Who is Michael Masters?

If you’ve never heard this name than take note. He was the person (amongst others, but he got most of the limelight) trying to convince congress that the high oil prices are at least partly a result of speculation, and funny enough, he made quite an impact after he appeared at a Senate committee hearing on May 20. Scratching the surface a little, and things begin to smell.  An not necessarily in a pleasant way..

His May 20 Senate committee testimony (see here) begins in a heart wrenching way, a concerned citizen trying to do the right thing:

I have been successfully managing a long-short equity hedge fund for over 12 years and I have extensive contacts on Wall Street and within the hedge fund community.  Itʼs important that you know that I am not currently involved in trading the commodities futures markets. I am not representing any corporate, financial, or lobby organizations.  I am speaking with you today as a concerned citizen whose professional background has given me insight into a situation that I believe is negatively affecting the U.S. economy.  While some in my profession might be disappointed that I am presenting this testimony to Congress, I feel that it is the right thing to do.

But he goes to the heart of the matter immediately after that:

You have asked the question “Are Institutional Investors contributing to food and energy price inflation?”  And my unequivocal answer is “YES.” In this testimony I will explain that Institutional Investors are one of, if not the primary, factors affecting commodities prices today.

What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors.  Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors.  Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant

Chart One shows Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years!

As if a correlation means a causal relationship. That’s about the first thing students taking research method classes in the social sciences learn, but anyway. And, equally important, not everybody agrees with the importance of index speculators in the futures market:

Barclays Capital, an investment bank, calculates that “index funds”, which have especially exercised the politicians because they always bet on rising prices, account for only 12% of the outstanding contracts on NYMEX and have a value equivalent to just 2% of the world’s yearly oil consumption.

That’s hardly surprising, as the daily turnover of commodities futures far exceeds the $260B that these index investors have put to work in the commodities futures market over something like 5 years.

If you are a regular reader of this website you will know our position on this issue, as no actual deliveries take place, and there is no hoarding of oil that we are aware off, speculators are very unlikely to be responsible for the price rises.

But Masters claims that there are actual deliveries and hoarding!

In fact, Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years

Since we argued that we were not aware of any, and since we cannot be aware of everything, we started to dig around a little. First, the source he uses for this bold statement is the Energy Information Administration.

We have a hard time distilling any stockpiling, let alone 1.1B barrels by ‘Index Speculators’ (the funds that Masters especially targets, mostly pension funds who have increased their commodities exposure by investing according to various commodity indexes).

If anyone can read that from this table, please come forward..

And once again, not everybody agrees. The Economist had this to say:

More importantly, neither index funds nor other speculators ever buy any physical oil. Instead, they buy futures and options which they settle with a cash payment when they fall due. In essence, these are bets on which way the oil price will move. Since the real currency of such contracts is cash, rather than barrels of crude, there is no limit to the number of bets that can be made. And since no oil is ever held back from the market, these bets do not affect the price of oil any more than bets on a football match affect the result.

We made that last argument a couple of days before that already. When reading the latest BMO Financial group reports we came across Masters.

The man  Senator McCaskill  (D.-Mo.)  calls  “the most  important man  in Washington  right  now” was  telling  Senator  Lieberman  and  other  villain seekers what they wanted to hear.

The hedgefund Masters runs out of tax-ree Virgin Islands turns out to have large call options in airlines and General Motors, not a winning position so far, to say the least. However, taking these positions into account, his rant against pension fund speculators suddenly start to make sense, from that same BMO report:

he’s positioned perfectly—and perilously—to prosper if oil prices should sink suddenly amid a sea change of opinion that “it was all about pension fund speculators

If that would happen, he could even claim he was right all along, if oil prices go down on legislation that make it more difficult for speculators to speculate, isn’t that proof that speculation is behind the rise in the first place?

He would be a hero, but as stated, we remain very skeptical.