India's Groundbreaking Play to Stem Inflation By Daniel Dicker TheStreet.com Contributor 5/9/2008 10:13 AM EDT

A blockbuster news announcement emerged yesterday, and it's been mostly ignored in the financial press. The Indian government temporarily banned the trading of soybean oil and rubber futures. I was more than a little surprised to see this, as it represents to me an admission by a major democratic government of the power of speculative forces in local commodity markets. What it may be telling us about our own domestic futures markets is even more fascinating.

The Forward Markets Commission in India, an organization similar to our CFTC, yesterday halted all trading in soybean oil and rubber futures for four months. These are key markets for India, as half of its 1.1 billion inhabitants live on less than $2 a day and have been facing shortages and hoarding of core commodities because of rampant inflation. This move is similar to a ban on trading of wheat and rice imposed by the Indian government in 2006, an experiment that seemed to have little impact on the rising prices of those commodities.

The results in this case may be exactly the same as in the previous try -- but not because the supposition of speculation as a driving force in the inflationary spiral of commodity prices is wrong. Soybean and soybean byproducts are traded internationally and domestically by our own Chicago Board of Trade (now part of the CME Group (CME) ). In India, the daily traded value of soybean oil is less than $200 million, a pittance compared to the value of soybean oil trading hands daily on the CBOT (more than 50,000 contracts daily each worth about $350,000).

While commerce for soybean oil might be local to Indians, the pricing for it certainly is not. The Indian government might want to rein in speculation in its local marketplace and arrest the inflationary trend in core commodities, but the price at which these products change hands won't logically be imposed by cash settlements. The numbers coming out of Chicago will certainly still act upon the Indian cash markets.

This is clearly what happened when the Indians tried these regulatory tactics in 2006 -- wheat and rice forward prices are readily available from screens connected to Chicago, and markets in Mumbai cannot be artificially isolated. But two years later, with some analysts calling rising commodity prices a national security issue in the U.S. and in Europe, we might expect the rest of the world to be more interested in these ideas. Indeed, it is the announcement's intent that is so interesting, not its ultimate effect, which will probably be minimal.

The argument rages over whether speculative or fundamental factors are more to blame for ramping prices in agriculture and energy. While I have written often about my belief that speculation is the major driver of the upward pressure in prices, the announcement from the Indian government makes clear that it believes speculation to be an inflammatory influence on prices. More than that, the government has taken the bold step to limit access to a free marketplace in the name of a national economic and human crisis. One wonders whether the Indians have taken a first step in regulatory control that other nations will be forced to follow -- at least in some measure.

It might be impossible to completely stop speculation in the commodity sector -- if one commodity exchange puts up roadblocks to access, another one in another nation will surely be happy to take the spillover business. Even in the U.S., where the commodity markets in Chicago and New York dominate the world in volume and open interest, there are other fledgling commodity markets available.

However, there are easily applicable "hurdles" that could be used, if this government found the will, to make speculative access to the futures markets more difficult, including increased margin requirements, position limits and more onerous letters of credit. While couched in more politically correct forms, these "experiments" might be useful in trying to measure the level of speculative activity and its impact on price. Even an announcement from the CFTC or Department of Justice suggesting such an idea might be enough to have significant impact on price.

(A late addition: I became aware after writing this piece of the Democratic Senate's introduction of the Consumer-First Energy Act of 2008, introduced late Wednesday. Aong numerous provisions, the bill contains a suggestion of higher margins on oil futures trades and puts roadblocks to routing oil trade offshore, avoiding domestic position limits. I guess our government isn't as glacial as I thought!)

Of course, another significant impact in enacting such roadblocks would be on countless stocks that overwhelmingly depend on underlying commodity prices to set costs and profits -- consolidated oil and natural gas stocks, agriculture, gold and copper, potash and on and on. That's why I consider such an announcement so breathtaking.

One group that would instantly benefit from a cooling of oil prices are the refiners -- perhaps not intuitive, but true -- as their margins would almost instantly be restored. Other ideas of rotation that could give investors immediate gains are in the pummelled drug stocks and the equally miserable airline sector.

While this country will move carefully if it moves at all in this direction, it is clear that India has opened a Pandora's box not to be ignored. Look for other sovereign nations to carefully consider the ideas behind the Indian action, and don't be surprised to see a few follow their lead. This may shape up to be the political and economic story of the year, and it's one that I will be watching very closely.

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At the time of publication, Dicker had no positions in the stocks mentioned, but positions can change at any time.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks. Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years. Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals. Dan obtained a bachelor of arts degrees from the State University of New York at Stony Brook in 1982.

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