Thursday, March 4, 2010 3 comments ++[ CLICK TO COMMENT ]++

Never knew insider trading was legal in commodity markets

I never knew, until reading the following short blurb from a WSJ MarketBeat blog entry, that insider trading in commodity markets is legal (at least in USA.) As many are probably aware, trading on insider information is illegal in the stock market. WSJ's MarketBeat reports:


Under current regulations, the CFTC doesn’t ban trading on inside information. Here’s how the Journal [Wall Street Journal] explained it in a 2008 article:


Unlike most stock markets, insider trading isn’t generally illegal in commodities trading. An oil company can take advantage of inside information about its production outlook when it makes trades. However, if traders intentionally create an artificial price and use it to make money, charges of manipulation may arise.

 
I didn't know this until now. I am not really a commodity investor and am generally a long-term investor—insider information has little detrimental impact in these two scenarios—but it's still interesting from a theoretical point of view.
 
There are some who believe that trading on insider information should be allowed. They believe price discovery is improved if insider trading was allowed; and they generally argue that "shocks" will be less common (for instance, stock prices may not gap down or gap up as much when material information is released.) The author of the blog clearly falls into this camp since he is making fun of the government proposal to curtail insider trading in the commodity markets.
 
I personally find the view supporting insider trading ludicrous. I fall in the other camp that believes trading on insider information should be outlawed. Generally, but not always, insider trading provides a great advantage to insiders with the material information. If you value equality or some notion of fairness then I don't see how you can justify insider trading.
 
But do note that insider trading has very negligible impact on long-term investors. Fundamentals over the years will generally matter more than whether you "time" things properly (that's all insider trading generally provides, except in rare scenarios of corporate fraud or some grave outcome.)
 
 
On a side note, I wonder if the commodity markets more efficiently price assets better than the stock market. Yes, they are totally different things and cannot be compared directly, but in a rough sense, do they provide better price discovery? Those who argue in favour of allowing insider trading (usually academic types or corporate insiders) have always claimed that it will improve the markets. I wonder if that's actually true when it comes to the commodity markets... hmm... something to think about.

Conversely, are the anti-insider-trading types, like me, right? Do those insiders actually get a benefit? Would a firm that does a lot of trading, while having deep insight into the commodity markets, earn very high profits (an example would be an oil company with a big trading operation)? Would those "independent" trading firms (just a trading house without any knowledge of operations, pricing negotations between suppliers and customers, etc) earn less profits? I don't know but I wonder. I'm not too knowledgeable about commodity markets but my impression is that "independent" traders, including some big Wall Street firms like Goldman Sachs, earn hundreads of millions in profits while I haven't heard of oil companies or shipping companies or whatever else, making quite as much money. Maybe the investment banks and independent trading firms are more leveraged (i.e. profits are boosted) but whatever it is, the advantage to the insiders doesn't seem as big as critics like me would have you believe.

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3 Response to Never knew insider trading was legal in commodity markets

March 6, 2010 at 7:59 AM

很榮幸能到你的BLOG留言o^~^o........................................

outspoken
March 17, 2010 at 9:28 AM

I'm not sure it's possible to insider trade a commodity.  Of course a truly large firm may have some special insight, but there is no commodity where one player dominates the market.  The very definition of commodity is that one firm's product does not differ from another, which is entirely different from a stock where each firm's information on it's own stock will make little difference to another.  It would be like banning "insider trading" on the S&P 500 index.  How does one insider trade an index over which one exercises such limited control?

Sivaram
March 17, 2010 at 5:55 PM

I think you are right. It's hard to influence the market and, furthermore, there are also position limits in the commodity markets (whereas there is no limit in stock or bond markets.)

However, insider information may help you in specific scenarios.  Even if no producer has absolute control over the market, there are some situations where they know material information that can move the market. For instance, if you knew of OPEC decisions ahead of time (some national oil producers may,) one may be able to profit from that. It does appear that the oil markets move based on OPEC decision if the decision turns out to be a surprise, although it's not clear... or problems opening a major copper mine on time (which the company will know ahead of time) may impact copper prices. I don't know. But it's possible.

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