The recent spike in oil and gas prices has been attracting concern and accusations from all over the world. Yesterday Senator Clinton announced a crazy plan to sue OPEC producers for failing to produce more oil. This is a wild idea born of desperation in an election year. OPEC has repeatedly said that they do not need to produce more oil as no one is actually in need of more oil. Demand for consumption is not the issue here, other forces are at work.

Yesterday, the US Senate Committee on Homeland Security & Governmental Affairs held a hearing on "Financial Speculation in Commodity Markets: Are Institutional Investors and Hedge Funds Contributing to Food and Energy Price Inflation?" The Senate committee heard from those defending the role of speculators in oil and commodities markets as well as those who argue that excessive speculation is the root of global price surges.

Today BusinessWeek reports on yesterday's senate hearing in "Are pension funds fuelling high oil demand?" Clearly recent price spikes are not just from demand and not just from speculators. Clearly both have played a key role in an uptrend which is becoming increasingly precarious for all of us. But recently "demand" in energy and commodity markets have come to include players who had for many years stayed almost completely out of the equation. This new type of demand is from a new category of speculators: institutional investors like corporate and government pension funds, university endowments, and sovereign wealth funds. Infact Index speculators are a primary cause of recent price spikes in commodities.

"Speculative activity in commodity markets has grown dramatically over the last several years. In the past decade, the share of long interests -- positions that benefit when prices rise -- held by financial speculators has grown from one-quarter to two-thirds of the commodity market. In only five years, from 2003 to 2008, investment in index funds tied to commodities has grown twentyfold, from $13 billion to $260 billion."

Data shows that over the last five years, China's demand for oil has increased by 920 million barrels, while over the same period, index speculators' demand has increased by 848 million barrels. So China's growth in oil demand has only slightly outpaced the demand by this new group of investors and speculators.   more »

I have long said that I am not impressed with efficient market theories about the genius and rationality of capital markets in asset pricing. Markets can often be just plain dumb, driven by irrational and erroneous assumptions of emotional participants.

Here is the latest example. Today the Financial Times reports Moody’s awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models!! See Moody’s error gave top ratings to debt products and watch this short news clip for Monty-Python-esque impact.

Although the error was apparently discovered by some Moody's insiders in 2007, the products in question remained triple A until January this year when, amid general market declines, they were downgraded several notches. The products were designed for institutional investors. In the recent credit market turmoil, those who still hold the products will have suffered some paper losses while others who have bailed out have lost up to 60 per cent of their investment.

This is a common skit that we have seen many times in the financial world. The asset holders lose big chunks of their capital. They turn to the asset advisors and say you gave us bad advice. The asset advisors turn to the product creators and raters and say you designed bad products. The product creators and rating agencies say it’s not our fault the computer screwed up. Conveniently, no one is there to accept the blame when the music stops, though many made enormous fees passing the potato ‘round and ‘round while the music played.

Oh yes, and there is nothing risky about the current price of oil either...the computer models all agree that demand is accurately setting the price.   more »