Stop enabling the speculators
Commentator Robert Reich says while speculation is driving commodity markets up, the blame rests with the government and regulators who haven't taken the proper steps to reign them in.
Commentator Robert Reich (APM)
More on Commentaries, Commentary - Robert Reich, Robert Reich
TEXT OF COMMENTARY
Bob Moon: You've heard us talk about the efforts of federal regulators to reign in the speculation in the commodities market. Oil futures regulators in Britain and the U.S. have now come to an agreement. They'll plug what's referred to as the London Loophole that allows traders to step around regulations.
Commentator and economist Robert Reich has taken a look at all the factors at play in the speculation market. He says the problem isn't the speculators, it's the enablers.
Robert Reich: If it were just supply and demand, gas would probably be selling for around $3.50 a gallon, not $4, and food would be 20 percent cheaper. The difference is due to speculation.
Of course, all markets are speculative to some degree. Every time we purchase a share of stock, we're speculating. Problems occur when prices are bid upward not because underlying values are rising but because investors expect other investors to make the same gamble. This can create a bubble.
And whether it's crude oil or corn, houses or financial derivatives or the stock market before the Great Crash of 1929, speculative bubbles cause huge market disruptions, both when they fill up and when they pop.
Sometimes bubbles are manipulated. Prominent investors who hold certain stocks or commodity futures will publicly predict when those prices will rise, and then they profit when others act on the predictions. Alternatively, certain institutional investors are so large they move the markets, prompting other big investors to make the same move. That's why some members of Congress want to ban large institutions from commodities futures markets or at least limit the size of stakes each investor can hold.
But the biggest speculative bubbles happen when investors don't need to use their own money and can borrow to the hilt for whatever looks promising. That's why margin requirements were imposed on individual investors after the Great Crash, proving that another way to prevent excessive speculation is to require certain minimum levels of collateral.
The failure to require down payments from home buyers when mortgages became dirt-cheap beginning in 2003 contributed to the housing bubble. The failure to require investment banks to risk their own capital when they made risky bets on derivatives led to the credit crisis. So what about minimal collateral for investments in commodities futures like oil?
You see, the problem isn't speculation per se. Whether it's oil or food, financial derivatives or houses, the real problem is the failure of government to curb excessive speculation.
Moon: Robert Reich teaches public policy at the University of California Berkeley.
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Comment | Refresh
From Calgary, AB, 06/30/2008
Speculators and Individual Investors
A self directed Registered Retirement Saving Plan (RRSP) provides an opportunity to either accumulate cash, bonds, mutual funds or company stocks tax free for the Individual Investor until retirement. These plans are available through banks such as Toronto Dominion (TD), CIBC (CM) and Royal Bank (RY).
There are four reasons why an Individual Investor has an RRSP. First of all, it provides a tax deduction in the year in which it was purchased, thereby allowing the Individual Investor to be taxed at a lower rate.
Second, it provides a means of saving money for retirement.
Third, it allows an opportunity for the investment to grow.
Forth, it allows the Individual Investor the freedom to pick and choose stocks rather than relying on money managers to invest on their behalf.
There are four main classes of stocks that an Individual Investor can purchase. They include large caps, mid caps, small caps and Income Trusts.
Large cap stocks are like huge ships in that it takes a long time for the company to change direction. Typically stock prices can change as much as +/- 5% a day and +/- 20% over a six month period. The capitalization can be over $5B. These stocks are moderately speculative, but can be very volatile with the potential of a large return if you are willing to wait.
Mid caps stock prices can typically change as much as +/- 10% a day and +/- 50% over a six month period. The capitalization is between $1B and $5B. These stocks can be very speculative and volatile with the potential of high returns or losses over a short period of time.
Small cap stock prices can typically change as much as +/- 20% a day and +/- 100% over a six month period. The capitalization is between $250M and $1B. These stocks can be extremely speculative and volatile with the potential of the highest or lowest return over a very short period of time.
Income Trust stock prices typically change as much as +/- 3% a day and +/- 20% over a six month period. These stocks are the least speculative with low volatility and a very stable dividend over a long period of time.
The stock markets today are very volatile for two reasons.
The first reason is Stock Traders can now trade stocks from their home or office with sophisticated PCs and software. For example, the Stop Loss function is a powerful software tool that has led to high volatility in world markets by allowing narrow limits to be set for large volumes of stock trades.
Jerome Kerviel’s sell off of stock in European markets resulted in a drop of 6% in world stock market share prices over a three day period starting Jan. 21, 2008. The Tsunami effect resulted in a massive sell off of stocks on the North American stock markets. The implication was that a world market crash was about to occur following a Federal Reserve board rate cut announcement. At the time it was a good opportunity to see the real value of stocks held by large Stock Traders and an indication of the overvalued stock markets.
The second reason for stock market volatility could be the influence of large Stock Traders in the rise and fall of share prices.
Below are a number of situations that result in stock prices to rise and fall significantly.
Undervalued Stocks
Stock Traders have accounting resources for whom they have a keen understanding of a company’s value and how much the stock is worth. They may enter the stock market on a daily basis buying huge quantities of stock for their clients that are undervalued according to their calculations. The basis for their calculation is economic fundamentals. They make it known of their stock picks on TV shows, advertisements and web sites. Individual investors watch these TV programs and may buy these stocks at higher prices believing the stocks are undervalued. As time goes on more people buy the stock paying incrementally more for each transaction. Eventually the stock becomes fully valued and the Stock Traders sells off their holdings. The Individual Investors will retain the shares until they come to the realization that the share price has stopped moving and they are left holding the fully valued stock. With no stock price movement, they sell the stock at a loss. As more people see the downward movement, more stock is sold off until it becomes undervalued again.
Technical Analysis
Stock Traders also analyse stock from a technical analysis viewpoint. They rely on the behaviour of traders and analyse trends of stock prices over periods of time with no acknowledged understanding of a company’s value and how much the stock is really worth. They may enter the stock market on a daily basis buying huge quantities of stock for their clients based on their analysis. They make it known of their stock picks on TV shows, advertisements and web sites.
Inflated Stock Value
Stock Traders may have holdings in certain selected companies. They will buy additional shares, but in smaller quantities and at artificially inflated prices. They may enter and exit the stock market on a daily basis adjusting prices up for no legitimate reason. This process may last for weeks. There is never a news flash giving a reason for the stock rise. Individual Investors may see the price rise on a stock market pull back and buy it believing the stock price will continue to rise indefinitely. Normal reaction is to pay more for a fast rising stock to secure the shares. When the Stock Traders see that the daily trading volume is high, they may start selling off, usually at a small discount until all their shares are sold.
This action is sometimes called “taking money off the table” or “taking a profit”.
Quarterly Earnings Reports
Stock prices tend to rise or fall prior to and after a company reports quarterly earning results. If a commodity price has been rising significantly during a quarter, there is high probability the company will report greater than anticipated earnings. For example, high crude oil prices may have a significant impact on 2008 Q2 earnings of companies such as ExxonMobile (XOM), ConocoPhilips (COP), BP Petroleum (BP) and Suncor Energy (SU).
If Stock Traders anticipate positive earnings results, they may purchase large quantities of stock at low prices well in advance of the corresponding company’s earnings announcement. This action can be risky depending on the sector, cyclic patterns and particular commodity. The stock price may rise higher leading up to the announcement as traders buy more shares. Individual Investors may see the news flash of earnings and pile in only to benefit from small gains. Once again the Stock Traders may sell the stock having made their profit and knowing that the stock price will drop.
Commodity Contracts
Annual commodity contracts between suppliers and buyers of commodities such as potash, coal and iron ore concentrate have a significant impact on the price of stocks. High contract prices have resulted in a significant stock price rise for companies such as Potash (POT), Vale (RIO), Consol Energy (CNX), Arch Coal (ACI), Fording Coal (FDG), Companhia Vale (RIO) and United States Steel (X).
Stock Traders may purchase large quantities of stock at low prices months before the contract announcement. Individual investors may see the news flash of the new contract price and pile in buying company shares only to benefit from small gains. With now further gains possible, the Stock Traders may sell the stock having made their profit and knowing that the stock price may drop.
Bad News
Often there is bad breaking news which results in a sell off of the affected company stock. An extended power shortage, mine flood and bad asset backed securities have recently resulted in company stocks in Anglogold Ashanti (AU), Cameco (CCO), CIBC (CM) and Bear Stearns (BSC) dropping significantly.
Stock Traders may have the ability to sell large quantities of stock immediately upon the bad news announcement or automatically if stock drops below a Stop Loss threshold. The Individual Investor may get stuck holding the devalued stock. They may know so little about the issue at hand that they may drop all stocks within the sector. For example, TD Bank (TD) had no asset back security issues but saw a significant drop in share price.
Good News
Often there is good breaking news which results in a price rise of the affected company stock. For example, recent news of a discovery of a large deposit of shale oil, coal and crude oil made by Arc Energy (AET), Enerplus (ERF), Continental (CLR), Range (RRC), Tallisman (TLM), Duverney (DDV), (Goldsource (GXS) and Petroleo Brasileiro (PBR) resulted in stock prices to rise significantly.
Stock Traders have the ability to immediately buy large quantities of stock upon a good news announcement. These types of announcements often result in a delayed pull back. The Individual Investor will often purchase the stock prior to the pull back. Once again the Stock Traders may sell the stock having made their profit and knowing that the stock price will drop.
Acquisitions
Often acquisition announcements immediately result in a rise in the stock price of the acquired company. Recent acquisitions or attempted acquisitions of companies such as Bell Canada (BCE), Yahoo (YHOO) and Cordero (COR) have resulted in a significant share price rise.
Stock Traders have the ability to buy large quantities of stock immediately upon the acquisition announcement. These announcements do not result in a share price pull back. Stock Traders may sell the stock after the deal is consummated and having made their profit.
The Individual Investor may not significantly benefit from the acquisition if they are late buying into the stock.
Trends
Trends such as Crocs (CROX), Lululemon (LULU) and Research in Motion (RIM) often create hype that results in share prices soaring beyond their intrinsic value.
Stock Traders have the ability to buy large quantities of stock when the hype immediately starts. These types of announcements often result in a delayed pull back as well. When the stock price peaks, Stock Traders may sell the stock having made their profit and knowing that the stock price will drop.
Technological Breakthroughs
Companies involved in technological breakthroughs usually see a significant rise in the stock price. Companies such as Petrobank (PBG), Ivanhoe Energy (IE), Quantum Fuels (QTWW), Timminco (TIM), Synthesis Energy (SYMX), Shlumberger (SLB), Rentech (RTK), Global Resources (GBRC) and Dupont (DD) have seen great volatility in their stock price due to these types of recent announcements.
Stock Traders have the ability to buy large quantities of stock when the technological breakthroughs are announced. These types of announcements often result in a delayed pull back. Once again the Stock Traders may sell the stock having made their profit and knowing that the stock price will drop if the innovation does not go forward immediately.
Value of the Dollar
Stock Traders may buy stocks in a foreign market knowing that the value of the domestic currency is going to drop. For example, it has been forecasted that as the US economy comes out of the recession in Q3 2008, the value of the US dollar will rise about 15% above the value of the CND dollar. Stock Traders have the ability to quickly sell large quantities of CND stock and buy large quantities of US stock prior to the step change. After the Canadian and US dollars have stabilized, the Stock Traders may sell the US stock having made their profit.
Stock Promotion
Stock Traders are often given a stock purchase discount or commission in return for promoting IPOs (Initial public offerings). The stock may be initially offered at a certain asking price, then reduced over time to attract more buyers. Individual Investors may start buying into the stock before it eventually recovers and it may surpass the IPO price. Recent examples of companies issuing IPOs include VISA (V) and Sprott (SII).
Subsequent Stock Issues
Known as a Brokered Private Placement (BPP), companies often issue stocks to be used for additional exploration expenditures, working capital or general corporate expenses. A recent example of a company that issued a brokered private placement is Goldsource (GSX). Generating additional cash in this manner is a positive indication of a highly potential asset and normally results in a stock price increase.
Stock Traders have the ability to immediately sell large quantities of stock when BPP announcements are made. These types of announcements often result in a temporary pull back. Stock Traders may sell large quantities of the stock to avoid losses due to stock dilution.
Inside Trading
Certain company officials known as Inside Traders are required to disclose the purchase and sale of their company stock. When an insider buys or sells stock it may be an indication of good or bad things to come or it may be sold for other legitimate reasons. A recent example of inside trading was an official selling company stock of Newfield (NFX).
Normally this action results in little or no change to the share price, but occasionally an Inside Trader sell off triggers a Stock Trader to sell off the company stock.
A stock market may only provide you details of the last 12 stock traders per trading session for a certain period of time so you never know the previous traders. Public disclosure of Inside Trader actions is often necessary.
Stock Buy Backs
Occasionally companies feel the selling price of their stock is too low and buy back large quantities. Known as Normal Course Issuer Bid (NCIB) this often leads to a stock price rise. A recent example was PetroCanada (PCA) buying back 5% of their outstanding shares.
Stock Traders tend to immediately buy large quantities of the company stock if the buy back quantity is significant.
Stock Splits and Consolidations
Stock Traders with deep pockets may often buy large quantities of stock in certain companies well in advance of company announced stock splits or consolidations. Companies involved in recent stock splits and stock consolidations include Suncor Energy (SU) and Pacific Rubialis (PEG). Upon the stock split or consolidation announcement, Stock Traders buy stocks knowing that the whole share price, and split (or consolidated) share price will rise dramatically and temporarily in two steps. The Individual Investor may be slow to purchase the whole stock and end up with the split (or consolidated) stock. Following the split, the Stock Traders may sell the stock having made their profit and knowing that the split stock price will eventually drop.
Commodity or Sector Cycles
Upside of the Commodity or Tech cycles may take up to three years to peak and three years to bottom out. Stock Traders buy and sell stocks for the quick turnover in profit. They do not hold stock for the long term, where as your traditional Individual Investor may hold a stock years on end.
Pure Speculation
Occasionally there is a news flash about a huge resource discovery made affecting many companies. Typical examples are the Bakken, Monteny and Utica Shale discoveries. Using the Utica Shale discovery as an example, a single news flash reported one well drilled by Forest (FST) resulted in significant natural gas flow. Immediately, Stock Traders bought up stock in companies such as Gastem (GMR), Petrolia (PEA), Questerre (QEC), Junex (JNX), Petrolympic (PQC) and Epsilon (EPS) stake holders in the surrounding area. Additional shares, but in smaller quantities were bought increasing the share price. Individual Investors entered the stock market on a daily basis. This process lasted for weeks without any further news flashes. Eventually the stock of the companies started selling off, usually at a small discount each day until the stock price bottomed.
All the situations outlined above require a degree of risk and speculation. In all cases Stock Traders have the ability to purchase and sell large quantities of stock, creating great volatility in the market place. This allows them to profit from the stock purchases and sell offs made by Individual Investors and to a lesser degree other Stock Traders. Individual Investors may know very little about the technology, cyclic patterns and the significance of company news flashes. They may be hesitant to buy or sell in response to news flashes and events out of fear of losing their investment value. They may end up losing more often than not in most of the situations outlined above.
Well seasoned Stock Traders may reap more profit from the stock market by buying and selling stocks continuously, then if they simply left the stock untouched for years on end. Individual investors are not Day Traders. They may be retired relying on a stable investment income or hold down a job that requires their full attention. They don’t normally buy and sell stocks during a days trading session. An Individual Investor’s only option to provide a secure source of income is to leave stocks untouched for years on end.
Individual Investors are being forced into buying a very small select group of stocks. These are stocks with minimum Stock Trader exposure and manipulation, minimum volatility, a consistent and above average dividend return, growth potential and a high probability of the associated company being acquired. Examples of companies that meet this criteria include Income Trust funds such as Canadian Oil Sands (COS), Superior Plus (SPF), True Trust (TUI), ARC Energy (AET) and Enerplus (ERF).
Unfortunately, Income Trust funds have been legislated to convert to taxable Canadian corporations in 2011 and Individual Investors such as pensioners and non professions will be forced to compete with Speculators for a fair return on investment and steady retirement income.
It would be fair to pensioners and non professionals if the Canadian Federal Government cancelled the legislation requiring existing Income Trusts to convert to taxable Canadian corporations provided stocks are in an RRSP program.
If this plan is unacceptable perhaps Stock Traders should be taxed per trade for both US and CND stock Market trades and the proceeds used to supplement retirement incomes. Retailers are taxed 8% PST & 5% GST for the re-sale of goods in Ontario. Speculators buying and re-selling stock is no different than retailers buying and selling bananas. Perhaps this action would take the speculation and volatility out of the stock markets.
This option would certainly be more acceptable than Dions’ proposed $40/MT carbon tax on gas emissions from refiners exporting oil to the US.
George Gorski
06/19/2008
Don Dykstra,
There is a buyer for every seller in all markets, at all times. At every step up (and down) the dotcom bubble, there was a buyer corresponding to every seller.
According to your flawed logic, futures prices should never move up or down at all.
From HOUSTON, TX, 06/19/2008
I agree with most of what Dr. Reich said, except his comment that commodity futures trading drives up the price of crude oil. Without going into details, trading futures contracts is a zero sum game. For every buyer there is a seller. If there are 10 million contracts to buy oil there are another 10 million offsetting contracts to sell oil.
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