In a seminal article in today's Washington Post, we finally have some hard facts on what has caused this huge run-up in the price of oil (and other commodities) over the past few years, and especially this Spring and Summer (when oil hit $147/barrel).

Even though traders on the floor will tell you that commodities are driven by huge hedge fund speculators now, this much speculation is a shocker:

Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.

But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel. Even more surprising to the commodities markets was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.

The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency.

This article should reveal to all Americans that our system of unfettered markets has now officially screwed us all. It's a fascinating read, starting with this:

To build up the vast holdings this practice entails, some swap dealers have maneuvered behind the scenes, exploiting their political influence and gaps in oversight to gain exemptions from regulatory limits and permission to set up new, unregulated markets. Many big traders are active not only on NYMEX but also on private and overseas markets beyond the CFTC's purview. These openings have given the firms nearly unfettered access to the trading of vital goods, including oil, cotton and corn.

The commodities industry had long been regulated:

For most of the past century, regulators put limits on financial actors to prevent them from dominating commodity exchanges, which were much smaller than the bond or stock markets. Only commercial operations, such as farms, airlines, manufacturers and the middlemen that handle their trading activities, were allowed to buy nearly unlimited quantities. The goal was to allow these businesses to minimize the effect of price swings.

But something strange happened in 1991, then again in 2000:

The first major change to this regulatory framework occurred in 1991, when Goldman Sachs, through a subsidiary called J. Aron, argued that it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms.

The CFTC granted this request. More exemptions soon followed, including one to the Houston-based energy trader Enron.

A second turning point came when Congress passed the Commodity Futures Modernization Act of 2000. The law formally allowed investors to trade energy commodities on private electronic platforms outside the purview of regulators. Critics have called this piece of legislation the "Enron loophole," saying Enron played a role in crafting it.

In the months after the act was passed, private electronic trading platforms sprang up across the country, challenging the dominance of NYMEX.

And how much did this industry grow over the past five years? Can you say 2000%? It's absolutely stunning:

Using swap dealers as middlemen, investment funds have poured into the commodity markets, raising their holdings to $260 billion this year from $13 billion in 2003. During that same period, the price of crude oil rose unabated every year.

CFTC data show that at the end of July, just four swap dealers held one-third of all NYMEX oil contracts that bet prices would increase. Dealers make trades that forecast prices will either rise or fall. Energy analysts say these data are evidence of the concentration of power in the markets.

So now, with this article, it should be clear to every layman why he or she is spending record amounts at the pump: Our government, starting in 1991 and then again in 2000, sold out its traditional regulatory role to its rich Wall Street benefactors, at the expense of all of us. Coupled with the natural growth of the world population, you have a recipe for higher and higher prices:

In the coming years, commodity investments by funds could grow to $1 trillion, veteran hedge fund manager Michael Masters said in testimony before the Senate earlier this year. In an interview, he said this trend could raise commodity prices for everyone in the coming years and "have catastrophic economic effects on millions of already stressed U.S. consumers."

Just think of that every time you fill up at the gas station or buy that loaf of bread or bag of rice. And, most importantly, think about it when you enter that voting booth in November. If you think prices are high now, you can rest assured that they are guaranteed to go higher under a McCain presidency as he continues to reduce government regulation even beyond its minuscule role now...

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Tags: barrel of oil, commodities, crude oil, NYMEX, oil, speculators

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In an interesting article last year, M. P. Dunleavey from the NY Times discusses the fable of the ant and the grasshopper:

The ant works hard all summer, socking away provisions for the winter; the grasshopper frolics away each day. The ant warns the grasshopper that he's being hedonistic and short-sighted. The grasshopper ignores the ant, and continues on his merry way -- only to perish when winter sets in.

It's a rather stern lesson about financial prudence, but there is a reason this tale has survived through the ages -- and still preoccupies many researchers who study the eccentricities of human economic behavior. Why do the grasshoppers of the world have such a hard time emulating the ants?

It's an old story that a few economists have tried to explain:

Yet economic research has demonstrated that most people find it hard to resist the siren song of "seize the day and spend what you have now" -- even though a lifestyle based on constant consumption doesn't enhance anyone's long-term store of happiness and often puts people on shaky financial ground.

This conundrum also bedevils those who work in the field of personal finance. Why do millions of Americans resist saving for their retirements? Why do so many carry thousands of dollars in credit card debt?

Indeed, the article uncovers research for some pretty plain and simple advice: focus on what makes you happy, since investing in your well-being and quality of life go a long way towards a more fulfilling life:

Tim Kasser, an associate professor of psychology at Knox College in Galesburg, Ill., studied 200 people who embraced Voluntary Simplicity, a movement focused "less on materialistic values -- like wanting money and possessions and status -- and more on what we called intrinsic values or goals," Professor Kasser said. The three main intrinsic values were being connected to family and friends, exploring one's interests or skills and "making the world a better place," he said.

Essentially what they found was that a life focused on those three things is more fulfilling then a life of consumption:

The study found that when people invested more in intrinsic values, like relationships and quality of life, and less in consumption, it seemed to increase their happiness. And, the study suggested, there may be a financial gain to doing so. Those in the simplicity group were far more likely than the control group to say that they were careful about their spending, Professor Kasser said.

Live simply, save money, be happier. Indeed, one of the best bumper stickers ever made said, "The secret to happiness is keeping your expenses low."

Amen!

For more resources to explore, go to the Simplicity Forum and check out what they've got to say...

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Tags: conspicuous consumption, consumption, frugal, happiness

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Since Ronald Reagan became president in 1980, the word "government" has become a four letter word, especially when it comes to the private sector. The past eight years has been a particularly fruitful period for big business running rampant over us citizens, taking from the "commons" and exploiting investors.

One particularly egregious example is in the Auction Rate Securities market. If you haven't heard of Auction Rate Securities, it's probably because you had no need for them. But this $200 billion market seized up earlier in the year when the credit crises hit, and millions of investors have been unable to retrieve their money from big banks across the nation even though they were told that the money was good as cash:

Beginning on Thursday, February 7th, 2008, auctions for these securities began to fail when investors declined to bid on the securities. The four largest investment banks who make a market in these securities (Citigroup, UBS AG, Morgan Stanley and Merrill Lynch) declined to act as bidders of last resort, as they had in the past. This was a result of the scope and size of the market failure, combined with these own firm's need to protect their capital during the 2008 financial crisis.[citation needed]

On February 13 (2008) 80% of auctions failed. On February 20th, 62% failed (395 out of 641 auctions). As a comparison, from 1984 until the end of 2007, there were a total of 44 failed auctions.

Essentially, what had been a normal market, where investors could redeem their money at any time turned into a nightmare because most of the banks that provided liquidity in the past decided not to provide that service anymore. Hence, the Attorney General of New York, Mario Cuomo, had to step in and sue Citigroup in order to make them cough up the dough:

Citigroup Inc. (C) (C) will buy back more than $7 billion in auction-rate securities and pay $100 million in fines as part of settlements with federal and state regulators announced Thursday.

Citigroup will buy back the securities from tens of thousands of investors nationwide under separate accords with the Securities and Exchange Commission, New York Attorney General Andrew Cuomo and other state regulators. The buybacks will have to be completed by November.

The nation's largest financial institution also will pay a $50 million civil penalty to New York state and a separate $50 million civil penalty to the North American Securities Administrators Association, which represents securities regulators in the 50 states and the District of Columbia.

The SEC also will consider levying a fine on Citigroup, the agency's enforcement director Linda Thomsen, said at a news conference.

So here we have an example of government stepping in to protect and retrieve the people's money, since there was no law that stated that Citigroup had to pony up the money to redeem the auction rate securities.

Thank god we have government on our side working for us, right?

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Tags: Andrew Cuomo, auction rate securities, Citigroup

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In a bear market like we're experiencing now, it seems like any stock you might be interested in owning goes down the minute you buy it. And yet there are millions of investors who are convinced that they can beat the market, either through individual stock picking (not a chance) or through a balanced mutual fund portfolio (better chance).

A recent NY Times article asks the question, "How many mutual fund managers can consistently pick stocks that outperform the broad stock market averages -- as opposed to just being lucky now and then?" The article attempts to answer that question:

Countless studies have addressed this question, and have concluded that very few managers have the ability to beat the market over the long term. Nevertheless, researchers have been unable to agree on how small that minority really is, and on whether it makes sense for investors to try to beat the market by buying shares of actively managed mutual funds.

Yet, there is a new study out that...

...builds on this research by applying a sensitive statistical test borrowed from outside the investment world. It comes to a rather sad conclusion: There was once a small number of fund managers with genuine market-beating abilities, as judged by having past performance so good that their records could not be attributed to luck alone. But virtually none remain today. Index funds are the only rational alternative for almost all mutual fund investors, according to the study's findings.

The study, "False Discoveries in Mutual Fund Performance: Measuring Luck in Estimating Alphas," has been circulating for over a year in academic circles. Its authors are Laurent Barras, a visiting researcher at Imperial College’s Tanaka Business School in London; Olivier Scaillet, a professor of financial econometrics at the University of Geneva and the Swiss Finance Institute; and Russ Wermers, a finance professor at the University of Maryland.

You can read the nitty gritty of the research, but the crux of the story is that fund managers used to be more successful picking stocks that beat the market but have since faded in their ability to beat the market. The reasons for this decline could be due to a number of factors:

Professor Wermers says he and his co-authors suspect various causes. One is high fees and expenses. The researchers' tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability -- far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It's just that they can't come out ahead after all their funds' fees and expenses are paid.

Another possible factor is that many skilled managers have gone to the hedge fund world. Yet a third potential reason is that the market has become more efficient, so it's harder to identify undervalued or overvalued stocks. Whatever the causes, the investment implications of the study are the same: buy and hold an index fund benchmarked to the broad stock market.

And has this study affected the researchers use of mutual funds?

Professor Wermers says his advice has evolved significantly as a result of this study. Until now, he says, he wouldn't have tried to discourage a sophisticated investor from trying to pick a mutual fund that would outperform the market. Now, he says, "it seems almost hopeless."

Hopeless? Hmmm...just like the stock market feels these days...

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