New CFTC Rule Limits Commodity Trading… Again!

Birds fly, fish swim, dogs bark, and the Commodity Futures Trading Commission (CFTC) sets rules. That’s just how this world works!

Staying true to its mandate to protect U.S. market participants from fraud and abuse, the CFTC recently passed a new rule that aims to control excessive speculation and prevent manipulation by limiting trading in commodities markets.

Now, we all know that this isn’t the first time that the CFTC has set position limits on commodity trading. It’s been doing so since the Commodity Exchange Act was passed in 1936.

But this time around, its new rule is targeted specifically at energy-related commodities such as NYMEX contracts for natural gas, and various oils and metals. Without going into the nitty-gritty details, the bottom line is that this new regulation could prevent large firms from entering big positions and inflating commodity prices.

Of course, approving a new rule is one thing, but executing it is a whole different matter. Most say this new ruling may not even take effect until 2013. And even then, it will still be closely watched and evaluated as Congress has ordered the CFTC to determine how the new limits have impacted the markets 12 months after implementation.

What does this rule have to do with forex traders like you and me?

As I pointed out earlier, the CFTC’s position limits aim to curb excessive speculation which often results in sudden price jumps in commodities and, in effect, commodity-related currencies. When these position limits are implemented, price action of both commodities and comdolls could be more dependent on natural market forces such as supply and demand.

However, be mindful that the markets could be in for a brief selloff in commodities and comdolls once the rule takes effect. After all, several traders and institutions could decide to unload their commodity positions, just as they did when gold and silver margin requirements were raised earlier this year.

Another possible effect of this rule is that it could help stabilize price levels in the long run. This would be beneficial for companies that rely heavily on fuel and raw materials for production since they’d no longer have to worry so much about adjusting their profit margins for commodity price changes every now and then.

Aside from that, reduced speculative trading on commodities could help tame inflationary shocks and help central banks focus more on stimulating their economy and less on maintaining price stability.

While the CFTC’s position limits on commodity trading could solve a lot of problems, there are naysayers who point out that the rule could do more harm than good. For one, the CME Group warns that such restrictions will push commodity investors to markets outside the U.S. as they seek hedging and risk management alternatives offshore.

If that happens, the position limits rule might not achieve the CFTC’s desired effect of reducing excessive speculation. After all, there are plenty of commodity exchanges elsewhere and traders are likely to opt for less regulation. Orders spread over several exchanges could then make the market less liquid and less transparent as traders could conceal their full positions from the CFTC.

At the end of the day, the CFTC’s desire to regulate market activity might actually end up depriving them of better market oversight. Of course, there’s still plenty of time for the CFTC to take these possible effects into account and make the necessary changes before they take effect. Do you think the potential benefits would outweigh the possible risks though?