certain, but currently unknown threshold.
For the record, if the rise in the price of silver and gold were to trigger a Grand Mal Seizure in the worlds financial markets similar to those experienced in the early 1930's, I would never blame it on the rise in price of an ounce of metal. I would blame it on people like former US Treasury Secretary, Lawrence Summers. He understood the relationship between gold and interest rates and yet while acting as Secretary of the US Treasury, he facilitated a Grand Mal Manipulation of the price of gold, enabling the financial establishment to have their way with the debt and money markets and to hell with everyone else. There will be a price to pay for all that people like Lawrence Summers have done in the gold and debt markets. Until I see an independent audit of US Treasury's Gold Reserves that disproves the above, I will believe all I have said above.
Do I believe the above paragraph describes what has happened in the financial markets? Yes I do, and I believe the gold and silver miners and their shareholders, like me, have had to endure a "can't win" situation for years because of it.
Section 3: Table 1 Rules all Commodity Trading
Table 1 explains every situation that results in a profit or loss when trading commodity futures contracts for both short and long positions.
(*) With currency futures contracts Table 1's conditions are reversed, why? A more accurate way of looking at long and short positions of any contract, including currencies futures would be to say:
- longs make money when the * Dollar * value of the contract goes up
- shorts make money when the * Dollar * value of the contract goes down
Need I say the longs and short side of * any * contract loses money when the market moves opposite to the above conditions? When the dollar value of wheat goes up in value, the dollar value of the contract goes up too because:
More Dollars for One Bushel of Wheat = More Dollars for 5000 Bushels of Wheat. Table 1 is applicable for the movement in the price of wheat.
However, with currencies, when the value of the foreign currency contract goes up, the *dollar value* of the contract goes down. Remember, a Japanese Yen contract is moved by the price of the Japanese Yen. Stronger Yen = Weaker US Dollar. This is the exact opposite of what happens when the value of wheat goes up as wheat is valued in dollars. For this reason, with currencies futures contracts, long side profits are made by buying high contract values that go to lower contract values - this actually produces more * Dollars * in the value of the currency contract. This is why Table 1's profit and loss conditions are reversed for the Longs and Shorts in currency contracts.
It is important to note, while speculators live and die by the dictates of Table 1, it is not in anyway unusual if the commercials do not always trade in the futures markets with the intent of profiting by their trading. But being businesspeople, I have to believe significant losses from their activities in the futures markets are not sought after either as they will subtract money from the company's bottom line.
For the commercials, the futures markets are a means of providing insurance against the risks of unexpected price swings in their market. After all, General Mills makes their money by manufacturing, marketing and selling Wheaties to a hungry world, not trading on the Chicago Board of Trade like a speculator!
Section 4: Explanation of my Data and Methodology
I have never seen similar charts on this data. For this reason I think it is important for me to go into detail on the methodology used for these charts. I hope to answer any questions concerning my data and methods in the text and tables below.
My data is from Barron's which started to publish the CFTC, Commitment of Traders (COT) data in their 31 Oct 1994 issue.
NOTE: all dates are the dates Barron's published the CFTC data, * NOT * the date the CFTC published the data. The author uses the Barron's issue dates because this is how his data is dated.
The CFTC published this data every other week up to 01 January 2001, there after the CFTC required the data from the large commodity traders every week. For this reason you will see I used a "5 Period" moving average instead of a 5 week moving average. In my charts below the data points for both COT data and commodity prices prior to 01 January 2001 are from every other week, as that is when Barron's published the CFTC COT data. After 01 January 2001 the data is published every week. So the 5 Period Moving Averages prior to 01 Jan 2001 span 10 week periods, and after 01 Jan 2001 the 5 periods span 5 week periods.
Table 2
For each of the ten commodities listed on Table 2 I have constructed two charts derived from the COT and commodity price data:
1). 5 Period M/A Charts a ratio of reported (long contracts / short contracts) -1, charted with the price of the commodity being examined. Both the (L/S)-1 ratio (Red Line) and commodity price data (Black Line) are smoothed out with a 5 period moving average.
2). Commercial Trading Performance Chart is an estimate of cumulative capital gain and losses of the commercial traders charted along with the price of the commodity being examined.
Table 2 is associated with the (L-S)-1 Red Line Plot on the 5 Period M/A Charts.
The red plot on the (5 Period M/A) chart is derived from the following formula:
(Number of Long Contracts / Number of Short Contracts) - 1
This formula produces a positive number when the commercials are net long, a negative number when the commercials are net short, and a zero value when the commercials hold and equal number of long and short contracts. Table 2 examines the how often the commercials in each listed category are net long or net short as reported to the CFTC since 31 Oct 1994 to present. There are 400 data points in the sample.
Column I gives the average value of (L/S)-1 for the 400 data points. As you can see except for the Japanese Yen and the Corn contract, all other commercials have been net short since October 1994. However, Yen bulls are also Dollar bears, so if someone insisted that the corn commercials were the only actual pure net bulls for the past eleven years, I see their point.
Column II & III gives the number of data points the commercials have been net long (II) and net short (III) in the 400 data point sample spanning the time period from the 31 October 1994 to 25 July 2005 issues of Barron's.
Column IV & V displays the identical data given in Columns II & III but in percentage terms. Column IV shows the percent of the 400 data points the commercials held net long (bullish) positions and column V for net short (bearish) positions.
A point of interest, the silver commercials in the past 400 CFTC reports have never reported to the CFTC a net long position. Eleven years is a long time to be net short, no other commodity market commercial has traded their market in this manner.
Column V & VI gives the number of times the (L/S)-1 plot had crossed the zero line in the below (5 Period M/A) charts. Column V gives the number of times the (L/S)-1 plot goes from a negative value to a positive value, indicating the commercials went from a net short to net a long position. Column VI gives the number of times the (L/S)-1 plot goes from a positive value to a negative value, indicating the commercials went from a net long to a net short position.
Table 3 is associated with the Commercial Trading Performance Charts.
"The commercials are usually right" is an accepted truism frequently heard in the commodity markets. I take this to mean in the push and pull of trading in their market, the commercials usually take the money the speculators lose. However, I have never seen a chart illustrating when or how much money the commercials are taking from the speculators. My charts on "Commercial's Trading Performance" for the ten commodities examined do just this using the data published in Barron's every week. NOTE: the data points on the commercials profits and losses are only my best guess estimates based upon the data available to me in Barron's.
It is expected the actual profits and losses the commercial traders actually experience would differ by some unknowable degree with the assumptions used in Table 3. This being said, I would be very surprised if the commercial traders were losing money when my estimates indicated they were making money, or making money when my estimates indicated they were losing money.
Table 3's Two Base Assumptions
1). Positions held by commercials are maintained until the next reporting period. Table 3 assumes the traders do not trade between their reports to the CFTC when in fact they do change their positions constantly.
2). Prices published in Barron's for the commodity examined were the prices the commercial traders were using when they performed my fictional once a period trading. As in assumption 1) this is not the case. The reported positions and prices used for Table 3 are not even taken from the same day.
With all the faults these assumption have, I believe the data published in Barron's allows us to see if the commercial traders are or are not trading profitably and the degree they are making their profits or losses. The data in Barron's is good enough for what I am asking it to do - to see if there are discernable trending patterns in the CFTC commercial data. There are.
Table 3's Methodology
My method for computing the data points for the commercials trader's cumulative profits or losses is very simple and is accomplished in 4 steps.
1) Determine (B-A) / The Gain or Loss of One 5000 Bushel Wheat Contract
Looking at the price of wheat for reporting periods of 15 May 95 (Cell A) and 29 May 95 (Cell B), I have subtracted (Cell A) from (Cell B) and placed the resulting value in the column listed "$ Price $ Change One Contract", or (Cell B-A). The location of the input cells for this calculation will be found in the cells highlighted in light red on Table 3. However the displayed value of (Cell B-A) will be much larger than the simple calculation of (Cell B) - (Cell A). This is because the price is given in (Cells A) and (Cell B) are in cents for 1 bushel of wheat, while the value for (Cell B-A) is giving us the dollar price change in one contract of wheat which contains 5000 bushels of wheat. So a (+/-) change in of only one cent or $.01 for (Cell B) from (Cell A) will result in a (+/-) 5000 cent or $50 change in (Cell B-A) as in the below formula:
So remember, a (+/-) change of one cent in the price of 1 bushel of wheat produces a (+/-) $50 change in one 5000 bushel wheat contract. A (+/-) change of 10 cents in the price of 1 bushel of wheat changes the price of one 5000 bushel wheat contract by (+/-) $500.
With the value of (Cell B-A) giving us the (+/-) dollar change of one 5000 bushel wheat contract from one period to the next. We now need to compute the number of contracts held by the commercial traders and to determine if the net position of their Long / Shorts positions is net long or short.
2). Determine (C-D) / The Number of Contracts held Long or Short
Looking at Table 3 once again, we now discuss (Cell C) or "Long Contracts Held", (Cell D) or "Short Contracts Held", and (Cell C-D) or Long Contracts - Short Contracts. This calculation is as simple as
Long Contracts (Cell C) - Short Contracts (Cell D) = Net Long - Short Contracts (C-D)
These Cells are highlighted in yellow. When (Cell C-D) is a positive value the net position of the commercial traders is LONG, when (Cell C-D) is a negative value the net position of the commercial traders is SHORT.
3) Determine [ (Cell B-A) * (Cell C-D) ] / Commercial net Profit or Loss for the Period
Again refer to Table 1. (Cell B-A) * (Cell C-D) = (+/-) Dollar change of the Commercial's net Position for the Period.
(*) With currency contracts this is reversed!
4) Determine Plotting Data for the Chart
The plotting data for the below "Commercial's Trading Performance Charts" is only a running sum of all the periods up to the point in question. Positive value (Cell B-A) * (Cell C-D) add to the running sum, negative (Cell B-A) * (Cell C-D) subtract from the running sum.
Due to space constraints on Table 3, step 4) is not listed, but is seen as the Red Plot on the Commercial Trading Performance Chart.
Closing Observations and Comments
The commercials are very effective in their use of trading capital with which they attempt to keep market prices and volatility as low as possible. When they cross foils with the speculators, commercial traders usually win. Commercials have deep pockets that allow them to take massive temporary losses to defend what I imagine is a market price that is good for their business. Once they have achieved a certain level of capital and the market is priced acceptably to them, they stop trading for additional profits and wait until the next time they defend their "good for business price."
I applaud General Mills' use of this excellent trading strategy to keep the price of wheat low enough so I and millions of others can enjoy the start of our day with a bowl of the "The Breakfast of Champions!" However, when I studied the Wheat charts, I was a bit concerned General Mills was not aggressive enough trading in the wheat market. NOTE TO GENERAL MILLS: I would advise increasing your trading capital by a few hundred million dollars. Please feel free to use my e-mail address to inform me where I should send my consulting fees bill to.
As long as large grain merchants like General Mills, ADM or Cargill do not decide to defend a price so low and drive the farmers who produce grain out of business, this trading strategy of defending lower prices is the model of ethical trading and is just good business for all concerned. Clearly the Giants in the grain industry have no intention of ruining the farmers and to prove my point I ask you to examine my corn data.
The corn market data strongly suggest the commercials have been unsuccessful in defending * higher * corn prices at considerable loss to their trading capital. Table 2 shows the corn commercials being net long for the past eleven years without profit for themselves. I am not an expert in the corn market, but looking at my data on corn, if someone were to tell me the big grain merchants were trying to drive the farmers to ruin, I would have to disagree with that assertion. Assuming the corn farmer were having problems for low prices I would have to say the most likely reason would be the farmers are growing too much corn. I have produced no evidence to support any allegations that the Chicago Board of Trade is a place where the corn farmers get abused by the giant merchants in the grain trade. In fact, the data would say it is just the opposite for the grains commercials.
This is not the case with the metals markets. We are currently in a period of great demand for all metals by the emerging economies of China and India. The above ground inventories of metal have been significantly depleted, and yet we see the metal commercials fighting tooth and claw against higher prices that would make sorely needed new bodies of metals ore economic to mine. Unlike the grain commercials who do appear interested in the continuing viability of all the participants in the production of grain, the metal commercials seem indifferent to the plight of the small exploration companies and marginal producers of metal.
If the world we lived in was one of growing supply and diminishing demand for metal, I would have no problem with anything I have seen in my metal commercials charts, but is 2005 a world of growing supply and diminishing demand for metal? I think not. So it is entirely appropriate for organizations like GATA to ask the reasonable question: what are the commercials in the metals markets doing?
Section 5: Charts
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