Don't Treat Commodities Like Stocks

Bubble? Manipulation? These words are being bandied about by the financial press but have absolutely no meaning in the context of the commodity markets right now.

In trying to understand the quick rise (and falls!) in the prices of commodities such as oil, corn and wheat, many of this country's most respected economic journalists have used the typical models of other markets. That's just wrong, because the futures markets do not operate like any other market out there.

Let's discuss just what makes the commodity markets unique and why you cannot try to understand their prices solely using traditional economic theory. Then, we'll hopefully be in a better position to try and predict where they're going.

First, the futures markets were never intended to be used the way they are now being used. Futures markets were intended to be price-discovery instruments for the hedging of products for legitimate buyers and sellers. Farmers needing to know what their income would be for crops not yet harvested could hedge in the futures market and know precisely what they would be paid. Similarly for end-users -- Nabisco could plan exactly what it would cost to buy wheat for its Ritz crackers for the next several months. Market makers like me were in business trying to match buyers and sellers, adding liquidity.

But now, everything has changed. All manner of investors are flocking to the commodity markets to get exposure to the hottest market out there. Speculation is driving price to a degree where it swamps the "correct" price discovery of legitimate buyers and sellers.

When I was trading on the floor of the New York Mercantile Exchange for most of my career, you needed to have quite a lot of preparation if you wanted to be involved in the futures markets. You needed a relationship with a dedicated futures broker and you needed a special account, most of the time only granted if you could pass thresholds of knowledge about the nature of futures trading. You needed to be on the phones constantly, getting quotes and having orders filled by hand; it was difficult and risky to be off the floor and know precisely what was going on in the pits.

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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.