©2008 Michael W. Masters and Adam K. White, all rights reserved.

THE ACCIDENTAL HUNT BROTHERS

How Institutional Investors Are

Driving Up Food And Energy Prices

 Michael W. Masters

 Portfolio Manager

 Masters Capital Management

mike@accidentalhuntbrothers.com

 Adam K. White, CFA 

 Director of Research

 White Knight Research & Trading

adam@accidentalhuntbrothers.com

www.accidentalhuntbrothers.com

• The Hunt Brothers were famous for trying to corner the silver market. 

They were successful in driving the futures price of silver from under 

$10 to over $50 an ounce. When the COMEX stepped in and made 

them liquidate their position, silver prices dropped back to $10 an 

ounce within three months.

• Institutional Investors, with nearly $30 trillion in assets under 

management, have decided en masse to embrace commodities 

futures as an investable asset class. In the last five years, they have 

poured hundreds of billions of dollars into the commodities futures 

markets, a large fraction of which has gone into energy futures.

• While individually these Investors are trying to do the right thing for 

their portfolios (and stakeholders), they are unaware that collectively 

they are having a massive impact on the futures markets that makes 

the Hunt Brothers pale in comparison.

• In the last 41⁄2, years assets allocated to commodity index replication 

trading strategies have grown from $13 billion in 2003 to $317 billion 

in July 2008. At the same time, the prices for the 25 commodities that 

make up these indices have risen by an average of over 200%.

S&P GSCI Spot Price Index vs. Index Speculator Assets

Source: Bloomberg, Goldman Sachs, CFTC Commitments of Traders CIT 

Supplement, calculations based upon CFTC COT/CIT report (see appendix). 

2008 figure is as of 7/1/08.

• Todayʼs commodities futures markets are excessively speculative, 

and the speculative position limits designed to protect the markets 

have been raised, or in some cases, eliminated. Congress must act 

to re-establish hard and fast position limits across all markets. 

Special Report July 31, 2008

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19701972197419761978198019821984198619881990199219941996199820002002200420062008

COMMODITY INDEX ALLOCATIONS 

(BILLIONS OF DOLLARS)

S&P GSCI SPOT PRICE COMMODITY INDEX

OTHERS

DJ-AIG

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S&P GSCI SPOT INDEX
The Accidental Hunt Brothers July 31, 2008

ABOUT THIS REPORT

• Chapters One and Two of this report are foundational. They examine the nature 

of the commodities futures markets and the characteristics of Index Speculators 

respectively. 

• Chapter Three presents the evidence that Index Speculators have been at least 

partially responsible for the tripling of commodities futures prices over the last five 

years. If you read only one chapter in this report this is the one to read. 

• Chapters Four, Five and Six are shorter, conceptual chapters that tackle the 

topics of the Price Discovery Function, Excessive Speculation and Speculative 

Position Limits, respectively. They are valuable for understanding the nature of 

the solutions recommended to combat Excessive Speculation and Index 

Speculation. 

• Chapter Seven presents our recommended legislation solutions.

ABOUT THE AUTHORS

Michael W. Masters is a long/short equity hedge fund portfolio manager and the 

founder of Masters Capital Management, LLC. Mr. Masters graduated in 1989 from

the University of Tennessee with a B.S. in Finance. Mr. Masters was an AllAmerican swimmer at UT. In 1994, Mr. Masters founded Masters Capital 

Management (MCM). MCM is a global investment management firm that trades and 

invests in public and private, domestic and international, bonds and equities. In 

March of 2005, Mr. Masters and Wilbur L. Ross, Jr. formed a partnership to focus on 

investments in early-, mid- and late-stage companies employing nanotechnologyenabled products and solutions. Mr. Masters was profiled in the book "Stock Market 

Wizards" by Jack D. Schwager and was the winner of the "Open Your Heart" award 

in 2004 from the organization Hedge Funds Care. Mr. Masters has started several 

foundations including St. Croix Mission Outreach and the Atlanta Men's Enterprise 

Network. Mr. Masters currently serves on the boards of several charitable and 

private organizations.

Adam K. White, CFA is currently the Director of Research at White Knight Research 

and Trading an independent research consulting firm. Prior to his current position 

Mr. White was a successful research analyst with Masters Capital Management. In 

his 6-year tenure with Masters Capital he had primary research coverage for financial 

services stocks and was also head of derivatives strategy. Before that he worked for 

3 years at The Coca-Cola Company in their treasury department where he was 

responsible for managing their billion-dollar emerging market currency portfolio. He 

was also head of the "portfolio project" at Coke treasury and built many of the options 

pricing systems they use today. Coming out of graduate school, Mr. White worked 

for Swiss Bank Corporation as a Risk Management Advisor responsible for 

marketing, pricing and hedging interest rate swaps and options. Mr. White holds a 

B.S. in Accounting from the Fisher School of Accounting at the University of Florida 

as well as an M.B.A. in Finance and Economics from the Graduate School of 

Business at the University of Chicago. Mr. White also holds the Chartered Financial 

Analyst designation.
The Accidental Hunt Brothers July 31, 2008

TABLE OF CONTENTS

EXECUTIVE SUMMARY ................................................................................. I

CHAPTER ONE: FOUNDATIONAL INFORMATION.................................... 1

COMMODITIES FUTURES DEFINED............................................................................... 1

FIRST VITAL FUNCTION: OFFSETTING PRICE RISK ....................................................... 1

SECOND VITAL FUNCTION: PRICE DISCOVERY............................................................. 1

TWO TRADITIONAL TYPES OF MARKET PARTICIPANTS .................................................. 2

FOUR DISTINCT TYPES OF MARKETS........................................................................... 3

Capital Markets..................................................................................................................3

Financial Futures Markets .................................................................................................3

Physical Commodity Markets ............................................................................................4

Commodities Futures Markets...........................................................................................4

BRINGING CLARITY TO BLURRED DISTINCTIONS ........................................................... 4

SPECULATIVE PRICE BUBBLES.................................................................................... 5

COMMODITIES FUTURES ARE NOT INVESTMENTS......................................................... 5

CHAPTER TWO: RISE OF THE INDEX SPECULATOR ............................... 7

WHAT IS AN INDEX SPECULATOR? .............................................................................. 7

WHO ARE THE INDEX SPECULATORS?......................................................................... 7

WHY ARE THEY INDEXING? ........................................................................................ 7

WHAT ARE THE INDICES? ........................................................................................... 8

HOW DO PENSION FUNDS ALLOCATE MONEY TO THESE INDICES?................................ 9

HOW DOES A SWAP WORK?....................................................................................... 9

THE GOLDMAN ROLL................................................................................................ 10

INDEX SPECULATORS INVEST ULTRA-LONG-TERM...................................................... 10

INDEX SPECULATORS ARE LONG-ONLY ..................................................................... 11

INDEX SPECULATORS HAVE A PRICE-INSENSITIVE DOLLAR DEMAND ........................... 11

INDEX SPECULATORS DAMAGE THE PRICE DISCOVERY FUNCTION .............................. 11

CHAPTER THREE: INDEX SPECULATORS HAVE DRIVEN FOOD AND 

ENERGY PRICES HIGHER.......................................................................... 12

INTRODUCTION ........................................................................................................ 12

MONEY FLOW, EXPRESSED AS BUY ORDERS, MOVES PRICES .................................... 12

INSTITUTIONAL INVESTORS HAVE DRIVEN PRICES HIGHER BY POURING MONEY INTO 

COMMODITIES FUTURES........................................................................................... 13

INDEX SPECULATOR DEMAND HAS DRIVEN PRICES HIGHER........................................ 14

THE ADDITION OF INDEX SPECULATOR DEMAND TO EXISTING DEMAND HAS CREATED A 

MASSIVE DEMAND SHOCK ........................................................................................ 14

Crude Oil in Perspective..................................................................................................15

Copper in Perspective .....................................................................................................17

Wheat in Perspective.......................................................................................................17

Corn in Perspective .........................................................................................................18

Sugar in Perspective .......................................................................................................18

INDEX SPECULATORS HAVE BOUGHT MORE COMMODITIES FUTURES THAN ALL OTHER 

GROUPS COMBINED................................................................................................. 19

INDEX SPECULATOR DEMAND IS HUGE COMPARED TO THE SIZE OF COMMODITIES 

FUTURES MARKETS ................................................................................................. 20

INDEX SPECULATOR DEMAND IS INSENSITIVE TO PRICE.............................................. 22

MARKET POWER IS CONCENTRATED IN THE HANDS OF LARGE SWAPS TRADERS ......... 23

EXAMPLE OF SWAPS DEALERSʼ INFLUENCE OVER WTI CRUDE OIL.............................. 23

SUMMARY ............................................................................................................... 24
The Accidental Hunt Brothers July 31, 2008

CHAPTER FOUR: PRICE DISCOVERY FUNCTION .................................. 25

INTRODUCTION ........................................................................................................ 25

SPOT PRICES ARE EQUAL TO FUTURES PRICES IN GRAIN AND ENERGY MARKETS ....... 25

Price Discovery in Grains ................................................................................................26

Price Discovery in Energy ...............................................................................................26

ALL STORABLE COMMODITIES WITH PHYSICAL DELIVERY PROVISIONS CAN BE 

ARBITRAGED ........................................................................................................... 26

FUTURES PRICES ARE THE BENCHMARK FOR SPOT MARKET TRANSACTIONS .............. 27

THE EFFECT OF OVER-THE-COUNTER DERIVATIVES MARKETS ON THE PRICE DISCOVERY 

FUNCTION OF FUTURES MARKETS ............................................................................ 27

SUMMARY ............................................................................................................... 28

CHAPTER FIVE: EXCESSIVE SPECULATION.......................................... 29

INTRODUCTION ........................................................................................................ 29

PHYSICAL HEDGERS: NORMAL SUPPLY AND DEMAND CURVES.................................... 29

INDEX SPECULATORS: INSENSITIVE SUPPLY AND DEMAND CURVES............................. 29

TRADITIONAL SPECULATORS: ADAPTIVE SUPPLY AND DEMAND CURVES..................... 30

TWO STATES OF THE COMMODITIES FUTURES MARKETS............................................ 30

Normal State....................................................................................................................31

State of Excessive Speculation .......................................................................................31

IMPLICATIONS OF THE DIFFERING SUPPLY AND DEMAND CURVES OF COMMODITIES 

FUTURES MARKETS PARTICIPANTS ........................................................................... 32

THE TIPPING POINT WHERE SPECULATION BECOMES EXCESSIVE............................... 33

TODAYʼS COMMODITIES FUTURES MARKETS ARE EXCESSIVELY SPECULATIVE ............ 33

SPECULATION HAS GROWN TO EXCESSIVE LEVELS IN ALMOST ALL COMMODITIES ...... 35

SUMMARY ............................................................................................................... 36

CHAPTER SIX: SPECULATIVE POSITION LIMITS.................................... 37

INTRODUCTION ........................................................................................................ 37

CONDENSED HISTORY OF SPECULATIVE POSITION LIMITS........................................... 37

EXCESSIVE SPECULATION IS NOT THE SAME AS MANIPULATION.................................. 38

POSITION LIMITS RAISED .......................................................................................... 38

POSITION LIMITS EVADED......................................................................................... 39

POSITION LIMITS ELIMINATED ................................................................................... 40

SUMMARY ............................................................................................................... 40

CHAPTER SEVEN: LEGISLATIVE SOLUTIONS........................................ 41

INTRODUCTION ........................................................................................................ 41

STEP ONE: RE-ESTABLISH FEDERAL SPECULATIVE POSITION LIMITS FOR ALL 

SPECULATORS IN ALL COMMODITIES IN ALL MARKETS................................................ 41

STEP TWO: DEFINE EXCESSIVE SPECULATION NUMERICALLY ..................................... 42

STEP THREE: ELIMINATE (OR SEVERELY RESTRICT) INDEX SPECULATION.................... 43

BENEFITS OF THESE PROPOSALS.............................................................................. 44

EMPTY THREATS OF OFFSHORE MIGRATION.............................................................. 44

SUMMARY ............................................................................................................... 46

CONCLUSION .............................................................................................. 47

MORE INSTITUTIONAL INVESTORS WANT TO INVEST IN COMMODITY INDEXES............... 47

WALL STREET IS NOW PROMOTING THIS INVESTMENT TO RETAIL INVESTORS.............. 47

THE PROBLEM WILL NOT SOLVE ITSELF .................................................................... 48

APPENDIX: HOW TO CALCULATE INDEX SPECULATORSʼ POSITIONS

...................................................................................................................... 49
The Accidental Hunt Brothers July 31, 2008

i

EXECUTIVE SUMMARY

The commodities futures markets are a unique hybrid form of marketplace where two 

distinctly different categories of market participants transact side by side. Physical 

Hedgers access the markets to reduce the price risk of their underlying physical 

commodity businesses, while Speculators trade in the markets to make maximum 

profits.

When Physical Hedgers dominate the commodities futures marketplace, prices 

accurately reflect the supply and demand realities that physical consumers and 

producers are experiencing in their businesses. When Speculators become the 

dominant force, prices can become un-tethered from supply and demand, reaching 

irrationally exuberant heights.

In 1936 Congress devised a system to prevent the kind of speculative bubbles we 

are seeing today. The Commodity Exchange Act placed limits on the size of 

Speculatorsʼ positions, thereby ensuring the dominance of bona fide Physical 

Hedgers. Congress established position limits with the understanding that the proper 

functioning of the commodities futures markets was essential to the health of the 

American economy.

Today the agricultural and energy markets rely on futures prices as their benchmark 

for the pricing of nearly all their transactions in the real world “spot” markets. For 

many commodities, when the futures price rises by $1, the spot price rises by $1 as 

well. This pricing method is preferred by Physical Hedgers because it allows them to 

use the futures markets to hedge their price risk on a dollar-for-dollar basis.

Unfortunately, this price discovery function of the commodities futures markets is 

breaking down. With the advent of financial futures, the important distinctions 

between commodities futures and financial futures were lost to regulators. Excessive 

speculation gradually became synonymous with manipulation, and speculative 

position limits were raised or effectively eliminated because they were not deemed 

necessary to prevent manipulation.

Swaps dealers who trade derivatives in the completely unregulated over-the-counter 

(OTC) markets have been given the same virtually unlimited access to the futures 

markets that bona fide Physical Hedgers enjoy. These swaps dealers have 

convinced Institutional Investors that commodities futures are an asset class that can 

deliver “equity-like returns” while reducing overall portfolio risk. These investors have 

been encouraged to make “a broadly diversified, long-only passive investment” in 

commodities futures indices. As a result, a new and more damaging form of 

Speculator was born; we call them Index Speculators.

As Chart 1 demonstrates, the result has been a titanic wave of speculative money 

that has flowed into the commodities futures markets and driven up prices 

dramatically.
The Accidental Hunt Brothers July 31, 2008

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Chart 1. S&P GSCI Spot Price Index vs. Index Speculator Assets

Source: Bloomberg, Goldman Sachs, CFTC Commitments of Traders CIT Supplement, calculations 

based upon CFTC COT/CIT report (see appendix). 2008 figure is as of 7/1/08.

The total open interest of the 25 largest and most important commodities, upon which 

the indices are based, was $183 billion in 2004. From the beginning of 2004 to 

today, Index Speculators have poured $173 billion into these 25 commodities. As 

Chart 2 shows, this has caused futures prices to rise dramatically as the commodities 

futures markets were forced to expand in order to absorb this influx of money.

Chart 2. Commodities Futures Market Size (Billions) vs. S&P GSCI Spot Price Index

Source: Bloomberg, Goldman Sachs, CFTC Commitments of Traders CIT Supplement, calculations 

based upon CFTC COT/CIT report (see appendix). Figures represent annual averages and 2008 

figure is an average through 7/1/08.

Index Speculators have bought more commodities futures contracts in the last five 

years than any other group of market participant. They are now the single most 

dominant force in the commodities futures markets. And most importantly, their 

buying and trading has nothing to do with the supply and demand fundamentals of 

any single commodity. They pour money into commodities futures to diversify their 

portfolios, hedge against inflation or bet against the dollar.

The four largest commodity swaps dealers - Goldman Sachs, Morgan Stanley, J.P. 

Morgan and Barclays Bank –are reported to control 70% of the commodity index 

swaps positions. Recently released Commodities Futures Trading Commission 

(CFTC) data from the House Energy Committee shows that swaps dealers have 

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19701972197419761978198019821984198619881990199219941996199820002002200420062008

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Dollar Value of Physical Hedgers' Positions

Dollar Vale of Traditional Speculators' Positions

Dollar Value of Index Speculators' Positions
The Accidental Hunt Brothers July 31, 2008

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grown to become the largest holders of NYMEX WTI crude oil futures contracts. 

Chart 3 shows that, as their positions have grown in size, so has the price of oil.

Chart 3. Swaps Dealers Positions in NYMEX WTI Crude Oil Futures vs. WTI Price

Source: Commodities Futures Trading Commission (CFTC) via the House Energy Committee, 

Bloomberg

Congress can put an end to excessive speculation by simply re-establishing 

meaningful speculative position limits that apply on all exchanges trading U.S.-based 

commodity futures contracts. These speculative position limits also need to be 

applied to transactions in the over-the-counter swaps market, since that market is 

now 9 times bigger than the futures exchanges.

In addition to imposing speculative position limits, Congress should take the 

additional step of prohibiting or severely restricting the practice of commodity index 

replication. This practice represents a new threat to the markets because it inflates 

commodities futures prices, consumes liquidity and damages the price discovery 

function.

Speculative position limits worked well for over 50 years and carry no unintended 

consequences. If Congress takes these actions, then the speculative money that 

flowed into these markets will be forced to flow out, and with that the price of 

commodities futures will come down substantially. Until speculative position limits 

are restored, investor money will continue to flow unimpeded into the commodities 

futures markets and the upward pressure on prices will remain.

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The Accidental Hunt Brothers July 31, 2008

1

CHAPTER ONE: FOUNDATIONAL INFORMATION

Commodities Futures Defined

Commodities futures markets have existed in the United States since 1865.1 A 

commodities futures contract is a standardized legal agreement to transact in a 

physical commodity at some designated future time.2 It is standardized in the sense 

that it spells out the time and place of delivery as well as the quantity and quality of 

commodity to be delivered. The only unspecified portion of the contract is the price, 

which is determined in the commodities futures marketplace.

Since their inception, commodities futures markets have provided two valuable 

functions for physical commodity market participants (the actual consumers and 

producers of the physical commodities). In the Commodity Exchange Act of 1936, 

Congress recognized that the commodities futures markets provide physical market 

participants with: (1) the means to offset price risk, and (2) a means for price 

discovery.3 Since 1974, Congress has entrusted the Commodities Futures Trading 

Commission (CFTC) with preserving these two vital functions and with protecting 

them against the threat of fraud, manipulation and excessive speculation.

First Vital Function: Offsetting Price Risk

Commodities futures markets provide a way for physical commodity market 

participants to hedge against the risk of price fluctuations. As an example, a physical 

commodity producer, such as an Iowa corn farmer, who is able to sell futures 

contracts against the amount of the expected harvest can lock in a price for corn and 

thereby eliminate price risk. A physical commodity consumer, such as a cereal 

manufacturer, who is able to buy futures contracts for the amount of corn it needs to 

produce corn flakes can lock in its input costs and eliminate its price risk.

These physical commodity market participants benefit because they are not at risk 

from price fluctuations and can therefore plan effectively for the future of their 

businesses. Because food, energy and industrial metals form the basic building 

blocks of our economy, the financial health of physical commodity market participants 

is vital to the overall health of the American economy.

Second Vital Function: Price Discovery

Properly functioning commodities futures markets provide a way for physical 

commodity market participants to determine with the greatest possible accuracy the 

current price for physical commodities in the overall marketplace. As an example, 

the farmer in Iowa needs to know the prevailing price for corn before selling to a local 

consumer. Knowing the futures price allows the farmer to determine if it makes more 

sense to ship the corn somewhere else in order to get a better price. Likewise, the 

cereal manufacturer needs to know the prevailing price for corn so that it can 

negotiate a fair price with its suppliers.

 

1

 “Our History,” Chicago Board of Trade, 

http://www.cbot.com/cbot/pub/page/0,3181,942,00.html

2 “Financial Futures and Options,” Todd E. Petzel, Quorum Books, New York, 1989, page 5.

3

 Commodity Exchange Act of 1936: Title 7 Chapter 1 Section 5a 

http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=browse_usc&docid=Cite:+7USC5
The Accidental Hunt Brothers July 31, 2008

2

Commodities, by their very nature, are consumed around the globe. Physical 

commodity markets exist worldwide, but because commodities are bulky and costly 

to transport, the prices in these markets can vary substantially. For that reason, 

commodities futures prices have become the benchmark by which prices are set in 

the physical markets.4

In Chapter Four we discuss the price discovery function in depth. 

Since prices are the mechanism by which a capitalist economy functions and 

allocates resources, having this single benchmark for commodity prices is very 

valuable. Without the price discovery function of the commodities futures markets, 

the American economy as a whole would function inefficiently.

Two Traditional Types of Market Participants

Historically, the commodities futures markets have had two distinct categories of 

participants: bona fide Physical Hedgers and Speculators.

Bona fide Physical Hedgers have already been discussed. These are physical 

commodity market participants that are trying to reduce or eliminate the price risk 

they face from their commercial activities in the spot markets. These are the 

producers and consumers - the corn farmers and the cereal companies of the world.

The commodities futures markets were started by physical commodity producers and 

consumers to improve their businesses and ultimately to strengthen the economy. 

These markets exist for their benefit.

Speculators are participants in the commodities futures market who do not have an 

underlying physical commodity position to hedge. They are hoping to profit from 

changes in futures prices. When commodities futures markets function as they 

should, Speculators provide an essential function: they accept price risk in exchange 

for providing liquidity.

As an example, if our corn farmer wants to sell futures contracts but the cereal 

company is not in the market that day buying, who can the farmer sell them to? The 

answer is that Speculators are willing to buy from the corn farmer one day and sell to 

the cereal company another day. For this reason, the commodities futures markets 

need a certain number of Speculators in order to ensure sufficient liquidity.

When the commodities futures markets are functioning as they should, Speculators 

are actively buying and selling and adjusting their prices based on what they think the 

Physical Hedgers are going to do. Speculators have traditionally been students of 

the supply and demand dynamics in the underlying physical markets, because those 

dynamics are what determine the behavior of Hedgers.

As an example, if many corn crops were failing, then farmers would not have as 

many futures contracts to sell. Because of the reduced supply of corn and the 

consequent reduced supply of corn futures contracts, futures prices would normally 

 

4

 The terms “physical markets,” “spot markets” and “underlying markets” all refer to the 

markets in which tangible commodities are bought and sold by actual producers and 

consumers. In contrast, the futures markets are where derivative contracts based on 

commodities are traded.
The Accidental Hunt Brothers July 31, 2008

3

rise. Historically, Speculators have had to understand and act on these dynamics in 

order to stay in business.

Four Distinct Types of Markets 

Commodities futures markets are not capital markets. It is critical to understand the 

similarities and differences (presented in Exhibit 1) between the four different markets

discussed in this report. A thorough understanding of the current problems and 

proposed solutions is not possible without recognizing these crucial distinctions.

Capital Markets

The two most common capital markets are the debt markets and equity markets. 

These markets exist to provide debt and equity financing to corporations and other 

entities. In the primary markets bonds and stocks are issued to investors. In the 

secondary markets investors trade these securities back and forth amongst 

themselves. In 2004-2005, worldwide bond and stock markets totaled approximately 

$97.9 trillion in size, with debt markets accounting for $54.3 trillion and equity 

markets $43.6 trillion.5

Financial Futures Markets

Commodities futures exchanges began 

trading futures contracts based on financial 

securities beginning in the 1970s. These 

financial futures became very popular in 

the 1980s. Financial futures are based on 

things such as Eurodollar deposits, 

Treasury Bonds, foreign currencies and the 

S&P 500 stock index. These are derivative 

markets, so they allow Investors / 

Speculators to assume price risk or to 

hedge price risk depending on their 

position in the underlying securities relative 

to the futures.6 

Just like the capital markets, the financial 

futures markets are the exclusive domain 

of one type of market participant –

Investors / Speculators. Trading for them 

is also a two-way street, as they trade back 

and forth amongst themselves.

 

5

 CIA World Factbook: Debt figure is for 2004 and equity figure is for 2005. 

https://www.cia.gov/library/publications/the-world-factbook/geos/xx.html#Econ

6 Within the capital markets and the financial futures markets there is little difference between 

the trading behavior of Investors and Speculators. Wikipedia has a good description of the 

differences between investing and speculating and what is commonly defined as investment. 

http://en.wikipedia.org/wiki/Investing

Exhibit 1. Four Distinct Markets

COMMODITY 

MARKETS

CAPITAL 

MARKETS

Crude Oil, Corn, 

Copper, etc.

Stocks, Bonds, 

Real Estate, etc.

$1.6 Trillion

(2002)

$97.9+ Trillion

(2004-2005)

Physical 

Commodity 

Producers and 

Consumers

Investors / 

Speculators

COMMODITIES 

FUTURES

FINANCIAL 

FUTURES

Derive their value 

from physical 

commodities

Derive their value 

from capital markets securities

$0.18 Trillion

(2004)

$21 Trillion

(2008)

Physical Hedgers 

AND Speculators

Investors / 

Speculators
The Accidental Hunt Brothers July 31, 2008

4

Financial futures have far surpassed commodities futures in terms of volume and 

open interest and represent the lionʼs share of profits for many of the futures 

exchanges. Total open interest for financial futures was in the neighborhood of $21

trillion in July of this year.7

Physical Commodity Markets

Physical commodity markets are tangible real world markets where producers and 

consumers meet to buy and sell commodities. Rather than being a two-way street 

where an existing pool of securities is traded back and forth between participants, it is 

a one-way street where producers produce and consumers consume. Once 

producers have sold their production, they do not come back to the commodity 

markets until they have produced more. Likewise, once consumers have purchased 

commodities, they do not return to the markets until they have consumed what they 

purchased.

In 2002, the worldwide annual production of the 25 largest and most important 

commodities in the world was $1.6 trillion.8 While this is a large number, it is dwarfed 

by the size of capital markets and financial futures markets.

Commodities Futures Markets

The commodities futures markets are small markets, especially when compared with 

the capital markets. As we will see in Chapter Three, the commodities futures 

markets were only $183 billion in size in 2004.

Commodities futures markets are unique because they involve not one but two 

distinct categories of market participants. Unlike the other markets we have 

discussed, physical commodity market participants co-exist alongside Speculators. 

Trading amongst Speculators is generally a two-way street like in the capital markets. 

In contrast, Physical Hedgers only have to trade once to establish their hedges and 

then they either take delivery of the physical commodity or unwind their hedges prior 

to delivery.

This hybrid combination of two distinctly different categories of market participants 

with differing goals, behaviors and trading patterns make the commodities futures 

markets unique.

Bringing Clarity to Blurred Distinctions

When financial futures started to gain popularity in the 1980s, many Wall Street 

investment banks that previously had no presence in commodities futures began to 

acquire trading firms with seats on the futures exchanges.9 During the first hundred 

years that commodities futures markets existed, Wall Street had little interest in 

 

7 Rough calculations based on July 1 Commitments of Traders report published by the CFTC. 

Eurodollars and Treasury Bills are over $14 trillion and $4 trillion respectively.

8 This figure was calculated using average 2002 prices from Bloomberg and production figures 

from the Food and Agriculture Organization of the United Nations, the U.S. Geological Survey 

– U.S. Department of the Interior, and the Energy Information Association – U.S. Department 

of Energy. These are the same 25 commodities that compose the major commodity indices.

9

 An example of this phenomenon would be the Goldman Sachs purchase of J. Aron in 1981.
The Accidental Hunt Brothers July 31, 2008

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commodities futures. It was only after acquiring these futures trading firms to get 

access to the financial futures markets that Wall Street got interested in the 

commodities futures business that they inherited as a result of their acquisitions.

Most Institutional Investors today fail to see the distinction between capital markets 

and commodities futures markets. They can call up Goldman Sachs and purchase 

instruments in both markets. They can use Bloomberg to get data on both markets, 

and when they open the Wall Street Journal they can read about both markets. And 

yet, as we have seen already (and will explore further), there are crucial distinctions 

between commodities futures markets and all other markets.

Speculative Price Bubbles

It is worth noting that speculative price bubbles occur in capital markets and not in 

physical commodity markets. In fact, in just the last 10 years the U.S. capital markets 

have seen three distinct major bubbles: the tech / internet bubble of 1998-2000 

(equities), the housing bubble of 2004-2007 (real estate) and the current credit crisis 

(CDOs / SIVs / subprime) in the debt markets.

In order for a price bubble to occur, there must be a group of Investors / Speculators, 

trading back and forth amongst themselves, that are continuously re-valuing upward 

the profit potential of a class of financial instruments. When consumers purchase 

physical commodities, they are simply looking to consume those commodities. 

Consumers donʼt buy commodities for reasons other than consumption.

Because Speculators participate in commodities futures markets, these markets are 

capable of experiencing a speculative price bubble. Because Physical Hedgers only 

want to reduce their price risk, as long as they are the dominant group in the 

marketplace, speculative bubbles cannot form. But if Speculators somehow become 

the dominant force, then they can eventually drive the markets to speculative excess. 

We discuss this in detail in Chapter Five.

Commodities Futures Are Not Investments

Historically, physical commodities themselves have been looked upon as poor 

“investments” because they have a negative real rate of return. Economists agree 

that the long-term equilibrium price for a commodity generally equates to its marginal 

cost of production. Since marginal costs for commodity production have been steady 

to declining due to the application of modern technology, the prices of commodities 

have historically not kept up with overall inflation. Chart 4 shows that prior to recent 

increases, spot commodity prices have traded sideways for three decades.
The Accidental Hunt Brothers July 31, 2008

6

Chart 4. S&P GSCI Spot Price Index (1970-2002)

Source: Bloomberg

Commodities futures contracts do not pay interest, rents, dividends, or entitle the 

holder to a share of a companyʼs future cash flow. Therefore, the only return 

someone can hope to achieve is a favorable change in the price of the contract. This 

is why buying commodities futures is considered speculation and not investment. For 

decades, pension plan fiduciaries, as well as other trustees, were prevented from 

purchasing futures contracts because the Prudent Man rule forbade speculation and 

therefore prohibited the purchase of futures contracts.10

In the early 1990s, the Prudent Investor rule was adopted by most states that allowed 

trustees to purchase instruments with a view toward the impact it would have on their 

total portfolio. With the advent of financial futures, futures contracts were no longer 

expressly prohibited because financial futures could potentially be used to hedge the 

price risk of financial securities within an investorʼs portfolio. The Prudent Investor 

rule did not, however, declare that speculation was acceptable.11

 

10 “Trust Examination Manual,” Federal Deposit Insurance Corporation, Section 3 - Asset 

Management - Part I(C) Prudent Investments. 

http://www.fdic.gov/regulations/examinations/trustmanual/section_3/fdic_section_3-

asset_management.html#c

11 ibid.

0 

50 

100 

150 

200 

250 

300 

350 

197019711972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002

S&P GSCI Spot Price Index
The Accidental Hunt Brothers July 31, 2008

7

CHAPTER TWO: RISE OF THE INDEX SPECULATOR

What Is an Index Speculator?

Index Speculators are Institutional Investors engaged in commodities futures trading 

strategies that seek to replicate one of the major commodities indices by 

mechanically following that indexʼs methodology. Index Speculators aim to profit 

from price movements in commodities futures. They are not in the market to hedge 

an underlying exposure to physical commodities. They are not involved in the 

production or consumption of actual tangible commodities. Therefore, Index 

Speculators are not Physical Hedgers; instead, they are a particularly damaging form 

of Speculator.

Who Are the Index Speculators?

Index Speculators are predominantly Institutional Investors such as corporate and 

government pension funds, sovereign wealth funds, university endowments, public 

and private foundations and life insurance companies.12 Normally, these 

organizations invest in the debt, equity and real estate markets. According to the 

most recent estimates, Institutional Investors have approximately $29 trillion dollars 

allocated to various asset classes.13

Why Are They Indexing?

To understand why Institutional Investors would pursue a speculative commodity 

index replication trading strategy, it is important to understand a little bit of recent 

history. As was mentioned in the last chapter, prior to the early 1990s, pension funds 

were banned from trading commodities futures. From the mid 1990s to 2000, 

pension funds and other investors increased their allocations to stocks. So when the 

tech bubble burst in 2000, their portfolios suffered. In the subsequent two years, 

equities performed poorly. Investors were negatively impacted by the 9/11 attacks, 

the ensuing recession, the Enron and WorldCom accounting scandals and the buildup to the Iraq War.

By 2003, these investors wanted to reduce their holdings of equities and increase 

their allocation to “alternative assets.” Institutional Investors were looking for new 

asset classes that would provide returns that were uncorrelated with the existing 

assets in their portfolios. Investments in commodities were being marketed to these 

pension funds as “providing equity-like returns” while reducing overall portfolio risk.14 

In these pitches, the pension funds were encouraged to make a “broadly-diversified, 

long-only, passive investment” in commodity indices. The discovery of commodities 

futures as a new investable asset class was to many of these Investors akin to 

discovering the Holy Grail.

 

12 Pension funds represent about 65%-75% of institutional assets (source: Standard & Poorʼs 

“2008 Money Market Directory”). When we refer to pension funds in this report we are often 

using them as an example for the overall category of institutional investors.

13 Tax-exempt assets $26TT: “UK pension fund returns at five-year low,” IFAonline, Jennifer 

Bollen, January 28, 2008. http://www.ifaonline.co.uk/public/showPage.html?page=698204

Sovereign Wealth Funds $3TT: “Sovereign Wealth Funds,” Council On Foreign Relations, Lee 

Hudson Teslik, January 18, 2008. http://www.cfr.org/publication/15251/

14 “Investing and Trading in the GSCI,” Goldman, Sachs & Co., June 1, 2005.
The Accidental Hunt Brothers July 31, 2008

8

What Are the Indices?

The Standard & Poors - Goldman Sachs Commodity Index15 and the Dow Jones -

AIG Commodity Index16 are the two most popular commodity indices, with the S&PGSCI holding approximately 63% market share to the DJ-AIGʼs 32% market share.17 

Table 1 shows their component weights. The S&P-GSCI has 24 commodities that 

are weighted according to their worldwide production values. The DJ-AIG has 19 

commodities (18 of which it shares with the S&P-GSCI) that are weighted based on 

worldwide production and liquidity factors.

Because futures prices have 

become the benchmark for 

spot prices, both indices are 

based on commodities futures 

prices and not on underlying 

spot prices. The S&P-GSCI 

and the DJ-AIG are both based 

predominantly upon the prices 

of the nearest-to-expiration 

futures contracts for their 

respective set of commodities.

Please note that most popular 

investment indices such as the 

S&P 500 Stock Index are 

based upon capital markets 

securities. The critical 

distinction between these 

indices and the commodities 

market indices is that the 

commodities indices (the S&PGSCI and the DJ-AIG) are 

based not on tangible 

securities but on derivative 

instruments – futures contracts.

Because commodities futures 

expire every one to three months, these indices specify a process of rolling the 

weights of the futures from the expiring monthʼs contract to the next available 

contract.18 This rolling of weights takes place on five (5) consecutive business days 

near the beginning of the month prior to expiration.19 On each one of these days the 

 

15http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_gsci/2,3,4,0,0,0,0,

0,0,1,1,0,0,0,0,0.html for the S&P-GSCI

16 http://www.djindexes.com/mdsidx/?event=showAigHome

17 Chapter 3 details how much money is benchmarked to each of these indices.

18 The DJ-AIG says that for commodities with monthly contracts (mostly energy and base 

metals) they will skip a month and roll to the contract with two months to expiration. The net 

effect is that the roll occurs 6 times a year instead of 12 times a year.

19 For the S&P-GSCI the roll period is business days 5-9 and for the DJ-AIG it is business days 

6-10.

Table 1. Commodity Index Weights (as of 7/1/08)

S&PGSCIDJAIGWtd 

Avg

Agricultural Cocoa 0.2% 0.0% 0.2%

Coffee 0.5% 2.7% 2.1%

Corn 3.6% 6.9% 5.2%

Cotton 0.7% 2.2% 1.6%

Soybean Oil 0.0% 2.9% 2.9%

Soybeans 0.9% 7.4% 5.1%

Sugar 2.1% 2.8% 2.6%

Wheat 3.0% 3.4% 3.1%

Wheat KC 0.7% 0.0% 0.7%

Livestock Feed Cattle 0.3% 0.0% 0.3%

Lean Hogs 0.8% 2.5% 1.8%

Live Cattle 1.6% 4.1% 3.0%

Energy Brent Crude Oil 14.8% 0.0% 14.8%

WTI Crude Oil 40.6% 15.0% 36.6%

Gasoil 5.4% 0.0% 5.4%

Heating Oil 5.3% 4.5% 5.1%

Gasoline 4.5% 4.1% 4.4%

Natural Gas 7.6% 16.0% 11.9%

Base Metals Aluminum 2.1% 6.9% 5.1%

Lead 0.2% 0.0% 0.2%

Nickel 0.5% 1.7% 1.2%

Zinc 0.4% 1.8% 1.4%

Copper 2.6% 6.7% 4.9%

Precious Metals Gold 1.5% 6.1% 4.6%

Silver 0.2% 2.4% 2.1%

 Source: Standard & Poors, Dow Jones and calculations
The Accidental Hunt Brothers July 31, 2008

9

index transfers 20% of its weight from the expiring contract to the next futures 

contract.

How Do Pension Funds Allocate Money to These Indices?

In order to replicate these indices a trader must purchase futures contracts and then 

roll these positions in the exact manner that the indices roll their weight from one 

contract to the next. Since this roll takes place every month, this strategy requires the 

trader to be very active in trading futures. For this reason, most Institutional Investors 

choose to outsource the management of their futures trading to Wall Street Banks.

Reportedly, 85% to 90% of Institutional Investors seeking to allocate money to

commodities choose to do so by entering into over-the-counter (OTC) commodity 

index swaps with Wall Street Banks.20 Once an institution has entered into the swap 

agreement, it becomes the Bankʼs responsibility to trade the futures correctly in order 

to replicate the index on the investorʼs behalf

How Does a Swap Work?

In a swap agreement, two counter-parties agree to exchange two different sets of 

cash flows. The most common swaps are for interest rates, where one party pays a 

fixed rate and the other party pays a floating rate.

In a typical commodity index swap agreement (depicted below), the pension fund 

agrees to pay the 3-month Treasury-bill rate plus a management fee to a Wall Street 

Bank, and the Bank agrees to pay the total return on either the S&P-GSCI or the DJAIG index.21

Once the swap is entered into, the pension fund will take the notional amount of the 

swap and invest that amount in 3-month T-bills. This enables the pension fund to 

make the periodic payments to the Wall Street Bank. Sometimes this strategy is 

referred to as a collateralized commodities futures strategy because the Index 

Speculator is effectively posting 100% margin and is therefore fully collateralized.

Diagram 1. Commodity Index Swap

Source: Goldman Sachs

Once entered into, the swap obligates the Wall Street Bank to pay the S&P-GSCI 

Total Return Index to the pension fund.22 Therefore, the Bankʼs swaps trader must 

hedge the position. In order to perfectly replicate the S&P-GSCI TR index, the trader 

 

20 “Commodities: Whoʼs Behind the Boom?” Gene Epstein, Barronʼs, March 31, 2008. 

Examination of the CFTCʼs CIT Supplement to the Commitments of Traders report also makes 

it clear that 85% to 90% of all index positions are held by swaps dealers.

21 “Investing and Trading in the GSCI,” Goldman, Sachs & Co., June 1, 2005

22 Because assets benchmarked to the S&P-GSCI are nearly double that of the DJ-AIG, all 

examples reference the S&P-GSCI.

Pension

Fund

Wall 

Street 

Bank

Percentage Change in S&P GSCI Total Return Index

3-Month Treasury Bill Rate

Per Annum Hedge Management Fee
The Accidental Hunt Brothers July 31, 2008

10

must exactly follow the commodities futures trading strategy outlined by the S&PGSCI index methodology. 

Diagram 2. Commodity Index Swap Hedging

The Goldman Roll

Whether the Index Speculators are trading futures themselves, or they have 

outsourced their trading strategy to a swaps dealer, there comes a time when their 

commodities futures position must be rolled in order to avoid delivery of physical 

commodities. To do this, a trader will enter into a pre-packaged trade called a 

“calendar spread.” In a calendar spread, a trader simultaneously buys a more distant 

future and sells their closer-to-expiration future. It is commonplace for traders to roll 

their positions forward to avoid delivery, so the market facilitates these spread trades, 

which have their own bid and ask quotations. By packaging the buy and sell together 

as one trade, the market impact on price is minimized.

Even so, when all Index Speculators roll their positions in unison, it impacts the 

markets significantly. In Chapter Three, when we detail the size of Index 

Speculatorsʼ futures positions, it will become apparent that because all Index 

Speculators follow the exact same trading methodology, they have a huge impact on 

the commodities futures markets. A quick Google search for the term “Goldman Roll” 

will yield many articles from trading websites about how Speculators plan to position 

themselves in advance of the regularly recurring Goldman Roll phenomenon.

23

Index Speculators Invest Ultra-Long-Term

It is important to note that pension funds and other Institutional Investors have 

extremely long investment time horizons. For example, the average duration of a 

pension fundʼs portfolio is designed to match the average employeeʼs years until 

retirement. This can easily be 20 years or more, depending on the organization.

That means that when Index Speculators enter into their commodities futures 

positions, they intend to maintain that position, via continuous rolling, for a very long 

time. Therefore, they capture large amounts of available liquidity that they have no 

intention of releasing in the foreseeable future. 

We noted in Chapter One that the reason Traditional Speculators were not 

completely banned from the commodities futures markets was because they provide 

beneficial liquidity to the markets. An Index Speculator that consumes liquidity for 

decades at a time hurts rather than helps the commodities futures markets. Investors 

would not be allowed to hoard physical commodities, they should not be allowed to

hoard commodities futures contracts either.

 

23 http://www.google.com/search?q=goldman+roll

Pension

Fund

Wall 

Street 

Bank

%S&P-GSCI TR

3-Mo T-Bills

Annual Fee

Commodities 

Futures 

Markets

Actively Trading 

Commodities 

Futures To 

Replicate The 

S&P-GSCI.
The Accidental Hunt Brothers July 31, 2008

11

Index Speculators Are Long-Only

Index Speculators are overwhelmingly “long-only;” they do not take short positions. 

While this type of investment behavior may be considered desirable in the capital 

markets, it is detrimental to the commodities futures markets. 

If Index Speculators took both long and short positions, then they would push prices 

both up and down. Some might push them up while others might push them down, 

thereby canceling each otherʼs impact on market prices. This is what Traditional 

Speculators do. Unfortunately, Index Speculators lean only in one direction - long -

and they lean with all their weight. The result is that they push prices in only one 

direction - up.

Index Speculators Have a Price-Insensitive Dollar Demand

Physical commodity consumers generally have fixed quantities that they must 

purchase as inputs for their manufacturing process. They are highly motivated to get 

the lowest average price per unit in order to minimize their total costs. 

Index Speculators, however, are insensitive to unit price. They do not need a set 

number of units, nor are they concerned with what price they pay. Instead, they have 

a fixed amount of money to allocate. They will buy as many units as they can at 

whatever price they have to pay until all of their money has been “put to work.” The 

“passive” nature of Index Speculators has been lauded, but is the root cause for their 

price insensitivity.

We will detail this highly detrimental aspect of Index Speculator demand in the next 

two chapters.

Index Speculators Damage The Price Discovery Function

Not only do Index Speculators buy without regard to price they also buy without 

regard to supply and demand fundamentals. By definition, these Institutional 

Investors invest in a broad basket of commodities and therefore have little, if any, 

view on the individual commodities. Every contract traded for reasons other than 

supply and demand is a contract that damages the price discovery function.

We discuss this in-depth in Chapters Four and Five.
The Accidental Hunt Brothers July 31, 2008

12

CHAPTER THREE: INDEX SPECULATORS HAVE DRIVEN FOOD AND ENERGY 

PRICES HIGHER

Introduction

In the last five years, futures prices have risen dramatically because of supply and 

demand and demand. What do we mean by this? Normal supply and demand in 

the commodity markets have always had an effect on futures prices, but now for the 

first time there is a huge new source of artificial financial demand that has also 

contributed greatly to higher prices. Institutional Investors have poured hundreds of 

billions of dollars into the commodities futures markets as part of a portfolio allocation 

decision. This titanic wave of money has greatly amplified the current upward trend 

of commodities futures prices.

Money Flow, Expressed as Buy Orders, Moves Prices

If a homeowner lists a house for sale and five buyers show up that same day with 

checkbooks in hand, the homeowner will likely get a higher price for the house than if 

only one buyer shows up after the house has sat on the market for months.24 Why is 

this? It is simple, money moves markets; money moves prices. 

When money flows into commodities futures markets it results in buy orders. At the 

most basic level, buy orders are the only thing that cause prices to rise in the futures 

markets. When a trader sends a buy order to the exchange floor or presses the “buy” 

key on a trading terminal, if the trader is attempting to buy more contracts than are 

currently offered for sale at the market price, then the market price will rise.

As a hypothetical example, if there are 50 WTI Crude Oil contracts offered for sale at 

$135.10 and another 50 WTI Crude Oil contracts offered for sale at $135.15 then a 

buy order of 100 contracts will result in the price moving up from $135.10 to $135.15. 

Please note that who initiates a buy order and why it is initiated are irrelevant when it 

comes to explaining an orderʼs impact on market prices. Almost all trading is 

anonymous. A 100-contract buy order from a bona fide Physical Hedger locking in 

input costs will have the exact same price impact as a 100-contract buy order from an 

Institutional Investor trying to allocate into commodity futures. 100 contracts is 100 

contracts and demand is demand, regardless of who is initiating the buy orders and 

why they are initiating them.

 24 Under both scenarios there is a seller and a buyer but two very different prices.
The Accidental Hunt Brothers July 31, 2008

13

Institutional Investors Have Driven Prices Higher by Pouring Money into 

Commodities Futures

Commodities futures market participants fully understand what causes prices to 

move. As the following quotes from recent research reports show, they know who is 

largely responsible for the rise in commodities futures prices:

“A Tidal Wave of Fund Flow - Despite the economic gloom many 

commodity prices hit new highs in recent weeks, driven largely by 

investment inflows.”25

Citigroup - April 7, 2008

“You have a generalized commodity bubble due to commodities 

having become an asset class that institutions use to an increasing 

extent.”26

George Soros, April 17, 2008

“The entry of new financial or speculative investors into global 

commodities markets is fueling the dramatic run-up in prices”27

Greenwich Associates - May 2008

“Without question increased fund flow into commodities has boosted 

prices.”28

Goldman Sachs - May 5, 2008

“We have argued recently that some of the price buoyancy during Q1 

reflected financial flows and investments in oil and other 

commodities. . . . Our study indicated that for every $100 million in 

new inflows, WTI prices increase by 1.6%. . . . Our conclusion for 

this study is that we are seeing the classic ingredients of an asset 

bubble.”29

Lehman Brothers - May 29, 2008

 

25 “Great Bulks of Fire IV,” Citi Commodities Strategy, Alan Heap and Alex Tonks, April 7, 

2008, page 1.

26 “Soros Says Commodity `Bubble' Still in `Growth Phase' (Update3),” Bloomberg News, Saijel 

Kishan and John Rega, April 17, 2008. 

http://www.bloomberg.com/apps/news?pid=20601087&sid=aUN8_k_wjFOM&refer=home

27 “Financial Investors Fueling Commodities Boom,” Greenwich Associates, Andrew Awad, 

Woody Canaday, et al., May 2008, page 1.

28 $100 oil reality, part 2: Has the super-spike end game begun?,” Goldman Sachs Global 

Investment Research, Arjun N. Murthi, Brian Singer, et al. May 5, 2008, page 12.

29 “Oil Dot-com,” Lehman Brothers Energy Special Report, Edward Morse, Michael Waldron, 

et. al., May 29, 2008, page 3.
The Accidental Hunt Brothers July 31, 2008

14

Index Speculator Demand Has Driven Prices Higher

Chart 5 shows that in the five years from 2003 to July 1, 2008 commodity index 

investment rose by a factor of 25 times from $13 billion to $317 billion and commodity 

prices have tripled.

One of the clearest indications that Index 

Speculator demand is driving prices 

higher is the fact that every single one of 

the 25 commodities which make up the 

S&P GSCI and the DJ-AIG indices have 

all risen substantially during the last five 

years.30 If purely fundamental economic 

factors were at work, then one would 

expect to see some prices going up and 

some prices going down. Table 2 shows 

that the prices of these 25 commodities 

skyrocketed by an average of more than 

200% from July 2003 to July 2008

The Addition of Index Speculator 

Demand to Existing Demand Has 

Created a Massive Demand Shock

In the past when commodities prices have 

spiked, it has typically resulted from a 

significant supply shortage, also known 

as a “supply shock.” For instance, the 

Arab Oil Embargo in 1973 dramatically 

reduced the available supply of oil and 

caused oil prices to rise.

 

30 These index commodities are also the 25 largest and most important from the standpoint of 

the world economy. That is why they were chosen to be part of the indices.

Chart 5. S&P GSCI Spot Price Index vs. Index Speculator Assets

Source: Bloomberg, Goldman Sachs, CFTC Commitments of Traders CIT Supplement, calculations 

based upon CFTC COT/CIT report (see appendix). 2008 figure is as of July 1, 2008

Table 2. Commodity Futures Prices

July 1, 2003 – July 1, 2008

Agricultural Cocoa + 101%

Coffee + 160%

Corn + 214%

Cotton + 18%

Soybean Oil + 196%

Soybeans + 160%

Sugar + 121%

Wheat + 177%

Wheat KC + 190%

Livestock Feed Cattle + 30%

Lean Hogs + 11%

Live Cattle + 48%

Energy Brent Crude Oil + 397%

WTI Crude Oil + 364%

Gasoil + 448%

Heating Oil + 399%

Unleaded Gas + 298%

Natural Gas + 154%

Base Metals Aluminum + 124%

Lead + 265%

Nickel + 157%

Zinc + 141%

Copper + 433%

Precious Metals Gold + 169%

Silver + 298%

Average + 203%

Source: Bloomberg

 $- 

 $50 

 $100 

 $150 

 $200 

 $250 

 $300 

 $350 

 100 

 200 

 300 

 400 

 500 

 600 

 700 

 800 

19701972197419761978198019821984198619881990199219941996199820002002200420062008

COMMODITY INDEX ALLOCATIONS 

(BILLIONS OF DOLLARS)

S&P GSCI SPOT PRICE COMMODITY INDEX

OTHERS

DJ-AIG

SP-GSCI

S&P GSCI SPOT INDEX
The Accidental Hunt Brothers July 31, 2008

15

Today, commodity prices have risen dramatically but there are few shortages. There 

are no consumers waiting in line for gasoline. OPEC says that there are no supply 

shortages in the world oil markets.31 The shelves of grocery stores around the world 

are stocked. The problem is that people cannot afford to buy the food.32 It is prices,

not supply, that has led to food riots around the globe.33

Currently, the commodities futures markets are experiencing a demand shock across 

all 25 commodities that make up the S&P-GSCI and DJ-AIG. Demand shocks are 

rare. Events can occur overnight which will wipe out large fractions of supply, but it is 

rare to see demand for something change dramatically in a short amount of time. A 

demand shock that would occur simultaneously in the 25 largest and most important 

commodities is something never before seen in history. But that is exactly what has 

occurred in the last five years. Even more amazing is the fact that even though 

commodities futures prices have tripled, demand appears to be growing at an 

accelerating rate. Pundits have pinned the blame for this demand shock on China 

but this only goes so far in explaining this phenomenon.

Table 3 on the next page shows how much of each commodity Index Speculators 

were holding via the futures markets in January 2003 and in July 2008.34 The middle 

column represents the net purchases of these Index Speculators in the commodities 

futures markets during the last 51⁄2 years. It is very important to put these purchases 

into perspective in order to grasp the magnitude of the impact this additional demand 

is having upon the markets.

While comparing incremental purchases in the physical commodity markets to 

incremental purchases in the commodities futures markets is not exactly an apples to 

apples comparison, it is still instructive for understanding this phenomenon. It gives 

us a sense of the impact on futures prices that these Index Speculator purchases 

might have. Since only a fraction of real world consumption is hedged with futures 

and 100% of Index Speculators purchases occur in the futures market, it is debatable

which entity is actually having the greater impact on the futures price.

Crude Oil in Perspective

In the popular press the explanation given most often for rising oil prices is the 

increased demand for oil from China. Remember, if demand for oil stays the same 

then prices will stay the same. If supply is constant then demand has to increase for 

prices to increase. Table 4 on the next page shows that in the last 51⁄2 years China 

has increased its consumption of petroleum by 992 million barrels. This is far and 

away the biggest increase of any country. There is little doubt that this increased 

demand is having some impact on crude oil prices.

 

31 “Market supplied with enough oil, OPEC official says,” Reuters, April 5, 2008. 

http://biz.yahoo.com/rb/080405/iran_opec.html

32 “The silent tsunami,” The Economist, April 17, 2008. 

http://www.economist.com/opinion/displaystory.cfm?story_id=11050146

33 “Britain: World Food Crisis a ʻSilent Tsunamiʼ,” AGENCE FRANCE-PRESSE, April 23, 2008. 

http://www.nytimes.com/2008/04/23/world/europe/23fbriefsWORLDFOODCRI_BRF.html?ref=world

34 See “Appendix: How to Calculate Index Speculatorsʼ Position Size”
The Accidental Hunt Brothers July 31, 2008

16

Table 3. Index Speculatorsʼ Futures Purchases Last 51⁄2 Years

Index Speculatorsʼ

Futures Stockpile 

as of 1/1/03

 Index Speculatorsʼ

PURCHASES

Last 51⁄2 Years

Index Speculatorsʼ

Futures Stockpile 

as of 7/1/08

Cocoa M Tons 18,828 297,592 316,420 

Coffee Pounds 195,716,944 2,192,733,056 2,388,450,000 

Corn Bushels 242,561,708 2,070,808,292 2,313,370,000 

Cotton Pounds 544,934,999 5,067,015,001 5,611,950,000 

Soybean Oil Pounds 163,135,678 4,346,164,322 4,509,300,000 

Soybeans Bushels 81,028,272 829,371,728 910,400,000 

Sugar Pounds 2,291,358,746 44,990,337,254 47,281,696,000 

Wheat Bushels 166,738,225 893,321,775 1,060,060,000 

Wheat KC Bushels 54,746,014 89,193,986 143,940,000 

Feed Cattle Pounds 104,446,612 475,803,388 580,250,000 

Lean Hogs Pounds 517,414,747 4,536,865,253 5,054,280,000 

Live Cattle Pounds 669,766,732 6,202,713,268 6,872,480,000 

Brent Crude Oil Barrels 47,075,357 161,236,643 208,312,000 

WTI Crude Oil Barrels 99,880,741 580,433,259 680,314,000 

Gas Oil M Tons 1,682,662 6,700,238 8,382,900 

Heating Oil Gallons 1,067,859,608 2,739,650,392 3,807,510,000 

Unleaded Gas Gallons 1,102,184,401 2,646,903,599 3,749,088,000 

Natural Gas MM Btu 330,652,415 1,975,417,585 2,306,070,000 

Aluminum M Tons 344,246 3,252,704 3,596,950 

Lead M Tons 82,019 179,731 261,750 

Nickel M Tons 20,147 102,715 122,862 

Zinc M Tons 133,381 1,175,419 1,308,800 

Copper M Tons 220,096.25 1,160,192 1,380,288 

Gold Ounces 979,863 8,737,837 9,717,700 

Silver Ounces 11,126,862 149,353,138 160,480,000 

Source: CFTC Commitments of Traders CIT Supplement, calculations based upon CFTC COT/CIT 

report (see Appendix: How to Calculate Index Speculatorsʼ Positions)

Looking at Table 3 it shows how much petroleum Index Speculators have purchased 

via the futures markets. Table 5 converts metric tons and gallons into their barrel 

equivalents showing that Index Speculators have increased their demand for 

petroleum by 919 million barrels in the last 51⁄2 years. This means that the increase 

in Index Speculatorsʼ demand is nearly equivalent to the increase in Chinese 

demand. 

Table 4. Increase in Chinese Demand for 

Petroleum (Last 51⁄2 Years)

Year

Consumption

(Barrels Per Year)

Year over 

Year Change

2002 1,883,660,777 

2003 2,036,010,338 152,349,561 

2004 2,349,681,577 313,671,240 

2005 2,452,800,000 103,118,423 

2006 2,654,750,989 201,950,989 

2007 2,803,010,200 148,259,211 

2008 2,948,835,000 72,912,400

Total Change 992,261,824

Source: Energy Information Administration, U.S. 

Department of Energy. Note: 2008 figure is an 

estimate and change figure is for half a year.

Table 5. Increase in Index 

Speculator Demand for Petroleum (Last 51⁄2 Years)

Petroleum Product Barrels

Brent Crude Oil 161,236,643 

WTI Crude Oil 580,433,259 

Gas Oil 49,045,744 

Heating Oil 65,229,771 

Unleaded Gas 63,021,514 

Total Change 918,966,932 

Source: CFTC Commitments of Traders CIT 

Supplement, calculations based upon CFTC 

COT/CIT report (see Appendix: How to 

Calculate Index Speculatorsʼ Positions)
The Accidental Hunt Brothers July 31, 2008

17

China is having an impact and it is well-known, but Index Speculators are having a 

similarly massive impact in the futures markets and the majority of commentators are 

unaware that it is even taking place. There is little question that traditional economic

factors are playing a part in commodity price increases, but Index Speculator demand 

is also having a very significant impact on commodity futures prices.

Table 3 shows Index Speculators have built a futures stockpile of nearly 1.1 billion 

barrels of crude oil and crude products. This means Index Speculators have 

stockpiled more paper barrels of oil than all the physical barrels of oil in all U.S. 

commercial storage tanks and the Strategic Petroleum Reserve combined.35

Copper in Perspective

In 2002, world copper consumption was 15 

million metric tons. For 2007, total world 

demand for copper was 17.7 million metric tons 

- an increase over 5 years of 2.7 million metric 

tons. China represented 2 million tons of the 

increase and the rest of the world was 670,000 

tons. Looking at Table 6, it shows that during 

this same time period, Index Speculators 

increased their copper futures position by the 

equivalent of 1.1 million metric tons of copper, 

better than half of Chinaʼs increased 

consumption and greater than the increased 

consumption of the entire rest of the world. 

The United States is the 2nd largest copper producer in the world behind Chile.36 

Index Speculatorsʼ current stockpile of copper futures, at 1.4 million tons, is greater 

than the total annual production of all the mines in the United States.37 Building 

construction is the largest use for copper in the United States; Index Speculatorʼs 

stockpile of copper futures could potentially supply the U.S. building construction 

industry for almost an entire year.38

Wheat in Perspective

In 2007 Americans consumed 2.22 bushels of wheat per person.39 That means all 

Americans combined consumed about 665 million bushels of wheat in 2007. At 1.3 

billion bushels, the current wheat futures stockpile of Index Speculators is now 

potentially enough to supply every American with all the bread, pasta and baked 

goods they can eat for the next two years! 

 

35 Energy Information Administration - U.S. Department of Energy, Petroleum Navigator, 

http://tonto.eia.doe.gov/dnav/pet/pet_stoc_wstk_dcu_nus_w.htm

36 U.S. Geological Survey, Mineral Commodity Summaries, January 2008, 

http://minerals.usgs.gov/

37 U.S. Geological Survey http://minerals.usgs.gov/minerals/pubs/commodity/copper/

38 Copper Development Association, http://www.copper.org/education/c-facts/homepage.html

39 Economic Research Service, U.S. Department of Agriculture, 

http://www.ers.usda.gov/Briefing/Wheat/consumption.htm

Table 6. Increase in Index 

Speculator Demand for Copper

(2002 through 2007)

Metric Tons

China 2,039,776

Index Speculators 1,160,192

Rest of the World 673,310

Source: World Bureau of Metal Statistics, 

CFTC Commitments of Traders CIT 

Supplement and calculations (see 

Appendix)
The Accidental Hunt Brothers July 31, 2008

18

Corn in Perspective

With food prices skyrocketing in the last year many economists are casting about for 

an explanation for the price move. They have focused on the fact that a third of the 

U.S. corn crop has been diverted away from exports and into ethanol production.40 

What most economists have not considered is the fact that Institutional Investors 

have purchased over 2 billion bushels of corn futures in the last five years. Right now 

Index Speculators have stockpiled enough corn futures to potentially fuel the entire 

United States ethanol industry at full capacity for a year.41 That means producing 5.3 

billion gallons of ethanol, which would make America the worldʼs largest ethanol 

producer.42

Sugar in Perspective

In 2007, Brazil was the worldʼs largest ethanol producer. Brazil produces ethanol 

from sugarcane. If Index Speculators were to use their current stockpile of refined 

sugar futures to produce ethanol it would potentially produce more than 2.6 billion 

gallons of ethanol,43 which would replace at least six months of U.S. ethanol 

production.

 

40 “The End Of Cheap Food,” The Economist, December 6, 2007. 

http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=7216688&st

ory_id=10252015

41 “Ethanol Reshapes the Corn Market,” Economic Research Service - U.S. Department Of 

Agriculture, Allen Baker and Steven Zahniser April 2006. 

http://www.ers.usda.gov/AmberWaves/April06/Features/Ethanol.htm

42 “Ethanol Production Could Be Eco-Disaster, Brazil's Critics Say,” Kelly Hearn, National 

Geographic News, February 8, 2007. 

http://news.nationalgeographic.com/news/2007/02/070208-ethanol.html

43 “Australian Liquid Biofuels National Production Boundaries,” Brian Fleay, January 2006. 

http://www.aspo-australia.org.au/References/Fleay/Fleay06BiofuelsVsPetrol.pdf
The Accidental Hunt Brothers July 31, 2008

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Index Speculators Have Bought More Commodities Futures than All Other 

Groups Combined

Table 7 compares Index Speculators purchases from Table 3 with purchases by the 

two other categories – Physical Hedgers and Traditional Speculators. It shows that 

Index Speculators have bought more commodities futures contracts in the last five 

years than any other group of market participants. In fact, they have bought more 

contracts than both Physical Hedgers and Traditional Speculators combined.

Table 7. Futures Contract Purchases by Category

(Last 51⁄2 Years: January 1, 2003 to July 1, 2008)

Physical 

Hedgers

Traditional 

Speculators

Index 

Speculators

Cocoa -32,461 65,060 29,759

Coffee -6,570 27,727 58,473

Corn 231,324 216,533 414,162

Cotton 40,618 19,019 101,340

Soybean Oil 715 10,332 72,436

Soybeans 13,305 73,360 165,874

Sugar 133,073 110,068 401,699

Wheat 13,136 34,942 178,664

Wheat KC -5,967 12,226 17,839

Feed Cattle 3,210 374 9,516

Lean Hogs 12,399 21,955 113,422

Live Cattle 7,435 26,349 155,068

WTI Crude Oil 433,997 527,787 580,433

Heating Oil -21,534 1,366 65,230

Unleaded Gas 14,957 38,719 63,022

Natural Gas 10,129 118,918 197,542

Gold -9,936 124,967 87,378

Silver 3,455 7,054 29,871

TOTAL 841,284 1,436,756 2,741,728

Source: CFTC Commitments of Traders CIT Supplement, 

calculations based upon CFTC COT/CIT report (see appendix). 

Note that Physical Hedgers in this table are equivalent to the 

Commercial category. Any Traditional Speculators utilizing the 

swaps loophole (see Ch. 6) show up here as Physical Hedgers. 

This table does not include spread trades or non-reported 

trades. WTI crude oil figures include NYMEX, ICE and NYMEX 

financial contracts as well as CFTC reclassification. CFTC 

does not report data for non-U.S. traded commodities.

If Index Speculators have bought more futures contracts than everyone else, is it not 

reasonable to assume that they have had one of the largest impacts on futures 

prices?
The Accidental Hunt Brothers July 31, 2008

20

Index Speculator Demand Is Huge Compared to the Size of Commodities 

Futures Markets

During the period from January 2003 to July 2008, the amount of money allocated to 

commodity indices grew from $13 billion to $317 billion. Most of the increase was 

from investor inflows, but a portion was due to the growth of prior period investments.

There is no publicly available data that 

shows the total amount of inflows into 

commodity indexation trading strategies, 

but some approximations can be made. 

End-of-year investment figures can be 

calculated using CFTC data44, and annual 

performance is known. Therefore, the 

amount that the prior yearʼs investment

has grown or shrunk can be computed. 

The remaining difference in the yearly 

change has to come from net inflows.45 

Table 8 shows estimated annual inflows 

for the two major commodity indices as 

well as the total.

The best way to estimate the size of the commodities futures markets is to look at the 

average daily dollar value of open interest for each commodity.46 When Wall Street 

Banks go out to pitch Institutional Investors on allocating money to OTC commodity 

index swaps, open interest is the gauge that they use to express the size of the 

commodities futures markets.47

Table 9 (on the next page) calculates the average daily dollar value of open interest 

by multiplying the average daily open interest in contracts times the average daily 

price. It shows that the average daily size of the commodities futures markets during 

2004 was only $183 billion.48 Looking back to Table 8, it shows that approximately 

$25 billion flowed into index replication strategies in 2004. So Index Speculator 

investment was about 14% of total market size. This amount of inflow had to have a 

huge impact.

 44 See “Appendix: How to Calculate Index Speculatorsʼ Positions” for more details

45 When during the year the inflows occurred is not known, so the assumption is made that all 

net inflows occurred evenly throughout the year. Changing assumptions on net inflow timing 

only affects the rate of growth for that yearʼs inflow, which never amounts to more than a few 

billion dollars difference.

46 Some market participants think that volume is a better measure of market depth, but most of 

the volume on the exchanges is generated by scalpers or day traders who want to profit from 

the ebbs and flows of intra-day price moves. For investors that plan to hold their positions for 

more than a few hours, open interest is the better measure of market depth, since any position 

held overnight is captured in the open interest figures.

47 “Investing and Trading in the GSCI,” Goldman, Sachs & Co., June 1, 2005.

48 Table 9 has no data for base metals in 2004. If base metals are assumed to be 

approximately $33 billion (like 2005), that would make the total commodities futures market 

size around $183 billion. Since base metals prices rose from 2004 to 2005 this is a 

conservative assumption. The $183 billion figure appears in Chapter 1.

Table 8. Estimated Annual Inflows 

(Billions)

S&P-GSCI DJ-AIG TOTAL

2004 $16.2 $8.9 $25.1

2005 $4.8 $12.4 $17.2

2006 $28.2 $11.3 $39.5

2007 $14.7 $15.4 $30.1

2008 $44.5 $17.0 $61.5

Total Inflows $173.4

Source: Author calculations
The Accidental Hunt Brothers July 31, 2008

21

To put it in proper perspective, it was mentioned in Chapter One that the worldwide 

equity markets are $44 trillion in size. What would happen to worldwide stock prices 

if the stock markets experienced an inflow of 14% or $6.1 trillion? The worldwide oil

markets involve production and consumption of 85 million barrels per day.49 What 

would happen to oil prices if the world demand for oil jumped by 14% or 11.8 million 

barrels per day? It is clear that prices would rise dramatically.

Tables 8 & 9 show that while the commodities futures markets were only $183 billion 

in 2004, Index Speculators poured $173 billion into the markets over the ensuing 41⁄2

years. This caused the market to expand and prices to rise dramatically in order to 

accommodate this huge growth in demand. Looking at Chart 6 we can see this 

dynamic at work. Each year as Index Speculatorsʼ positions expand, the size of the 

total market expands and prices are forced to rise in order to absorb these huge 

inflows of money.

 

49 Energy Information Administration - U.S. Department of Energy 

http://www.eia.doe.gov/emeu/international/oilconsumption.html

Table 9. Commodities Futures Markets Size – Dollar Value of Open Interest (Billions)

2002 2003 2004 2005 2006 2007 2008

Cocoa $1.8 $1.5 $1.6 $1.9 $2.0 $2.7 $4.1 

Coffee $1.4 $1.7 $2.7 $3.8 $4.2 $6.3 $8.4 

Corn $5.4 $5.1 $8.2 $7.7 $15.1 $23.8 $41.9 

Cotton $1.6 $3.0 $2.6 $2.8 $4.3 $6.8 $11.1 

Soybean Oil $1.4 $2.0 $2.5 $1.9 $3.2 $5.8 $8.7 

Soybeans $4.9 $7.3 $9.5 $8.8 $10.1 $20.9 $34.6 

Sugar $1.5 $1.7 $2.8 $5.1 $8.6 $8.2 $13.9 

Wheat $1.8 $1.9 $2.6 $3.8 $7.4 $11.6 $17.2 

Wheat KC $1.3 $1.1 $1.2 $1.5 $3.1 $4.1 $5.3 

Feed Cattle $0.5 $0.8 $0.8 $1.3 $1.5 $1.4 $1.7 

Lean Hogs $0.6 $0.9 $1.9 $2.3 $3.3 $3.9 $5.2 

Live Cattle $2.7 $3.6 $3.6 $4.9 $6.7 $7.9 $9.7 

Brent Crude Oil $6.6 $8.5 $12.6 $19.4 $31.1 $45.7 $61.8 

WTI Crude Oil $16.1 $20.4 $33.6 $55.3 $96.4 $171.0 $295.7 

Gas Oil $4.0 $3.7 $5.5 $10.2 $14.7 $21.0 $27.7 

Heating Oil $4.4 $5.1 $8.2 $11.8 $13.6 $17.9 $28.3 

Unleaded Gas $3.7 $3.9 $7.3 $10.3 $11.4 $16.1 $29.3 

Natural Gas $23.6 $27.8 $25.9 $42.4 $45.1 $54.1 $87.3 

Aluminum $- $- $- $12.3 $23.7 $27.6 $34.9 

Lead $- $- $- $0.7 $1.0 $2.2 $2.0 

Nickel $- $- $- $2.0 $4.4 $6.7 $6.7 

Zinc $- $- $- $2.7 $6.8 $6.9 $6.3 

Copper $- $- $- $15.4 $31.5 $34.0 $41.8 

Gold $5.6 $9.9 $13.2 $13.9 $18.9 $24.9 $40.1 

Silver $2.0 $2.4 $3.7 $4.3 $6.4 $7.4 $11.8 

TOTAL $91.0 $112.2 $150.1 $246.5 $374.5 $538.7 $835.2 

Source: CFTC Commitment of Traders and Bloomberg. For Base Metals, Brent Crude and Gasoil open 

interest represents futures only. No data for Base Metals in 2002-2004. All other commodities include 

delta-equivalent options positions but spread positions are omitted. WTI crude oil figures include 

NYMEX, ICE and NYMEX financial contracts. Figures represent annual averages and 2008 figure is an 

average through 7/1/08.
The Accidental Hunt Brothers July 31, 2008

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Chart 6. Commodities Futures Market Size (Billions) vs. S&P GSCI Spot Price Index

Source: Bloomberg, Goldman Sachs, CFTC Commitments of Traders CIT Supplement, calculations 

based upon CFTC COT/CIT report (see appendix). Figures represent annual averages and 2008 

figure is an average through 7/1/08.

We can also see that the consistent positive price performance of commodities 

futures has attracted more and more Speculators into the markets. Chart 6 shows 

that in the first half of 2008, Index Speculators poured money into the markets at the 

fastest rate yet, causing prices to rise at the fastest pace to date. As Table 8 shows, 

an estimated $61 billion flowed into these markets in just the first six months of 2008. 

So while the demand from physical commodity consumers is dropping as prices 

increase, the demand from Index Speculators is growing even more. This growth in 

artificial financial demand explains why commodities prices are continuing to rise in 

2008 despite physical demand decreases.

Index Speculator Demand Is Insensitive to Price

The price insensitivity of Index Speculators makes them far more damaging to the 

markets than Traditional Speculators. Traditional Speculators and Physical Hedgers 

are highly sensitive to the price they pay per unit for any particular commodity; their 

buy and sell decisions are determined by price per unit.

Index Speculators, in contrast, approach the commodities futures markets with a 

certain number of dollars, and they will buy however many units they can at whatever 

price they have to pay until all of their money is “put to work.” It would be like a 

person who goes to an auto dealership with $500,000 and is unconcerned with how 

many cars can be bought or what the price per car is as long as the entire $500,000

gets spent.

If a pension fund allocates $500 million to the S&P-GSCI, that means it has to 

purchase $200 million worth of WTI crude oil contracts. The pension fund trader (or 

swaps dealer) will go out and start buying contracts. If the full $200 million can not 

be spent buying contracts at the current price then the trader will pay higher and 

higher prices in order to induce other traders to sell. Remember, there is only one 

goal: to put the $200 million into crude oil. The pension fund does not care what the

per-barrel price is. If they have to drive prices up 30, 40, 50 cents in order to induce 

someone to sell to them, then they will do it and not think twice. They simply pour 

money into the markets until all their money is “put to work.”

100

200

300

400

500

600

700

800

900

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

S&P GSCI Spot Price Index

Dollar Value of Physical Hedgers' Positions

Dollar Vale of Traditional Speculators' Positions

Dollar Value of Index Speculators' Positions
The Accidental Hunt Brothers July 31, 2008

23

Market Power Is Concentrated in the Hands of Large Swaps Traders

It has been reported that 85% to 90% of all Index Speculators implement their trades 

through commodity swaps. Further reports indicate that four swaps dealers control

70% of these positions.

50 This means that 60% of all the positions attributed to Index 

Speculators are controlled by the commodity index swaps traders at four Wall Street 

Banks. According to Greenwich Associates, the four largest commodity swaps 

dealers are Goldman Sachs, Morgan Stanley, J.P. Morgan and Barclays Bank.51

Index Speculators average about 40% of total long open interest.52 Therefore, these 

four swaps traders control an average of 24% of total long open interest for the 25 

commodities that make up the indices. That means one out of every four contracts 

on the commodities futures exchanges is controlled by these four Wall Street Banks. 

This represents tremendous power over markets and pricing.

Example of Swaps Dealersʼ Influence over WTI Crude Oil

CFTC data on swaps dealersʼ positions in NYMEX WTI crude oil futures contracts, 

recently released by the House Energy Committee, shows that swaps dealers are 

now the single largest holder of WTI futures contracts on NYMEX. In April of 2008 

they held 30% of all outstanding contracts.53 Chart 7 shows that when one plots the 

rise of swaps dealersʼ futures positions with the rise in WTI crude oil prices, there is a 

very strong correlation.

Chart 7. Swaps Dealers Long Positions in WTI Crude Oil Futures vs. WTI Price

Source: Commodities Futures Trading Commission (CFTC) via the House Energy Committee, 

Bloomberg

 

50 “Commodities: Whoʼs Behind the Boom?,” Gene Epstein, Barronʼs, March 31, 2008. 51 “The Global Commodities Boom,” Greenwich Associates, Andrew Awad, Woody Canaday, 

et al., May 2008, page 1. 52 See Table 10 in Chapter 5. 53 In April 2008 (the most recent available data) swaps dealers in total held 858,877 contracts 

on the long side of the market. Average April open interest was 2,905,408 contracts, which 

results in 30% market share. This CFTC data can be accessed at the House Energy 

Committee website: http://energycommerce.house.gov/Investigations/EnergySpec.shtml

$0.00

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300,000

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600,000

700,000

800,000

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Jan-00

Apr-00

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NYMEX WTI Crude Oil Price

Swap Dealers NYMEX WTI Long Positions

Swap Dealers NYMEX WTI Long Positions

NYMEX WTI Crude Oil Price
The Accidental Hunt Brothers July 31, 2008

24

Summary

As hundreds of billions of dollars have poured into the relatively small commodities 

futures markets, prices have risen dramatically. Index Speculators working through 

swaps dealers have been the single biggest source of new speculative money. This 

has driven prices far beyond the levels that supply and demand would indicate, and 

has done tremendous damage to our economy as a result.
The Accidental Hunt Brothers July 31, 2008

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CHAPTER FOUR: PRICE DISCOVERY FUNCTION

Introduction

The price discovery function of commodities futures markets is absolutely critical to 

the economic health of the United States. If prices in the futures markets are inflated 

due to reasons other than true supply and demand, then spot prices will also be 

inflated, causing great damage to our economy.

Commodities futures markets exist for two purposes: price discovery and risk 

hedging. If prices in the futures markets do not correlate with real world spot prices, 

then it becomes impossible to hedge effectively. Therefore, commodities futures 

prices must correlate with spot prices or the markets fail in the fundamental purpose 

for which they were created.

There are three primary ways in which futures prices impact spot prices. In certain 

markets, the spot price is the futures price, in most markets there is an arbitrage link 

between spot and futures prices, and in all markets futures prices are the benchmark 

for spot market transactions.

Spot Prices Are Equal to Futures Prices in Grain and Energy Markets

Because commodities are bulky and costly to transport, spot markets for 

commodities are geographically dispersed. Many decades ago, local markets relied 

almost exclusively on local supply and demand to determine prices, with the result 

being that there were sometimes great differences between prices in various regional 

spot markets.

This pricing mechanism began to change in the 1980s when spot market participants 

in the agricultural and energy markets moved to embrace centralized futures markets 

as the best indicator of overall supply and demand conditions across all spot 

markets.54 These spot market participants agreed to price nearly all spot market 

transactions at the futures price plus or minus a “local basis” or “differential.”

Pricing spot transactions at the futures price plus or minus a spread was beneficial to 

physical commodity producers and consumers for two reasons. First, they trusted 

and believed that the futures price was the best indication of overall supply and 

demand in the marketplace. Therefore, by pricing their transactions off the futures 

price they would not have to search for a better price in some other corner of the 

overall market since presumably the futures price was the most accurate overall 

price. Second, by specifying that their spot market transactions would take place at 

the futures price, Physical Hedgers were able to fully and effectively hedge their 

transactions using futures contracts. Their only residual risk was the local basis, or 

differential, that under normal market conditions typically reflected the cost of 

transportation between various spot markets.

 54 “The Structure of Global Oil Markets—A Backgrounder,” Platts, A Division of McGraw Hill 

Companies, July 2007, page 5. http://www.platts.com/Resources/whitepapers/index.xml. 

Additionally, conversation with Tom Buis, President of National Farmers Union, June 10, 2008.
The Accidental Hunt Brothers July 31, 2008

26

Price Discovery in Grains

The CFTC describes the price discovery function this way: “In many physical 

commodities (especially agricultural commodities), cash market participants base 

spot and forward prices on the futures prices that are “discovered” in the competitive, 

open auction market of a futures exchange.”55

As an example, a wheat farmer delivering crops to the local grain elevator will be paid 

the Chicago Board of Trade (CBOT) wheat futures price plus or minus the local basis 

spread. Any grain elevatorʼs website will typically refer to the CBOT futures prices, 

along with a quote of the local basis. That means that if Wheat futures prices rise by 

20 cents, then if the local basis does not change, then spot Wheat prices will also rise 

by 20 cents.

Price Discovery in Energy

Platts, which is the leading pricing service for the energy industry, describes this 

pricing mechanism this way: “In the spot market, therefore, negotiations for physical 

oils will typically use NYMEX as a reference point, with bids/offers and deals 

expressed as a differential to the futures price. Using these differentials, Platts makes 

daily and in some cases intra-day assessments of the price for various physical 

grades of crude oil, which may be referenced in other spot, term or derivatives 

deals.”56

As an example of how this works, a New England Heating Oil distributor buying 

heating oil from the local wholesaler is going to be paying the NYMEX heating oil 

futures price plus or minus a local differential. That means that when the futures 

price rises by 20 cents, if the differential does not change, then the spot price will also 

rise by 20 cents, typically the same day.

The same is true for WTI crude oil. If a U.S. oil refinery wants to buy a tanker of 

crude oil, then the price it pays will be the NYMEX WTI crude oil futures price, plus or 

minus a local differential. Therefore, when the paper barrel price rises by one dollar, 

then the physical barrel price will also rise by one dollar.

Under this present system, price changes for key agricultural and energy 

commodities originate in the futures markets and then are transmitted directly to the 

spot markets. For these commodities, what happens in the futures markets does not 

stay in the futures markets, but is felt almost immediately in the spot markets.

All Storable Commodities with Physical Delivery Provisions Can Be Arbitraged

When there is a significant difference between futures prices and spot prices, market 

participants can enter into arbitrage transactions, which will enable them to earn risk-

 

55 “The Economic Purpose of Futures Markets and How They Work - Price Discovery or Price 

Basing,” Commodities Futures Trading Commission Website, 

http://www.cftc.gov/educationcenter/economicpurpose.html

56 “Platts Oil Pricing and Market-on-Close Methodology Explained - A Backgrounder,” Platts, A 

Division of McGraw Hill Companies, July 2007, page 3. 

http://www.platts.com/Resources/whitepapers/index.xml 
The Accidental Hunt Brothers July 31, 2008

27

free profits. The net result of these arbitrage transactions is to drive futures and spot 

prices together and ensure that they move in lockstep.

As an example, if the price for copper in the spot market is $1,700 a ton and the price 

of the copper futures contract with three weeks to delivery is $1,900 per ton, then a 

copper producer could sell a futures contract, store the copper in a warehouse for 

three weeks, and deliver the copper against that contract. By doing this, the copper 

producer is taking this supply of copper off the spot market, which will cause spot 

prices to rise relative to the futures, while their sale of the futures contract will cause 

futures prices to come down.

Alternatively, a Speculator could do the same thing by selling the futures contract, 

renting storage space, buying the copper on the spot market at $1,700, paying the 

storage costs to store the copper for three weeks, and then delivering the copper 

against the futures contract. In this case, their purchase of the copper on the open 

market is going to push spot prices up while their sale of the futures contract would 

push futures prices down.

The net effect of this strong linkage between futures prices and spot prices is that 

historically, when futures prices rise, spot prices rise along with them. So when 

Institutional Investors drive futures prices higher, the effects are felt immediately in 

spot prices and the real economy.

Futures Prices Are the Benchmark for Spot Market Transactions

For all commodities with active futures markets, the spot market participants are 

keenly aware of what futures prices are doing and generally look at futures prices as 

a gauge for pricing their spot market transactions. They make business decisions 

based on futures prices, which then affect the spot market and its prices.

One of the reasons that Goldman Sachs and Dow Jones based their commodities 

indices on commodities futures rather than spot commodities is the fact that futures 

prices are the best benchmark for overall spot prices. When they say on the news 

that a certain commodity reached a record-high price, they are typically referring not 

to spot prices but instead to the nearest-to-expiration futures contract. There is not a 

spot market trader in any physical commodity market that is not continuously aware 

of what futures prices are doing.

The Effect of Over-the-Counter Derivatives Markets on the Price Discovery 

Function of Futures Markets

The physical markets, futures markets and over-the-counter (OTC) swaps markets 

are all part of one big market. Physical Hedgers, Swaps Dealers and Speculators are 

participating in all three markets. If an oil producer can get a better price in the 

swaps market than the futures market or the physical market, then that producer will 

sell production via swaps. If a swaps dealer can get better prices on hedges in the 

futures market than in the swaps market, then the dealer will hedge with futures. For 

this reason there are strong arbitrage links between all three markets.

When an Index Speculator purchases a commodity index swap from a Wall Street 

Bank, that swaps dealer will turn around and hedge that swap in either the OTC or 
The Accidental Hunt Brothers July 31, 2008

28

the futures markets.57 If the swaps dealer buys futures as a hedge, then the Index 

Speculatorʼs purchase directly impact the futures price. If they match the Index 

Speculatorʼs purchase against a Physical Hedgerʼs sale then it still impacts the 

futures price because that Physical Hedgerʼs sale would otherwise flow to the floor of 

the futures exchange.

As an example, if Index Speculators want to buy one million barrels of crude oil in 

swap form and Exxon wants to sell one million barrels of crude oil in swap form, then 

one cancels out the other. If the Index Speculator had not been there demanding 

crude oil in the swaps market, then in order to hedge Exxonʼs sale of one million 

barrels the swaps dealer would have sold one million barrels worth of crude oil 

futures on the exchange. So by intercepting the sale of one million barrels in the 

swaps market, the Index Speculator has prevented one million barrels of selling 

pressure in the futures market. This means that (all things being equal), prices in the 

futures market will be higher than they otherwise would be.

Whether an Index Speculator buys in the futures market or the swaps market it has 

the same impact on prices since both are part of the overall market. This highlights 

the importance of looking at the OTC markets in conjunction with the futures markets. 

According to Bank of International Settlements data the notional value of OTC 

commodity derivatives is now over $9 trillion.58 This means that futures markets are 

the tip of the iceberg when compared with OTC markets. And just like an iceberg we 

have no idea what lies below the surface since these are completely unregulated 

“dark” markets with zero transparency.

Summary

Physical commodity producers and consumers trust and rely upon the price 

discovery function of the commodities futures markets to accurately reflect the overall 

level of supply and demand, pricing their spot market transactions in many cases 

directly off the applicable futures price. Unfortunately, their trust has been betrayed. 

Excessive speculation is inflating prices beyond what supply and demand 

fundamentals would suggest. If this trend continues unabated, then physical 

commodity producers and consumers will be forced to roll back the progress of the 

last 25 years and revert to the old pricing system.

 57 It is also possible for them to hedge the position with physical commodities since most 

swaps dealers have the ability to take and make delivery, especially in energy. See for 

instance: http://www.ubs.com/1/e/canada/about/commodities/presence.html

58 “Semi-Annual OTC Derivatives Statistics” Bank of International Settlements, December 31, 

2007. http://www.bis.org/statistics/otcder/dt1920a.pdf and 

http://www.bis.org/statistics/derstats.htm
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CHAPTER FIVE: EXCESSIVE SPECULATION

Introduction

The commodities futures markets are capable of reaching a state of excessive 

speculation. This occurs when Speculators replace Physical Hedgers as the 

dominant force in the marketplace. When commodities futures markets become 

excessively speculative, the price discovery function becomes damaged and 

eventually destroyed. The dramatic influx of Index Speculators has now brought us 

to a tipping point where our commodities futures markets are descending into a state 

of excessive speculation.

Because Speculators, both Index and Traditional, have distinctly different supply and 

demand curves when compared with Physical Hedgers, two states of the market are 

possible. We examine these differences in detail and then look at the state of the 

commodities futures markets today.

Physical Hedgers: Normal Supply and Demand Curves

Physical commodity producers and consumers have supply and demand curves that 

match what one would expect. As commodity prices rise, a producer wants to sell 

more and a consumer wants to buy less. As commodity prices fall, a producer wants 

to sell less and a consumer wants to buy more.

Notice that these production and consumption decisions have the effect of tempering 

price moves and reducing price volatility. If prices rise then demand decreases and 

supply increases, causing prices to revert toward equilibrium. If prices fall then 

demand increases and supply decreases also causing prices to revert toward 

equilibrium.

These supply and demand curves translate directly into the futures markets when 

physical commodity producers and consumers buy and sell futures to hedge their 

production and consumption. If a producer has more production, then it can sell 

more futures contracts and vice versa. If a consumer wishes to consume more, then 

more futures contracts can be bought and vice versa.

Note that Physical Hedgers are motivated to buy and sell in order to reduce their 

price risk. Therefore, they do not buy or sell in quantities greater than their 

underlying physical commodity exposure.

For these reasons, the buying and selling of physical commodity producers and 

consumers is always a direct reflection of the actual supply and demand that they are 

experiencing firsthand in the underlying commodity markets. Their trading decisions 

always strengthen the critical price discovery function of the futures markets.

Index Speculators: Insensitive Supply and Demand Curves

Index Speculators are insensitive to the supply and demand fundamentals in the 

individual commodity markets to which they are allocating money. By definition, 

these Institutional Investors invest in a broad basket of commodities and have little, if 

any, view on individual commodities. Chances are very good that the trustees 

making these investment decisions could not even name the 25 commodities that 

make up the major commodity indices.
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If a pension fund decides to allocate $500 million to a commodities futures strategy 

that replicates the S&P GSCI, the $200 million that consequently flows into WTI 

Crude Oil futures has nothing to do with the actual supply or demand for crude oil in 

the real world. The $15 million that flows into Wheat futures has nothing to do with 

the actual supply and demand for wheat.

The reasons an Institutional Investor might want to allocate money to commodities 

vary widely. Perhaps their investment committee recently voted to allocate millions of 

dollars to commodities for the purpose of diversification. They might manage a 

commodity index mutual fund or ETF, and have received cash inflows from investors. 

Perhaps they are seeking to hedge against inflation or to make a bet against the U.S. 

dollar. Or perhaps the performance in another part of their portfolio has been great 

and they want to rebalance by adding to their commodities futures position to 

maintain it at a fixed percentage of their portfolioʼs total value.

All of the aforementioned reasons have almost nothing to do with the actual supply 

and demand of the individual commodities that are part of the index basket. 

Therefore, every single contract traded for one of these reasons is a contract that 

weakens the price discovery function.

It is clear that hundreds of billions of dollars have poured into the 25 commodities that 

make up the major commodities futures indices, for reasons other than supply and 

demand. The consequent price increases we have seen are a result of excessive 

speculation and not real world supply and demand fundamentals. This greatly

damages the price discovery function.

Traditional Speculators: Adaptive Supply and Demand Curves

Traditional Speculators are always motivated by profit.59 Unlike the Physical Hedger 

who always buys and sells due to supply and demand and the Index Speculator who 

almost never buys and sells due to supply and demand, Traditional Speculators can 

and will adapt their buy and sell decisions to the reality they experience in the 

commodities futures marketplace.

Two States of the Commodities Futures Markets

There are two general states of the commodities futures markets. There is the 

normal state in which Physical Hedgers are the dominant force and prices are 

determined predominantly by supply and demand. And there is an abnormal state of 

excessive speculation in which Speculators are the dominant force and prices are 

determined by factors other than supply and demand.

This two-state phenomenon is only possible because there are two distinct classes of 

market participants. There are no other markets that we know of that have two 

classes of participants and therefore two distinct possible states.

 

59 We do not in any way seek to imply that there is anything dishonorable about making a 

profit. We are Speculators and we try to make profits every day – there is nothing wrong with 

generating returns for investors or for oneʼs self.
The Accidental Hunt Brothers July 31, 2008

31

Normal State

In a market that is dominated by the buying and selling decisions of Physical Hedgers 

who trade strictly based on supply and demand fundamentals, Traditional 

Speculators will base their trading decisions on those same supply and demand 

fundamentals. Traditional Speculators do this because they know that Physical 

Hedgers will move the prices (due to their dominance) and since Traditional 

Speculators want to profit from price moves, they go along.

If, for instance, Traditional Speculators observe that a flood in the Midwest is 

threatening the supply of corn, then they know that physical corn consumers will be 

motivated to hedge their price risk fearing price increases. They also know that 

physical corn producers will not be as motivated to sell futures contracts since they 

either have a reduced corn crop or they also anticipate rising prices. Therefore 

Traditional Speculators will make trading decisions according to this fundamental 

information.

Just like fellow Speculators in the capital markets, Traditional Speculators experience 

the same two governing emotions of fear and greed.60

Greed, in the prior example, will make them want to buy futures contracts in 

anticipation of what others in the market will do. At the same time fear will encourage 

them to not get carried away. They know that in a normal market if prices rise 

sufficiently, then physical consumers will reduce their purchases of futures contracts 

while physical producers will increase their sales of futures contracts to lock in the 

higher prices. 

Notice that Traditional Speculators totally match their trading behavior to the buy and 

sell decisions of the Physical Hedgers. They buy and sell based on supply and 

demand fundamentals. They also do not get carried away because they know that 

price moves will be tempered by the supply and demand responses of physical 

commodity producers and consumers.

State of Excessive Speculation

In a market that is dominated by Speculators and not by Physical Hedgers, 

Traditional Speculatorsʼ trading is not necessarily disciplined by traditional supply and 

demand considerations because the “enforcers” of supply and demand, the Physical 

Hedgers, are no longer wielding the influence over prices that they once were.

In this scenario, Speculators that see prices rising for any reason at all (it does not 

have to be based on fundamental supply and demand, although it could be) will want 

to jump on the bandwagon and profit too. There are many trading strategies, such as 

trend-following and momentum investing, that encourage exactly this type of 

trading.61 Add to this the fact that managers of other peopleʼs money are paid on 

relative performance and if Manager A is achieving higher returns in a particular 

commodity index, then Managers B & C have a strong incentive to participate in 

 60 See http://en.wikipedia.org/wiki/Behavioral_finance for a list of books on the topic

61 Remember there is no “value investing” in commodities futures since commodities have no 

investment value. Their only value is in consumption.
The Accidental Hunt Brothers July 31, 2008

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order to not fall behind. It is this phenomenon that leads to another hallmark trait of 

capital markets – herd investing.62

All of these factors have the strong potential to lead to upward price pressure and the 

amplification of an existing upward price trend. 

When this happens, Traditional Speculatorsʼ fear of price reversion is replaced by the 

fear of selling short in the face of this strong upward price trend. Traders will say 

things like “Iʼm not going to step in front of a freight train,” meaning that when there is 

considerable momentum, Traditional Speculators are afraid of selling short and 

consequently being “run over.”

In fact, some of the Traditional Speculators that fail to adapt their trading strategies to 

the new market reality will get run over and go out of business due to trading losses. 

This will leave the surviving Traditional Speculators to thrive in the new environment 

and it will strengthen their motivation to follow the new trading strategies.

The amplified positive price trend that is created in a state of excessive speculation 

draws the attention of other Speculators. These new Speculators decide to jump on 

the bandwagon and that begins a vicious cycle of accelerating price increases and 

greater price volatility. 

Traditional Speculators are capable of surviving and thriving in both types of markets. 

If Physical Hedgers dominate the markets, then the trading decisions of Traditional 

Speculators will mimic them and will strengthen the price discovery function. But if 

Speculators rule the markets then Traditional Speculators will, by necessity, adapt to 

the new reality, which will weaken the price discovery function.

Implications of the Differing Supply and Demand Curves of Commodities 

Futures Markets Participants

When commodities futures markets enter a state of excessive speculation then they 

become susceptible to the formation of speculative price bubbles. The longer 

commodities futures markets remain in a state of excessive speculation, the more 

damage is done to the price discovery function. 

As long as physical commodity producers and consumers are the dominant market 

participants they will “enforce” supply and demand fundamentals through their 

hedging decisions. If Speculators become dominant, then the commodities futures 

markets can become excessively speculative. Just like in the capital markets, 

speculative price bubbles can form.

There is a big difference, however, between price bubbles in the capital markets and 

price bubbles in the commodities futures markets. When internet stocks double or 

triple in value, then it does not affect the health or livelihood of your average citizen. 

But when food and energy prices skyrocket, then the economies of the developed 

world suffer greatly and the populations of developing countries are threatened with 

starvation.63

 62 See http://en.wikipedia.org/wiki/Behavioral_finance for a list of books on the topic

63 “The silent tsunami,” The Economist, April 17, 2008. 

http://www.economist.com/opinion/displaystory.cfm?story_id=11050146
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33

Physical Hedger 

77%

Traditional 

Speculator 16%

Index Speculator 

7%

Physical Hedger

31%

Traditional 

Speculator

28%

Index Speculator

41%

The Tipping Point Where Speculation Becomes Excessive

If we were academics we would say that speculation becomes excessive at the point 

that the marginal benefit of the liquidity that Speculators provide is exceeded by the 

marginal cost of the damage that they do to the price discovery function. Since we 

cannot quantify that point, as a practical matter, if the price discovery function is 

being damaged in a noticeable way, then a market has already passed the point of 

excessive speculation. Given that most physical commodity producers and 

consumers today believe that the futures markets have become un-tethered from 

supply and demand fundamentals, this is one of the strongest indications that the 

commodities futures markets are currently excessively speculative.

At the point that commodities futures markets “tip” into excessively speculative 

territory, Traditional Speculators wake up to the new market reality and abandon the 

“supply and demand” camp in favor of the “inflation hedge,” “weak dollar,” 

“uncorrelated alpha,” et cetera camp. They begin to base their trading decisions not 

on supply and demand but on the current market conditions they see around them.

As we discuss in the next chapter, it is precisely this type of tipping point 

phenomenon that speculative position limits were originally designed to prevent. It 

would not be possible for a market to reach the tipping point if all Speculators were 

subject to reasonable and rigid position limits.

Todayʼs Commodities Futures Markets Are Excessively Speculative

In the last five years Index Speculators have become the single most dominant force 

in the commodities futures markets. Graph 1 from Table 10 shows that in 1998, 

Physical Hedgers were dominant on the long side of the market. Physical 

Commodity Consumers represented 77% of the reported long open interest.

Physical Hedgers outnumbered Speculators by an average of more than 3 to 1.

Graph 2 from Table 10 shows that in 2008 the market looks radically different. First, 

Index Speculators are the dominant force on the long side of the market, with an 

average of 41% of the reported long open interest. When combined with Traditional 

Speculators, fully 68% of the long positions are speculative in nature meaning that 

Speculators now outnumber Physical Hedgers by more than 2 to 1.

Graph 1. Long Open Interest - 1998 

Source: see notes on Table 10

Graph 2. Long Open Interest - 2008

Source: see notes on Table 10
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It is important to understand what a monumental shift this represents.64 In the last 10 

years Physical Hedgersʼ positions have risen by 90%. During the same time

Speculatorsʼ positions have grown by more than 1300%. And this does not include 

the growth in speculative spread trading which has also been very large.

 64 As a hypothetical example: in order to go from a 3:1 ratio of Hedgers to Speculators to a 2:1 

ratio of Speculators to Hedgers the size of speculative positions has to increase 500%. If 

Hedgers own 3 contracts and Speculators own 1 contract, then Speculators need to buy 5 

contracts before their positions (now 6 to 3) will be double the size of Hedgers.

Table 10. Commodities Futures Markets - Long Open Interest Composition

1998 2008

Physical 

Hedger

Traditional 

Speculator

Index 

Speculator

Physical 

Hedger

Traditional 

Speculator

Index 

Speculator

Cocoa 89.3% 9.2% 1.5% 34.4% 44.7% 20.9%

Coffee 80.6% 17.7% 1.7% 28.7% 29.6% 41.7%

Corn 87.2% 8.5% 4.4% 40.6% 22.5% 36.8%

Cotton 84.4% 13.5% 2.2% 36.3% 22.6% 41.1%

Soybean Oil 72.7% 27.3% 0.0% 45.5% 19.8% 34.8%

Soybeans 86.6% 11.0% 2.4% 28.5% 28.2% 43.3%

Sugar 87.2% 9.4% 3.4% 36.0% 17.4% 46.5%

Wheat 67.5% 21.3% 11.3% 15.9% 18.2% 65.9%

Wheat KC 86.3% 5.4% 8.3% 38.1% 27.6% 34.2%

Feed Cattle 52.4% 37.3% 10.3% 17.0% 45.2% 37.8%

Lean Hogs 56.6% 27.6% 15.8% 13.6% 19.1% 67.3%

Live Cattle 67.6% 23.8% 8.6% 11.7% 27.3% 61.0%

WTI Crude Oil 84.1% 3.5% 12.4% 42.5% 28.6% 28.8%

Heating Oil 87.8% 2.0% 10.2% 36.5% 14.0% 49.5%

Unleaded Gas 80.0% 4.3% 15.7% 36.5% 23.4% 40.0%

Natural Gas 90.0% 3.0% 7.0% 58.3% 12.7% 29.0%

Gold 90.1% 8.5% 1.3% 19.8% 54.5% 25.7%

Silver 40.7% 59.0% 0.4% 24.2% 44.1% 31.7%

AVERAGE 77.3% 16.2% 6.5% 31.3% 27.8% 40.9%

Source: CFTC Commitments of Traders CIT Supplement, calculations based upon CFTC COT/CIT 

report (see Appendix: How to Calculate Index Speculatorsʼ Positions). Note that Physical Hedgers in 

this table are equivalent to the Commercial category. Any Traditional Speculators utilizing the swaps

loophole (see Ch. 6) show up here as Physical Hedgers. This table does not include spread trades or 

non-reported trades. WTI crude oil figures include NYMEX, ICE and NYMEX financial contracts as well 

as recent CFTC reclassification. Figures represent annual averages and 2008 is average through 

7/1/08.
The Accidental Hunt Brothers July 31, 2008

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

198819891990199119921993199419951996199719981999200020012002200320042005200620072008

Speculation Has Grown To Excessive Levels in Almost All Commodities

This enormous growth in speculation has not been limited to just a few commodities. 

The charts below show that speculation has grown tremendously in almost all the 

commodities that are part of the major commodity indexes. Index Speculation is 

affecting all the index commodities in the same detrimental way. One can see that in 

each of these cases we went from a market dominated by Physical Hedgers ten 

years ago to a market that is dominated by Speculators today.

Chart Compilation: Speculation Percentage in Energy, Grains and Softs (1988-2008)

WTI Crude Oil Gasoline Heating Oil Natural Gas

Corn Wheat Soybeans

 

Soybean Oil

Coffee Sugar Cocoa Cotton

Source: CFTC Commitments of Traders CIT Supplement, calculations based upon CFTC COT/CIT report (see Appendix: How to Calculate 

Index Speculators’ Positions). Since spread trades are speculative trades according to the CFTC they are included. WTI Crude Oil 

includes NYMEX, ICE and NYMEX financial contracts as well as recent CFTC reclassification. Figures represent annual averages and 

2008 is average through 7/1/08.
The Accidental Hunt Brothers July 31, 2008

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Summary

When two-thirds of all positions and an even larger fraction of all trading is done by 

Speculators, it becomes apparent that the ability of physical commodity producers 

and consumers to influence price determination is seriously diminished. Many 

Physical Hedgers have started to question their participation in markets that no 

longer reflect supply and demand.

It is clear that the price discovery function has been grossly distorted and that 

because the commodities futures markets are now dominated by Speculators (of 

which the Index Speculator is the most damaging type), prices in these markets 

move for reasons that increasingly have little to do with specific commodity supply 

and demand fundamentals.

Because of this disassociation between futures prices and the supply and demand 

realities in the physical markets, the commodities futures markets are no longer able 

to serve the only constituency they were ever intended to serve: bona fide Physical 

Hedgers. Many bona fide Physical Hedgers, now greatly outnumbered and having to 

transact in a market that is mainly driven by the activities of large institutional 

Speculators, are questioning the value of the futures markets for hedging purposes. 

If this trend continues, we can expect to see many physical commodity producers 

and consumers abandon the futures markets entirely as a vehicle for hedging 

purposes and price discovery. At that point, the futures marketsʼ destruction from 

excessive speculation will be complete.
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CHAPTER SIX: SPECULATIVE POSITION LIMITS

Introduction

The remedy for excessive speculation has been well-known since at least 1936. The 

speculative position limits put in place by the Commodity Exchange Act did a good 

job of protecting the commodities futures markets for over 50 years. Unfortunately, 

beginning in 1991, speculative position limits have been raised, circumvented and 

eliminated, with the result being the excessively speculative markets we are 

experiencing today.

Condensed History of Speculative Position Limits

The Commodity Exchange Act of 1936 prescribed speculative position limits for 

agricultural commodities in order to prevent commodities futures markets from 

becoming overly speculative.

“The fundamental purpose of the measure is to insure fair practice 

and honest dealing on the commodity exchanges and to provide a 

measure of control over those forms of speculative activity which too 

often demoralize the markets to the injury of producers and 

consumers and the exchanges themselves.”65

“It should be our national policy to restrict, as far as possible, the use 

of these exchanges for purely speculative operations.”66

“The bill authorizes the Commission . . .to fix limitations upon purely 

speculative trades and commitments. Hedging transactions are 

expressly exempted. That this power of the Commission will be 

exercised judiciously and for the purposes merely of preventing 

overspeculation and a type of ʻracketeeringʼ by a few large 

professional traders, may be assumed as a matter of course.”67

These limits were very effective in preventing excessive speculation and commodity 

price bubbles. The CFTC in 1981 mandated that all commodities futures should be 

covered by speculative position limits.68

Then, throughout the 1980s and the 1990s, financial futures gained in popularity until 

they came to dwarf commodities futures in terms of volume and dollar value of open 

interest. This meant that the CFTC was devoting most of its time and resources to 

regulating financial futures and not commodity futures.

 

65 Report No. 421, U.S. House of Representatives 74th Congress, Accompanying the 

Commodity Exchange Act, March 18, 1935.

66 President Franklin D. Roosevelt message to Congress February 9, 1934.

67 Report No. 421, U.S. House of Representatives 74th Congress, Accompanying the 

Commodity Exchange Act, March 18, 1935.

68 October 16, 1981—The CFTC adopts Regulation 1.61 (now part of CFTC Regulation 150, 

17 CFR 150) requiring exchanges to establish speculative position limits in all futures 

contracts. http://www.cftc.gov/aboutthecftc/historyofthecftc/history_1980s.html
The Accidental Hunt Brothers July 31, 2008

38

There is no threat of excessive speculation in financial futures because every 

participant in that market is an Investor / Speculator. Financial futures only need 

position limits in order to prevent a single Speculator from manipulating the market.69

Commodities futures are the only markets where two distinct classes of market 

participants transact – Physical Hedgers and Speculators. Speculative position limits 

in the commodities futures markets are needed not only to prevent manipulation but 

to ensure that Physical Hedgers remain dominant.

Somehow it appears that during this time period the CFTC lost sight of the crucial 

differences between financial futures and commodities futures. The CFTC began to 

equate excessive speculation with manipulation and they came to believe that 

position limits were only necessary to prevent manipulation.70

Excessive Speculation Is Not the Same as Manipulation

The Commodity Exchange Act clearly does not consider “excessive speculation” and 

“manipulation” to be the same thing. If it did, then it would not mention them 

separately and propose different remedies for each.71 Physical commodity producers 

and consumers are capable of manipulating the market and the CFTC has to provide 

strong oversight to make sure that this does not happen. But because Physical 

Hedgers are not Speculators, they can never make the market excessively 

speculative.

It seems clear that Congress saw the dangers of excessive speculation in the 

commodities futures markets, and that is why they prescribed a specific remedy of 

speculative position limits. And for decades regulators recognized the inherent value 

of speculative position limits and set them at levels that truly were a limit to 

speculation.

Position Limits Raised

As commodities futures markets grew in terms of volume and open interest, the size 

of a position that a Speculator would need to manipulate the market grew as well. 

Since the CFTC has recently been focused on preventing manipulation and not 

excessive speculation, the CFTC has raised speculative position limits for agricultural 

 

69 “In general, position limits are not needed for markets where the threat of market 

manipulation is non-existent or very low. Thus, speculative position limits are not necessary for 

contracts on major foreign currencies and other financial commodities that have highly liquid 

and deep underlying cash markets. A contract market may impose, for position accountability 

[sic] provisions in lieu of position limits for contracts on financial instruments, intangible 

commodities, or certain tangible commodities, which have large open interest, high daily 

trading volumes, and liquid cash markets.” – “Speculative Position Limits,” CFTC Website 

http://www.cftc.gov/industryoversight/marketsurveillance/speculativelimits.html#P8_883

70 ibid.

71 “However, Section 4a (7USC6a) is expressly concerned with “excessive speculation” and 

thus is not specifically an anti(-)manipulation provision. Rather, section 4a focuses upon 

market disorders attributable to unbridled speculative activity, without regard to whether that 

speculative frenzy has a manipulative purpose.” Section 5.02[1] “Derivatives Regulation,” Philip 

McBride Johnson and Thomas Lee Hazen, Aspen Press, 2004, page 1235.
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commodities several times in the last decade.72 By raising speculative position limits 

the CFTC has allowed speculation to increase and become excessive.

Position Limits Evaded

In 1991 the CFTC started to give commercial exemptions from position limits to 

swaps dealers for the purposes of hedging their over-the-counter swaps 

transactions.73 The rationale was that, like a physical commodity producer or 

consumer, these swaps dealers had an exposure that they were trying to offset and 

that they were not entering into these large positions for the purpose of manipulating 

prices. Since the CFTC did not see the potential for manipulation (which was their 

focus), the CFTC allowed these swaps dealers virtually unlimited access to the 

futures markets on par with what bona fide Physical Hedgers enjoy.

In so doing, the CFTC has opened a loophole for unlimited speculation. If a 

Speculator wants to take a large futures position for which they would normally face a 

speculative position limit, they can get around that by going to a Wall Street Bank and 

entering into a swap contract. These Wall Street Banks offer swaps on solitary 

commodities, which means they become a surrogate for Speculators wanting to 

circumnavigate position limits.74 As an example, a Speculator that wants to take a 

$500 million position in Wheat (clearly outside speculative position limits) can do so 

via a single commodity index (Wheat) swap.

This has opened up a loophole that allows unlimited speculation through swaps. 

There is clearly a big difference between a bona fide Physical Hedger who is trying to 

reduce price risk and a Wall Street Bank that is not in the physical commodities 

business at all and is simply serving as a conduit for Speculators.

Note finally that the inclusion of swaps dealers in the commercial category of the 

CFTCʼs “Commitments of Traders” reports has made these reports essentially 

meaningless. One can no longer look at the commercial category to gauge the 

amount of speculation present in the marketplace. This has left regulators and 

policymakers without the ability to accurately assess the level of speculation present 

in the commodities futures markets.

 72 See for instance, 63 FR 38525 (July 17, 1998), 70 FR 24705 (May 11, 2005), 72 FR 65483 

(November 21, 2007). We could find no evidence that speculative position limits have ever 

been tightened by the CFTC or an exchange in the last 10 years.

73 “And that actually happened in 1991 with a particular swap dealer that was hedging an OTC 

transaction with a pension fund, and the swap dealer came to us, and we said, "yeah, that 

qualifies for a hedge exemption," so we granted a hedge exemption to the swap dealer. And in 

the years since then, we've done the same for other swap dealers, as well.” - Remarks of Don 

Heitman, Division of Market Oversight, CFTC Agricultural Advisory Committee Meeting, 

Washington, D.C., December 6, 2007

www.cftc.gov/stellent/groups/public/@aboutcftc/documents/file/aac_12062007.pdf

74 “Similar hedge exemptions were subsequently granted in other cases where the futures 

positions clearly offset risks related to swaps or similar OTC positions involving both individual 

commodities and commodity indexes.” 72 FR 66097, Notice of Proposed Rulemaking, Risk 

Management Exemption From Federal Speculative Position Limits, November 27, 2007.

http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/file/e7-22992a.pdf
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Position Limits Eliminated

In 1998 the CFTC codified a practice they had been engaged in for several years that 

basically allowed commodities futures exchanges in “large and liquid” commodities 

futures markets to replace speculative position limits with position accountability 

limits.75 Position accountability limits do not actually limit Speculators in the size of 

the positions they can take. Instead, they represent a threshold after which the 

futures exchange is supposed to watch the Speculatorʼs position with greater 

vigilance in order to prevent manipulation.76 

Since exchanges get paid based on the volume of futures contracts that are traded 

and Speculators trade much more frequently than Physical Hedgers, the exchanges 

have a strong incentive to set the position accountability limits as high as possible 

and then to only intervene if there is manipulation taking place. The prevailing 

attitude is that manipulation is bad for business but speculation is great for business. 

Since the largest U.S. futures exchanges are now publicly traded for-profit 

corporations who are promising earnings growth to their shareholders, they cannot 

be relied upon to combat excessive speculation.

The CFTC sets federal speculative position limits for enumerated agricultural 

commodities, but the exchanges set all other position limits. In WTI crude oil, for 

instance, the NYMEX has replaced speculative position limits with position 

accountability limits except in the last three days prior to expiration. So effectively, 

there are no limits for WTI crude oil. Foreign Boards of Trade like the Intercontinental 

Exchange (ICE) are happy to comply with NYMEXʼs position limits because there 

essentially are none.

Summary

As we have shown, there is only one class of commodities futures market participant

that can be counted upon to always buy and sell based on supply and demand and 

always strengthen price discovery: the Physical Hedgers. That is why speculative 

position limits are necessary in order to ensure that they remain dominant.

To repair the damage to the price discovery function and to bring food and energy 

prices down to levels that more accurately reflect supply and demand, Congress 

should take action to undo the changes made to speculative position limits.

 75 “the Commission is proposing to codify an exemption permitting exchanges to substitute

position accountability rules for position limits for high volume and liquid markets.” 63 FR 

38525 (July 17, 1998) http://www.cftc.gov/foia/comment98/foi98--028_1.htm.

See also footnote 69.

76 In many ways this is a semantic charade because futures exchanges are actively monitoring 

all market participants. It is a foolish notion that someone with 21,000 WTI futures contracts 

will be actively monitored but someone with 19,000 WTI futures contracts will not be.
The Accidental Hunt Brothers July 31, 2008

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CHAPTER SEVEN: LEGISLATIVE SOLUTIONS

Introduction

The erosion and elimination of speculative position limits has made it possible for 

hundreds of billions of dollars to flow unimpeded into the commodities futures 

markets. This unbridled flow of money is one of the principal causes of the dramatic 

price increases we have seen. Congress must re-establish real speculative position 

limits in order to reverse the flow of speculative money and to wring the excess out of 

the commodities futures markets. Speculative position limits have worked effectively 

for decades and will work again without unintended consequences if Congress will 

take action.

In addition, Congress must tackle the issue of Index Speculation head on. Solving 

the excessive speculation problem will help reduce Index Speculation somewhat but 

many Index Speculators will still be able to slip in underneath the new speculative 

position limits. Because of the damage they do to the price discovery function they 

need to be prohibited or severely restricted in their ability to buy commodities futures.

Step One: Re-Establish Federal Speculative Position Limits for All Speculators 

in All Commodities in All Markets

Congress should convene separate panels composed exclusively of physical 

commodity producers and consumers for each individual commodity. These panels

shall recommend reasonable speculative position limits in the spot month as well as 

in all other individual months, and as an aggregate across all months. For 

commodities where real limits have been replaced by “accountability” limits, real 

limits must be re-established. Speculative position limits for all commodities should 

be Federal and should be enforced by the CFTC and not the exchanges, in order to 

ensure compliance.

The commodities futures markets exist solely for the benefit of bona fide Physical 

Hedgers, so they are best qualified to set the limits. These physical market 

participants understand the benefits of liquidity and will do nothing to jeopardize their 

ability to hedge. The CFTC can reject the Congressional panelsʼ recommendations, 

but they must be required to explain their rationale to Congress as well as their 

proposed alternative.

Speculative position limits must apply to every market participant (exempting bona 

fide Physical Hedgers) whether they access a futures market directly or trade in the 

over-the-counter market through swaps and other derivatives. Speculative position 

limits must “look through” any swap transaction and apply to the ultimate 

counterparty as if the transaction had been done on an exchange.

These position limits must be made to apply to any foreign boards of trade that are 

trading futures contracts that involve physical delivery inside the United States or that 

cash settle against contracts that involve physical delivery or cash settle against an 

index of U.S. prices. In other words the Swaps loophole, the London loophole and all 

other loopholes must be fully closed. If all the loopholes are not fully closed, then 

investors will be able to maintain access to U.S.-based commodities through one of 

these loopholes and the excessively speculative money will not flow out of the 

markets.
The Accidental Hunt Brothers July 31, 2008

42

Under this regulatory regime, if a panel of oil producers and oil consumers sets the 

speculative position limit at 3,000 contracts (equal to three million barrels of oil or 

about $400 million at todayʼs prices) then a Speculator can trade the equivalent of 

three million barrels through an OTC swap or on the NYMEX or on ICE. But their 

total position across all three markets cannot exceed three million barrels.

Further, these speculative position limits must be established at the control entity 

level so that a Speculator cannot establish five shell subsidiaries and then trade 15 

million barrels of oil.

Congress has two options for ensuring that speculative position limits apply in the 

over-the-counter swaps markets. Option one is to force all swaps dealers to clear 

their swaps transactions through the applicable futures exchange. This would have 

the added benefit of strengthening the current system and increasing its transparency 

Option two would be to require swaps dealers who want to access the futures 

markets for any purpose to report all of their swaps transactions directly to the 

CFTC.77 With this data the CFTC could calculate how much of a hedging exemption 

these swaps dealers would qualify for. 

As a final note, Wall Street Banks that own physical commodity businesses should 

not have an unlimited commercial exemption from position limits. If a Wall Street 

Bank wants to take positions that are bigger than its swaps book or its underlying 

commodity business then it must be subject to the same speculative position limits as 

every other Speculator in the marketplace.

Step Two: Define Excessive Speculation Numerically

Part of the reason that the term “excessive speculation” became synonymous with

“manipulation” was that the Commodity Exchange Act lacked a concrete definition of 

the term. Congress should clearly define excessive speculation and go the extra 

step of providing a specific remedy for situations in which individual Speculators are 

within their position limits and yet a specific commodity futures market as a whole is 

still excessively speculative.

Each Congressional panel of physical commodity producers and consumers should 

define numerically, based on a percentage of open interest, what constitutes 

“excessive speculation.” As an example, physical crude oil producers and 

consumers may decide that the crude oil futures markets should never be more than 

35% speculative (not including spreads) on a percentage of open interest basis.

The CFTC should be instructed to establish “circuit breakers” (a concept familiar to 

equity market participants) that adjust individual speculative position limits downward 

in order to prevent any individual commodity futures markets from reaching the 

overall limit established by the panel. These adjustments to individual limits should 

happen in a gradual fashion and be based on data that is averaged over time in order 

to minimize the impact on the markets. A Speculator whose existing position 

exceeds the newly established limit, by virtue of the downward adjustment in limits, 

would not be required to sell; they would simply be unable to add to their position.

 

77 Congress might consider requiring any financial institution that desires access to any of the 

CFTCʼs regulated markets (including financial futures markets) to submit to the reporting 

requirement for over-the-counter commodity swaps transactions.
The Accidental Hunt Brothers July 31, 2008

43

Building on our earlier crude oil example, the CFTC could publish a sliding scale from 

25% to 35% of speculative open interest that pares back the individual position limits 

from 100% to 20% of their normal size. So if the established aggregate speculative 

position limit was normally 3,000 contracts at an overall speculative percentage of 

25% or less, then if overall speculation reaches 30%, perhaps the individual position 

limit would adjust downward to 1,800 contracts.78

Step Three: Eliminate (or Severely Restrict) Index Speculation

Index Speculators consume liquidity for the ultra long-term. Every single futures 

contract they trade damages the price discovery function. They have made the 

commodities futures markets excessively speculative. And they are one of the most 

dominant forces in the commodities futures markets today. If they were removed 

from the markets then Physical Hedgers would once again become the dominant 

force in the commodities futures markets. This action is necessary to repair the price 

discovery function.

There lies a problem within a problem. Index Speculation has led to excessive 

speculation. If you solve the excessive speculation problem through speculative 

position limits, the Index Speculation problem will remain, since many Index 

Speculators will still be beneath the limits. Additional measures must be taken to 

address Index Speculation head on.

We offer 6 possible avenues for restricting or eliminating Index Speculation knowing 

that “where there is a will there is a way.” There might be more and creative ways to 

address the problem and we support any solution that eliminates Index Speculation.

1. Legislation could be passed which prohibits any Institutional Investor from 

investing in commodity index replication or substantially similar trading strategies 

that involve a pre-specified trading methodology and portfolio composition of 

three or more U.S. based commodities with the intention of maintaining a 

substantially uni-directional position for a largely uninterrupted and extended 

period of time. The CFTC could then develop guidelines for what constitutes an 

index replication or substantially similar strategy.

2. Number 1 above could be modified to impose a position limit on Index 

Speculators (expressed in dollars or in contracts) that is substantially less than 

the new limits that are imposed on Traditional Speculators. Index Speculators 

provide no beneficial liquidity to the commodities futures markets and instead 

inflict significant damage upon the price discovery function so they should be 

treated separately from all other Speculators.

3. By purchasing commodities futures contracts, in direct competition with U.S. 

corporations attempting to hedge their physical consumption, Institutional 

Investors are driving up prices and squeezing out actual businesses that need 

the futures markets to hedge. For that reason, it makes sense that tax-exempt 

entities that generate profits from trading futures contracts should have those 

profits taxed as Unrelated Business Taxable Income (UBTI). This is a clear case 

of a tax-exempt entity directly competing with a taxable entity.

 78 If position limits range between 3,000 contracts (100%) and 600 contracts (20%) based on 

an overall speculative percentage of 25% to 35%, then at 30% (the midpoint) speculative 

position limits would equal 1,800 contracts, which is halfway between 3,000 and 600.
The Accidental Hunt Brothers July 31, 2008

44

4. We would advocate eliminating indexing strategies at their source by modifying 

the Prudent Investor rule to make it clear that commodities futures are 

speculative instruments that are not prudent investments for trusteesʼ portfolios. 

5. The Commodities Exchange Act states, when discussing speculative position 

limits, that “such limits upon positions and trading shall apply to positions held by, 

and trading done by, two or more persons acting pursuant to an expressed or 

implied agreement or understanding, the same as if the positions were held by, 

or the trading were done by, a single person.”79 Since Index Speculators are all 

acting in express agreement by following the exact same published trading 

methodology, they should all be collectively subject to the speculative position 

limits of a single Speculator. Congress could compel the CEA to enforce this 

provision. Then the amount of money allocated to index replication would have 

to drop from the current level of $317 billion to the limits of a single Speculator, 

approximately $8 billion.

6. Congress could also compel the CFTC to use its emergency powers to make 

Index Speculator positions “liquidation only” so that positions cannot be 

increased in size.

Benefits of these Proposals

There are two key benefits related to these three proposed legislative changes. 

First, there are no unintended consequences associated with speculative position 

limits. We have had them since 1936 and they have been very effective at 

preventing excessive speculation while at the same time allowing for a healthy 

amount of liquidity within the commodities futures markets. By enacting these 

proposals, Congress would simply be updating the Commodity Exchange Act to 

reflect the new realities found in todayʼs markets.

The second key benefit of these proposals is that they get to the heart of the 

problem. A wall of speculative money flowed into the commodities futures markets 

because there were effectively no hard and fast speculative position limits to stop it, 

causing commodities futures prices to skyrocket. By re-establishing speculative 

reasonable and rigid position limits, much of the speculative money that was able to 

flow in must, by necessity, flow out. That will result in commodities prices coming 

down to levels that accurately reflect true supply and demand in the physical 

commodity markets.

Ten years ago the commodities futures markets were functioning properly and no one

was complaining about a lack of liquidity. Rolling back the clock on Index 

Speculation and forcing Index Speculators out of these markets will simply return 

things to the way they were ten years ago.

Empty Threats of Offshore Migration

Many of the groups that are profiting from the practices addressed by this legislation 

threaten that if Congress takes action then futures trading in U.S. commodities will 

simply move offshore. This is an empty threat.

 79 U.S. Code, Title 7, Chapter 1, Section 6a, http://frwebgate.access.gpo.gov/cgibin/getdoc.cgi?dbname=browse_usc&docid=Cite:+7USC6a
The Accidental Hunt Brothers July 31, 2008

45

Any futures contract that calls for physical delivery inside the United States is 

automatically subject to CFTC regulation.80 Any futures contract that cash settles 

against a U.S. contract with physical delivery provisions is also automatically subject 

to CFTC regulation unless specifically exempted.81 If not exempted, then no person 

inside the United States may lawfully trade that contract.82

So for instance, 60% of the volume of the cash-settled WTI crude oil contract on the 

Intercontinental Exchange (ICE) is traded by U.S. entities.83 If the CFTC had not 

exempted the ICE from regulation then those U.S. entities would not be able to trade 

that contract. The ICE WTI contract would have never gotten off the ground if the 

CFTC had not exempted it from regulation.

In order for any futures contract to be successful it must reach a “critical mass” of 

volume.84 Market participants always prefer the contract that has the most liquidity. 

They also prefer a marketplace located in a country with strongly established legal 

and banking systems. 

Since the United States is the largest consumer of energy in the world and the largest 

producer of food in the world, every U.S.-based physical commodity producer and 

consumer will favor a U.S.-regulated futures contract with physical delivery provisions 

inside the United States. This will be the contract that they choose as their 

benchmark for spot market transactions, which will encourage non-U.S. physical 

market participants to choose this contract as well. 

These Physical Hedgers will never abandon an established and fully regulated U.S. 

exchange in order to trade on a non-U.S.-regulated foreign exchange. They face no 

speculative position limits as bona fide Physical Hedgers, so they will prefer an 

exchange with tight speculative position limits. As a result, U.S.-regulated exchanges 

will have prices that most accurately reflect supply and demand fundamentals. 

Therefore, the volume from Physical Hedgers will grow rather than diminish.

Re-establishing speculative position limits will significantly reduce the speculative 

volume on commodities futures exchanges. But these limits will only affect the 

largest traders. The majority of small and mid-sized Speculators likely will remain 

well under the speculative position limits and will not be affected. If they are not 

bumping up against position limits, then they also would have no incentive to shift 

their trading to non-regulated foreign exchanges.

The only market participants with any incentive to trade elsewhere are the 

Speculators that are above the position limits. Since the purpose of position limits is 

to prevent these Speculators from trading beyond the limits, restriction of this trading 

would result in a net benefit to the commodities futures markets due to the elimination 

of excessive speculation.

 80 Section 4.05[2] “Derivatives Regulation,” Philip McBride Johnson and Thomas Lee Hazen, 

Aspen Press, 2004, pages 977-980.

81 Section 4.05[6] “Derivatives Regulation,” Philip McBride Johnson and Thomas Lee Hazen, 

Aspen Press, 2004, pages 983-986. See also Testimony of Michael Greenberger - June 3, 

2008: http://commerce.senate.gov/public/_files/IMGJune3Testimony0.pdf

82 ibid.

83 Conversations with House Energy Committee Staff 84 “Financial Futures and Options,” Todd E. Petzel, Quorum Books, New York, 1989, page 4.
The Accidental Hunt Brothers July 31, 2008

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In enacting legislaton Congress should not allow any exemptions from speculative 

position limits for any arbitrage traders trying to arbitrage price differentials between 

U.S. regulated and foreign non-regulated futures exchanges. This will effectively delink the prices between the two exchanges and will prevent any foreign non-regulated 

futures exchange from trying to “piggyback” off of our futures markets.

Summary

The implementation of the solutions outlined in this report will greatly increase the 

confidence of market participants around the world that our futures contracts prices 

are an accurate reflection of true supply and demand fundamentals. In the long term 

this will lead to greater participation in our futures markets and therefore greater 

volume.
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CONCLUSION

More Institutional Investors Want to Invest in Commodity Indexes

Because commodity futures prices have risen dramatically, Index Speculators have 

made large paper profits. This has encouraged other Institutional Investors to 

actively consider pouring billions more dollars into the commodities futures markets.

Pension fund consultants have been advocating portfolio allocations of between 5%85

and 12%86 to commodities indices. Considering that worldwide institutional assets 

are about $29 trillion87, if Institutional Investors heed the advice of their consultants, 

index replication could easily reach $1 trillion.88 Chart 8 asks the reader to consider 

what will happen to prices if institutional investment hits the $1 trillion mark?

Chart 8. S&P GSCI Spot Price Index vs. Index Speculator Assets

Source: Bloomberg, Goldman Sachs, CFTC Commitments of Traders CIT Supplement, calculations 

based upon CFTC COT/CIT report (see appendix). 2008 figure is as of 7/1/08.

Wall Street Is Now Promoting This Investment to Retail Investors

Wall Street Banks have seen how much money their peers are making and they want 

to start selling commodities index investments as well. There have been several new 

commodities indices launched in the last five years. Perhaps the most ominous sign 

is the recent spate of Exchange Traded Funds (ETFs) that have been launched to 

 

85 “Investing In Collateralised Commodities Futures,” Russellʼs Research For Excellence, 

Yvonne Ooi and David Rae, 2005.

86 “Strategic Asset Allocation and Commodities,” Ibbotson Associates, Thomas M. Idzorek, 

March 27, 2006.

87 Pension Funds $26 trillion: “UK pension fund returns at five-year low,” IFAonline, Jennifer 

Bollen, January 28, 2008. http://www.ifaonline.co.uk/public/showPage.html?page=698204

Sovereign Wealth Funds $3 trillion: “Sovereign Wealth Funds,” Council On Foreign Relations, 

Lee Hudson Teslik, January 18, 2008. http://www.cfr.org/publication/15251/

88 $1 trillion on $29 trillion would represent an average allocation of just 3.5%.

 $- 

 $200 

 $400 

 $600 

 $800 

 $1,000 

 $1,200 

100

300

500

700

900

1100

1300

1500

1700

1900

2100

19801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008

????

COMMODITY INDEX ALLOCATIONS (BILLIONS)

S&P GSCI SPOT PRICE COMMODITY INDEX

OTHERS

DJ-AIG

SP-GSCI

S&P GSCI SPOT INDEX

Where will 

prices be if 

assets reach 

$1 trillion?
The Accidental Hunt Brothers July 31, 2008

48

appeal to retail investors.89 This opens up a whole new source of potential profits for 

Wall Street if they can get retail investors to buy into the same strategies.

While Institutional Investors account for $30 trillion in worldwide assets, retail 

investors (including high net worth individuals) account for over $50 trillion in 

wealth.90 If left unchecked, they could pour billions into commodity index strategies 

as well.

The Problem Will Not Solve Itself

As long as there are effectively no hard and fast speculative position limits in the 

commodities futures markets, speculative money will continue to flow in and prices 

will continue to rise. The increase in food and energy prices can continue as long as 

Institutional Investors continue to pour more money into these markets.

Because futures price increases directly result in spot price increases, the world is 

experiencing dramatic food and energy price inflation as a result of Institutional 

Investorsʼ portfolio allocation decisions. The high prices caused by this artificial 

financial demand are holding Americans hostage because they cannot simply stop 

eating or driving to work.

Todayʼs markets are clearly suffering from excessive speculation. Physical 

commodity producers and consumers are already beginning to abandon these

markets. And the price discovery function continues to be damaged with each 

passing day. This problem will continue to grow until Congress takes action.

 

89 “Commodity ETFs: Hot Asset Wrappers,” Forbes, Joshua Lipton, April 17, 2008. 

http://www.forbes.com/etfs/2008/04/17/commodities-etf-etn-pf-etf_jl_0417etf_inl.html

90 “Global High Net Worth Assets Reach $50 Trillion, But Economic Woes Trim Growth Rate to 

9%,” Business Wire, March 27, 2008. 

http://www.streetinsider.com/Press+Releases/Global+High+Net+Worth+Assets+Reach+$50+T

rillion,+But+Economic+Woes+Trim+Growth+Rate+to+9%25/3492452.html
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APPENDIX: HOW TO CALCULATE INDEX SPECULATORSʼ POSITIONS

If one knows the total dollar figure invested in an index, then it is easy to calculate 

how much must be in each commodity, in dollars as well as in futures contracts.

Total Dollars 

Invested in 

Index

X

Weight of 

Individual 

Commodity

=

Dollars in 

Individual 

Commodity

Total Dollars 

Invested in 

Index

X

Weight of 

Individual 

Commodity

/

Dollar Value of 

a Commodity 

Contract

=

# Of Contracts 

in an Individual 

Commodity

And therefore, if one knows how many contracts are in an individual commodity along 

with the dollar value of a contract and the weight of that commodity in the index, then 

the total dollars invested in the index can be calculated as follows:

# Of Contracts 

in an Individual 

Commodity

X

Dollar Value of 

A Commodity 

Contract

/

Weight of 

Individual 

Commodity

=

Total Dollars 

Invested in 

Index

The CFTC, starting in January 2006, has been publishing the Commodity Index 

Trader Supplement to the Commitments Of Traders report. This supplemental report 

shows the reported positions of Index Speculators in 12 different agricultural 

commodities. Of the 12, two commodities - KC Wheat and Feeder Cattle, are only 

part of the S&P GSCI and one commodity: Soybean Oil, is only part of the DJ-AIG.

Both the S&P-GSCI and DJ-AIG publish on a daily basis the individual weights of 

their constituent commodities. Also, futures market data providers like Bloomberg 

publish daily closing prices for commodities. Since futures contract terms do not 

change, one can use this data to calculate the daily dollar values of the individual 

commodity contracts.

With these three data points, it is simple to calculate the total dollars invested in the 

S&P-GSCI and the DJ-AIG on a weekly basis. Once the total dollars invested in 

these two indices is known, then one can calculate the number of contracts held by 

Index Speculators in the other 13 non-agricultural commodities.

A detailed example of this 3-step process follows. 
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Step One - Estimate Total Amount Invested in S&P-GSCI and DJ-AIG

According to the CFTCʼs January 17, 2006 CIT report, Index Speculators had 

positions in KC Wheat, Feeder Cattle and Soybean Oil of 21,366, 5,613 and 59,264 

contracts respectively. Plugging in the weights and contract values from the 

appropriate sources yields the following calculations:

21,366 X $18,762.50 / 0.82% = $48,887,753,049

5,613 X $56,137.50 / 0.68% = $46,338,204,044

59,264 X $12,732.00 / 2.77% = $27,240,045,054

The resulting calculations show that the S&P-GSCI had somewhere between $46 

and $49 billion invested in it and the DJ-AIG had around $27 billion invested in it. 

This corresponds well to the figures published by Goldman Sachs and Dow Jones.

Step Two - Calculate Position Sizes for Other Commodities

Using $47.6 billion as an estimate for the S&P-GSCI, and $27.2 billion for the DJAIG, it is possible to calculate (using the formulas above) Index Speculators 

positionsʼ in all the other commodities. The table below shows the results. 

Calculation of Index Speculatorsʼ Positions (January 17, 2006)

Percentage Weights Positions (millions) Positions (contracts)

S&P-GSCI DJ-AIG S&P-GSCI DJ-AIG

Contract 

Value S&P-GSCI DJ-AIG

Combined 

Position

CFTC 

Actual

Cocoa 0.20% 0.00% $95.50 $0.00 $15,710 6,081 0 6,081 9,390

Coffee 0.80% 2.90% $373.20 $799.00 $46,425 8,039 17,201 25,240 28,777

Corn 2.00% 5.90% $954.00 $1,600.00 $10,438 91,398 153,292 244,689 305,264

Cotton 0.90% 3.20% $444.90 $862.00 $27,995 15,891 30,777 46,668 53,741

Soybean Oil 0.00% 2.80% $0.00 $753.00 $12,732 0 59,173 59,173 59,264

Soybeans 1.40% 7.80% $672.50 $2,116.00 $28,563 23,543 74,073 97,617 103,304

Sugar 1.90% 3.00% $884.90 $808.00 $17,438 50,742 46,352 97,094 124,487

Wheat 2.10% 4.80% $1,009.10 $1,300.00 $16,438 61,393 79,082 140,475 181,986

Wheat KC 0.80% 0.00% $396.00 $0.00 $18,763 21,106 0 21,106 21,366

Feed Cattle 0.70% 0.00% $329.50 $0.00 $56,138 5,869 0 5,869 5,613

Lean Hogs 1.40% 4.40% $663.80 $1,185.00 $23,790 27,902 49,824 77,726 69,591

Live Cattle 2.70% 6.10% $1,293.20 $1,660.00 $38,620 33,486 42,982 76,468 71,834

Brent Crude Oil 14.50% 0.00% $6,901.30 $0.00 $64,900 106,337 0 106,337

WTI Crude Oil 31.30% 12.80% $14,888.00 $3,482.00 $66,310 224,521 52,516 277,036

Gasoil 3.10% 0.00% $1,472.70 $0.00 $54,725 26,911 0 26,911

Heating Oil 8.00% 3.80% $3,823.70 $1,048.00 $75,243 50,818 13,924 64,742

Gasoline 7.90% 4.10% $3,780.50 $1,105.00 $76,579 49,368 14,424 63,792

Natural Gas 10.60% 12.30% $5,030.80 $3,355.00 $91,680 54,873 36,591 91,464

Aluminum 3.10% 6.90% $1,464.40 $1,866.00 $59,475 24,621 31,383 56,004

Lead 0.30% 0.00% $156.40 $0.00 $31,800 4,918 0 4,918

Nickel 0.70% 2.70% $312.80 $724.00 $88,182 3,547 8,214 11,762

Zinc 0.70% 2.70% $355.60 $736.00 $51,900 6,852 14,184 21,036

Copper (LME) 2.80% 0.00% $1,335.10 $0.00 $116,575 11,453 0 11,453

Copper (CMX) 0.00% 5.90% $0.00 $1,602.00 $54,225 0 29,542 29,542

Gold 1.80% 6.20% $875.90 $1,694.00 $55,430 15,802 30,568 46,370

Silver 0.20% 2.00% $99.20 $545.00 $45,100 2,201 12,080 14,280

TOTAL 100% 100% $47,613.00 $27,240.00

Source: Goldman Sachs, Dow Jones, Bloomberg, CFTC Commitments of Traders Report, CIT supplement and calculations
The Accidental Hunt Brothers July 31, 2008

51

Step Three - Compare with Actual CFTC Figures for Accuracy

The final column in the table shows the actual figures released by the CFTC. In 

almost all cases the estimates generated using this method yield results that are less 

than the actual reported results. This shows that this method yields conservative 

estimates.

Final Note

This method of calculating Index Speculatorsʼ positions is almost identical to the 

methods used by Philip Verleger (www.pkverlegerllc.com), Steve Briese

(www.commitmentsoftraders.org) and others. It is not clear who deserves the credit 

for developing this method but it clearly is not us.