The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders Read Free

by a massive influx of both everyday and professional investors. In the “listed” markets, where contracts traded at places like the New York Mercantile Exchange and the IntercontinentalExchange in Atlanta, volume shot from roughly500 million contracts per year in 2002 to nearly2 billion contracts in 2008.Meanwhile, in the over-the-counter market for commodity contracts, where an array of exotic financial products connected to physical commodities was traded party-to-party by phone and computer (in other words, off the exchange), the total value on paper of the trades outstanding spiked fromabout $800 billion tomore than $13 trillion over roughly the same period. Suddenly, commodity contracts, once a rounding error in the world of tradable products, were all the rage.
    Nonetheless, commodity investing was small compared to stocks, bonds, and currencies. Until the mid-2000s, most investors had never seriously considered adding commodities to their individual portfolios, which tended to favor simple, easily traded things like stocks and U.S. Treasury bonds. But something happened to commodities in the 2000s to change their minds: a huge increase in prices and an especially convincing sales job by Wall Street.
    Between the early 2000s and the middle of 2008, before the U.S. financial crisis hit, the contracts tracked by the Goldman Sachs Commodity Index, known as the GSCI for short—the commodity equivalent of the Standard & Poor’s 500 Index—nearly tripled in price. (S&P, in fact, bought the index and added its own name to the title in 2007.) Crude oil futures rose three and a half times their earlier levels. Corn futures also tripled. Even gold, an oddball commodity because it often performs better when the stock markets fall—and in this case stocks were on fire—nearly doubled.
    It was a period of easy money, and the benefits were felt all around, from state pension funds that had added commodities to their investments in order to mitigate their exposure to other, unrelated markets, to individual investors, who had dipped into commodities as a way to make money off of skyrocketing oil prices even though their gasoline was so much more expensive at thepump. Salesmen for the GSCI and other commodity indexes argued that their products were an important way to diversify investment portfolios. An array of new securities that traded like stocks but tracked precious metals like gold and silver had made commodity investing easier for regular people than ever before, and the commodity market’s inexorable upward movement meant that they’d be crazy not to buy in.
    “Wall Street did a nice job of marketing the value of having the diversification of commodities in your portfolio,” says Jeff Scott, chief investment officer of the $74 billion financial firm Wurts & Associates. “I don’t mean that sarcastically. And there is value to having certain commodities in your portfolio. Unfortunately, the return composition changed.” In other words, at a certain point the money wagon stopped rolling along.
    Until 2008, there were plenty of reasons to like commodities, most important of which was the torrid pace of demand in India and China. Those economies, which were driving up the price of raw materials around the world, were widely seen as the harbingers of what the buzzier banking analysts referred to as a new “supercycle,” a period of sustained world growth the likes of which had not been seen since World War II. There was also a prevalent theory known as “Peak Oil” suggesting that the world’s petroleum supplies were well on their way to being tapped out—a situation that would make crude oil, the engine of so many economies, frighteningly scarce. Both hypotheses augured a continuing climb in the price of oil.
    But during the second half of 2008, the belief in higher commodity prices vanished. Like stocks and bonds, commodities were roiled by the financial crisis in the U.S. The main commodity index plummeted,