Gary Gensler, the chairman of the Commodity Futures Trading Commission, seems to be hell bent on imposing trading limits on speculative energy traders. “No longer must we debate the issue of whether or not to set position limits,” said Gensler during hearings on speculation in energy markets. “There are three important questions that do remain: Who should set position limits? Who should be exempted from position limits? And at what level should position limits be set?” Such a position seems like a logical step (or at least one that should be well received by the public) towards eliminating volatility in prices of certain commodities that harm millions of American consumers, but the commission runs the risk of overregulating the market for commodities, a move that could negatively impact the liquidity of certain exchange-traded products.
According to the Wall Street Journal, the trading practices of large investors such as pension funds and endowments, who seek exposure to commodities without actually purchasing futures contracts, are being closely investigated. In addition to establishing position limits, the CFTC is also considering reducing some of the exemptions historically offered to big banks and index traders.
Impact On ETFs
This week’s hearings (which will continue into the first week of August) were called to investigate the role that large investors, including index funds and ETFs, play in setting prices for “commodities of finite supply” (essentially energy commodities). The worry is that certain investors may be distort market prices because they have such huge holdings in certain products. Perhaps the best example in the ETF space is U.S. Commodity Funds’ Natural Gas Fund, UNG. Since March, UNG, which invests in near-month U.S. natural gas futures, has attracted about $4 billion in cash inflows, growing more than sixfold in size. Earlier this month, UNG, which holds nearly 125,000 natural gas futures on the New York Mercantile Exchange, petitioned the SEC to increase the number of shares it could issue to 1.2 billion from 200 million. The SEC is yet to act on the request, perhaps waiting on the outcome of the CFTC hearings.
Critics believe that UNG is contributing to volatility in natural gas prices, which have fallen sharply over the last 12 months. Since UNG invests in near-month futures contracts,the fund must roll its holdings into second month contracts as the expiration date approaches. To do so, UNG must sell off near month futures and buy up second month futures, theoretically widening the contango in natural gas prices. UNG, which spreads its positions across the NYMEX and the ICE over-the-counter market, holds as much as 80% of the open interest in natural gas futures on the NYMEX.
Not surprisingly, not everyone agrees with the theory that large ETFs are contributing to market volatility and holding down natural gas prices. In a filing with the SEC last week U.S. Commodity Funds said reports of UNG’s impact on prices “significantly mischaracterize” the fund’s role in the market. “That’s like saying Switzerland was responsible for the attack on Pearl Harbor during World War II,” said John Hyland, Chief Investment Officer for UNG.
What the CFTC’s decisions ultimately mean for commodity ETPs remain to be seen. These securities have allowed investors to gain quick, easy, and cheap access to various resources that many believe are a critical component of any well-balanced portfolio. But because most investors don’t intend to hold the commodities they hold for commercial purposes, they technically qualify as speculators. Stay tuned over the coming weeks as the fallout from the CFTC hearings becomes more evident.
Disclosure: No positions at time of writing.