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Brown-Hruska: Futures Prices Follow Physical Markets

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WASHINGTON (–In a speech to the Natural Gas Roundtable at the University Club Tuesday [March 28], a commissioner of the Commodity Futures Trading Commission argued that market manipulation through derivatives is more difficult, and successes more rare, than is commonly believed.

Or, as Sharon Brown-Hruska phrased it, it’s the physical market dog that generally wags the futures market tail, not the other way around.

She surveyed several instances of real or alleged market manipulation in order to make this point. She said that she began her career at the CFTC in its division of economic analysis in 1990, when the agency was dealing with “the fallout from the stock market crashes and assertions that trading in the stock index futures markets led to the fall of stock prices–particularly in the case of the 1987 episode when ‘program trading’ was fingered as public enemy number one.”

She also included in her survey the Hunt brothers’ ill-fated adventures in the silver markets in the late 1970s.

She told her listeners that in early 2004 the CFTC received roughly 500 emails or letters asserting that the silver futures market had been the subject of manipulation by commercial traders. In this case, the charge wasn’t that the tail was wagging the dog, but that the tail was holding the dog still.

“What is interesting and different about silver is that normally we see charges of manipulation when there is a large price spike or collapse in the market prices,” she said. “In silver, the charge is that there has been no price appreciation for an extended period.”

But, she said, the Hunt/silver episode demonstrates that efforts to manipulate prices tend to be self-terminating and self-punishing. “During the silver run-up,” she said, “not only did commercial enterprises boost silver production, but ordinary citizens flooded the market with whatever silver could be found in their basements and attics. This made it costly for the Hunt brothers to continue to build on their position. Noting that the Hunts were unduly influencing the market, the exchanges and the CFTC took action that forced the Hunt brothers to sell off their silver holdings… . In general, prices provide strong incentives to economic agents to make adjustments.”

Futures contracts have a finite life, she noted. A position must be unwound prior to the expiration of the contract. Furthermore, trading in such contracts doesn’t tie up the underlying physical commodity, so it doesn’t create a shortage. “This can only be accomplished in the physical markets.”

Since she was talking to a natural-gas industry group, she came around in time to the situation closer to the front of their minds: that “managed money traders and hedge funds [are] a group that is responsible for pushing prices up or making them more volatile” in the energy markets.

She said that the annual consumption of natural gas in the United States is equivalent to Nymex open interest of about 2.1 million contracts. As a whole, though, managed money traders have held a net short position over the last four months of, on average, about 30,000 contracts. These numbers alone make it appear unlikely that the traders are a prime mover–their net position is but “part of the tail on a big, active, bouncing dog.”

She also maintained that the CFTC’s surveillance programs “have worked well to deal with potential manipulation and delivery problems in the markets,” and they work well because the futures market is centralized and the contracts are standard.

As preface to all this, as is the custom, Ms. Brown-Hruska had cautioned that “the views I express today are my own and do not represent an official position of the [CFTC] or its staff.”

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Contact Bob Keane with questions or comments at [email protected].