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Commodity Misconceptions

The price of oil has been the hottest topic in the news for the last 6 months. Today, the Saudis are meeting to discuss the unacceptable high price of oil and ways of controlling that price. To this, many supposed experts in commodity pricing have claimed that the US dollar is the cause for the high price.

The claim that a currency is the cause of a high commodity value is absurdly parochial. The US dollar is freely traded on the open money market. Therefore, if more people purchase dollars instead of their own currency, then the value of the dollar increases. When currency investors realize their gains, the relative value of a currency decreases, much like a stock. In effect, currency is the stock of a country, and commodities are traded by trading equity positions in countries.

The price of a commodity is controlled by contracts, not supply. You don't purchase hard commodities on the open exchange [3] [4]. Rather, you purchase the rights to a contract of a specific amount of that commodity. Then you find a buyer who should need that hard commodity. If this were always the case, then the commodity would have a supply/demand pricing history and would be controlled solely by consumption. [1]

With oil and other speculative commodities, though, this type of trading is no longer happening. Rather, speculators purchase contracts, and then sell them to other speculators who continue to hold their contracts knowing that they can keep the oil contract without burden. This type of unregulated electronic trading (which is how it occurs) creates an artificial demand for oil (and Gold too).

Then, an investor who has commodity contracts tells their investor buddies that the commodity is running low on supply, and artificially creates a feverish demand for this commodity. Since the investor does not have to disclose their commodity contract positions, they manipulate the market to their advantage. This is how the US stock market crashed in 1929.

There is speculation about increasing the regulation [2] of commodity futures trading and requiring further disclosure of such positions. This regulation will likely only affect new positions and not existing positions, thereby not reducing the manipulation price of the commodities in question.

You can bet that hedge funds with enormous cash reserves are the cause of the speculative pricing in the commodities futures markets. Many wealthy and powerful people have interests in these types of funds so there is no incentive to add regulation that would eliminate this incredible money making method.

[1] http://futures.tradingcharts.com/tafm/
[2] http://www.cftc.gov/
[3] http://www.optimusfutures.com/
[4] http://en.wikipedia.org/wiki/Commodity_market

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