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Hedge Funds Pile Into Commodities

Oct. 13, 2007 (EIRNS)—An article in www.bullionvault.com gives an impressive account of how hedge funds are plunging into commodity speculation, creating all sorts of new derivative instruments, cooking "a '70s-style inflation — or worse."

"Wall Street and the City are suddenly piling into the commodity markets... The Ph.D.s who cooked up the U.S. housing bubble are now applying their haute finance skills to gearing up the cost of natural resources. Hence, the complexity of the very latest commodity offerings. Expect a side-order of inflation to reach your dining table as a result very soon!

"When unlimited money-supply growth crashes into rising demand for limited-supply essentials — such as natural gas, copper, soybeans and cocoa — the result is sure to be price inflation as violent as the monetary inflation that preceded it. Add a sudden wall of money from Wall Street, the City [of London], Frankfurt, Paris and Tokyo ... all seeking a growth market to replace the can't-lose gamble of home-loan trading and credit... and the surge in basic resource prices will only accelerate. Now add a little pixie dust... plus a dollop of leverage ... and voila! One '70s-style inflation — or worse — cooked to order.

"'An army of structured credit experts is studying products such as Collateralized Commodity Obligations — or CCOs,' reports Reuters, 'tied to the performance of a portfolio of underlying commodities, such as precious metals or energy prices.' In a CCO, 'the issuer sells protection on the underlying commodity portfolio to the counterparty under what is known as a trigger swap agreement. To fund its obligations under the swap, the issuer sells notes in the amount of the protection sold, according to Fitch Ratings. Proceeds from the notes then serve as collateral for the issuer's exposure under the swap until it matures. At maturity the issuer liquidates the remaining asset and returns the proceeds to noteholders.'

"With it so far? My guess is — and at least I'll confess it's just guesswork — is that the Reuters journalist and most likely the bulk of investors about to start buying CCOs have no idea quite what these products are, either. All they'll see, instead, is a steady stream of potential income. Provided, of course, that the CCOs pay out at maturity.

"In other words, bond managers and fixed-income traders whacked by the collapse of mortgage-backed debt, can now put commodities into their portfolios — and just in time, too, for the runaway inflation about to hit thanks to monetary over-supply and heavily-geared financial buying. The magic of finance has turned consumable lumps of natural resources into a stream of income ... without the bother of digging the earth or planting a crop."