About Those Evil Speculators

A favorite meme has been that commodity prices have been driven up by the activity of "speculators." I have tended to be a bit dubious, particularly in the case of oil, where not a lot can be conveniently stored, but the Washington Post's David Cho tracks some speculators to their dens. Who are they? We have met the enemy, and the enemy is us. Or at least our pension funds.

Soaring fuel prices that are burning a hole in the wallets of consumers are not only benefiting oil companies and Middle Eastern producers. They are also lighting up the investment returns of pensions funds, which millions of ordinary Americans are counting on for their retirement.

California's public employees' pension fund, the world's largest, made its first investment of $1.1 billion into oil and other commodities early last year, and since then, Calpers has seen it soar 68 percent. Fairfax County pension managers have enjoyed a 61 percent return from a similar move over the past 12 months, far outpacing any other segment of the fund's portfolio.


"Our commodity investment has really helped," said Robert L. Mears, executive director of Fairfax County's Retirement Administration Agency. "This year would have been a lot worse."

Other pension funds are rushing to get in on the action as the prices of oil, precious metals, corn, uranium and other vital goods continue to reach record highs. Montgomery County officials are in the process of shifting 5 percent of their $2.7 billion pension fund away from stocks and into commodities.

These funds are part of a tidal wave of investment dollars that has flooded commodity markets in recent years and, critics say, contributed to the run-up in prices.

Pension fund managers are playing with Other People's Money and are charged, usually, with putting prudence first in such bets. Notoriously volatile commodities hardly fit that bill.

The investments can be very attractive because there are only light restrictions on whether they can be bought and sold using borrowed money. While risky, this can produce enormous returns.

For decades, trading commodity contracts was considered taboo by most pension funds because the market is so volatile and risky. Most fund managers relied on their stock and bond investments to enlarge their pools of retirement money.

That changed after the stock market crashed in 2001. Fund managers realized they needed more diversified portfolios that would perform well regardless of whether stocks did. At the same time, new financial products simplified trading by allowing big funds to buy into commodity indexes, which work like mutual funds, that were run by Wall Street firms, mainly Goldman Sachs and Morgan Stanley.[my italics]

Oh shit! Now I know where I've seen this movie before. How many times do we need to show it before we start to get the point?

Not to worry though, the Bush Administration is on the case:

Even as rising prices translate into staggering increases at the grocery store and at the pump, some regulators, including Treasury Secretary Henry M. Paulson Jr., say investors are not to blame.

Market magic will save the day. Or not. At any rate, his former minions at Goldman Sachs will probably do OK.