Banks, central banks & commodities
Manipulation and conspiracy theories are of all times. Last year, rumors surged that 1 particular giant broker in the US was doing all within its powers to depress the price of silver by selling silver futures. And the conspiracy became complete when rumors surged this was done at the request of the FED because precious metals were becoming too much of a competitor for paper fiat money. Another conspiracy - openly voiced by a former FED governor - was that the FED in the past had supported the stock market by buying futures and ETFs whenever a negative market correction started to live a life on its own.
The latest proposition for central banks to intervene in the markets comes from a former Bank of England Monetary Policy Committee member. And this time it's a call to control inflation expectations by controling/manipulating price expectations on commodities (especially oil). Before commenting on the sense and nonsense of this, a first practical question comes to mind : how are you gonna achieve this in practice ? Andrew Sentence - now PwC - proposes 2 options :
1) A pre-emptive policy move of the central bank by raising interest rates. This is what we call "leaning against the wind" or raising rates in time beyond a level necessary to maintain price stability, this whenever an asset bubble is detected. First sober personal observation : with this generation of central bankers in the West, this policy approach option doesn't stand much of a chance.
2) Directly intervening in the commodity markets so central banks becoming buyers and sellers in future contracts on oil, gas, soybeans, pork bellies, whatever.
Now this last option is intriguing. It also implies that the central bank should start with an inventory of commodities otherwise it would be outright selling naked contracts, or, selling commodity futures without having the underlying commodity in position when it attempts to depress prices. And to that extend this initiative is quite useless at present. Because it has been brought forward of course in order to stabilize the stagflationary forces of upward accelerating commodity prices. Buying inventory now only would make matters worse. To conclude : First central banks make an historic effort to avoid deflation and feed a healthy inflation expectation by printing and setting interest rates at virtually zero on a global scale. Then they realize they create the wrong inflation along the way. The solution would then be to set up a huge trading desk in commodities at the central bank. A central bank really becoming a grocery shop where you can trade all kinds of stuff : paper money, foreign currency, real estate, paper debt under all forms from AAA to junk, and last but not least food, orange juice, metals and energy !
Over now to financial innovation, private banks and commodities. Apparently there is a problem for banks to continue to fund loans for commodity trading houses. Or as a senior loan officer states : "our balance sheet can't move up at the pace as commodity prices increase. Nor do banks have sufficient access to the USD market to find the money". Commodity trade financing is indeed a large business with an estimated annual turnover of some 1500 bio USD. The big houses such as Glencore are not as such in trouble in finding the money to pre-finance deals, but apparently the smaller players are suffering from some kind of credit crunch.
So two major European financial players have come up with the following solution : a CCLO or a collateralized commodity loan obligation. This is briefly a loan multiplier at work : you grant a loan, you package it as if it is a bond and sell it to institutional investors : credit risk eliminated from the bank balance sheet and the process of granting new loans can start all over again with the money received from the sale to investors. And it's rock solid because in the world of commodity loans, hardly any default occurs, dixit a senior metals and oils trader at Trafigura. SocGen and BNP are envisaging to launch these covered bonds before year end. Nothing really rocket science exciting stuff but I just wonder:
1) How are rating agencies going to assess these kind of products in view of their past experience with rating covered bonds in real estate and other so-called "rock solid" stuff ?
2) Doesn't make much sense for central banks to lean against the wind or start trading in commodities if private banks on the other hand invent credit multipliers on the same underlying assets.