A police officer is walking down the street and sees a drunk crawling on all fours under a streetlight, obviously looking for something.
“Have you lost something?” says the police officer.
“Yes, occifer, I mean officer,” says the drunk. “I lost my keys.”
“Right about here?” asks the cop.
The drunk points toward a dark alley. “No, actually, in there?”
The puzzled police officer asks, “Then why are you looking here?”
“Because this is where the light is,” he answers.
And that is the logic behind the stricter regulations to curb speculation in the commodity markets proposed by the Commodity Futures Trading Commission (CFTC) — arguably the least effective and occasionally most ridiculous financial regulatory body in Washington.
Is the CFTC going after speculators working the trading desks on Wall Street? No, too hard to pin anything down.
Are regulators going after hedge funds that build and dump massive positions daily, hourly and by the minute? Nope, they don’t know how to do it.
Instead, since their idea of sophisticated financial investigation is to go to Yahoo Finance, they are going after futures-based commodity exchange-traded funds (ETFs) — the only intelligent way for individual investors to play commodity markets. The CFTC aims to reign in these ETFs by limiting how much of the futures market an ETF can lay claim to.
And why not? Individual investors do not lobby and cannot offer jobs to regulators once they leave the government. Big trading houses and hedge funds can and do.
I am not a conspiracy theorist — I believe the financial markets blew up because of a lack of proper regulation — but limiting the size of these ETFs is insane.
Not that ETFs, especially the double and triple leveraged ones, are good for markets, but they already exist, and to limit what they can do is to take away the private property of investors who already own these ETFs without due process.
ETFs Preemptively Halt Share Creation
Last week, the United States Natural Gas Fund (UNG), which owns about a fifth of certain benchmark gas contracts, said it wouldn’t issue more new shares in anticipation of these stricter regulations. Some other commodity ETFs have followed suit.
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UNG is suppose to track the price of natural gas, but in recent weeks it has traded up faster than the price of natural gas has risen due to demand by investors.
Average daily volume for UNG is more than 40 million units. Many professional investors also use the UNG as part of trades involving oil, the U.S. dollar, bonds and other commodities since they can hedge the UNG very cheaply with the purchase or sale of calls and puts. Also, the options are very liquid.
If an ETF such as UNG is capped, costs per unit may go up and the price of the ETF will deviate from the price of the underlying commodity due to the demand — or lack thereof — by investors, defeating the purpose of the ETF.
What it Means to You
So what is an individual trader to do?
You’ll need to research an ETF to see if it still issuing shares or if it is capped. Realize that if an ETF is capped, you can no longer count on the underlying commodity to drive the ETF in a predictable, measureable way. And you now need to avoid trading options on ETFs no longer issuing shares unless you are a pure technician trading movements in charts.
The other thing you can do is get an account with one of the big trading desks, tell them you want to trade commodities and watch you account evaporate in a few months. Any professional commodity trader will tell you that, over time, individual investors typically lose 100% of their capital when they trade commodity futures contracts directly.
Oh, and don’t forget to thank the CFTC for effectively pushing you out of the commodity game.
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