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Prediction: More volatility in oil and commodities

There appears to be more unrest in the world this week, which of course brings with it the increased nervousness of analysts and speculators.  One of the real questions arising is whether India will abide by the US call for sanctions to buying Iranian oil.  According to a Bloomberg report, Oil Minister S. Jaipal Reddy, Finance Minister Pranab Mukherjee and Foreign Secretary Ranjan Mathai have said India will continue to buy Iranian oil to meet its growing energy needs. While the Indian government has an excellent record of enforcing United Nations sanctions on Iran, India has objected to unilateral U.S. sanctions, according to U.S. officials.  The report goes on to note how the latest shipping data shows India and South Korea sharply increased oil purchases from Iran in January, according to a report released yesterday by the International Energy Agency in Paris. China halved its imports from Iran, from 550,000 barrels a day in December to 275,000 barrels a day in January, following a dispute over pricing terms that has now been resolved, the report said.

On the commodities front, an even more interesting picture is emerging that could dramatically shift the volatility of commodities.  A Reuters report notes that the banks are now locked in deep debate with the Fed, according to multiple sources. Goldman and Morgan Stanley argue the right to own such assets is ‘grandfathered’ in from their lightly-regulated investment banking days, or that at least they should be allowed to retain them as “merchant banking” investments, kept segregated from the trading desks.

Many people are unaware that these big banks stockpile commodities in oil in massive storage tanks and warehouses.  For example, Goldman owns Metro, a Detroit-based metals warehousing business, while JP Morgan owns a metals warehousing business Henry Bath.  Jason Schenker (a speaker at our next SCRC meeting April 30-May 1), notes that this is not surprising given the need of these banks to speculate in these markets.

“The truth of it is that having access to the physical markets is about optimization and knowledge – it gives you the visibility of the market to make far more successful proprietary trading decisions in both physical and financial markets,” Schenker notes.

“That’s why for many years the most successful traders had access to both markets, and why we’ve seen little sign they’re moving quickly to divest these assets now. It’s trading with material non-public information – the difference compared with equity markets is that it’s perfectly legal.”

Should these banks lose the debate, the result may be the biggest shake-up in commodity markets since the early 1980s, when Wall Street decided to enter the speculative opportunities that presented themselves in crude oil cargoes, copper stockpiles and power plants.  (Remember Enron?)

The loss of these assets due to regulation would be a blow for the banks at the worst possible moment, with their proprietary trading desks shut down, commodity merchants trying to poach their top traders and new Basel III capital regulations requiring them to further build capital reserves.

The impact on the commodity markets would no doubt be substantial as well, although there is no way of knowing the impact up or down…..all we know is that more volatility is on the horizon!