Theories about Market Manipulation

AN INTERESTING DEBATE has been developing in various places as to whether or not some sort of market manipulation is taking place that has been supporting the stock market while causing gasoline prices to sink. These accusations have increased lately because falling gasoline prices, as well as rising stock market prices, are both viewed as favorable toward President Bush, and more specifically toward helping Republicans hold the House and Senate in the upcoming midterm elections.

This discussion is a new variation of a long-standing debate about the active (or inactive) roles of the Plunge Protection Team (PPT) and the Gold Anti-Trust Action Committee (GATA), the former acting at critical times to prop up the market, and the latter when it comes to ideas centering on central bank suppression of the price of gold. I will leave a discussion of the PPT and GATA for a later time, but will add my 2 cents to the question of stock market manipulation via Treasury actions and gasoline manipulation by Goldman.


Let’s analyze both sides of this debate, starting with a recent article from The New York Times called, “Change in Goldman Index Played Role in Gasoline Price Drop”:

“Goldman Sachs, which runs the largest commodity index, the GSCI, said in early August that it was reducing the index’s weighting in gasoline futures significantly. The announcement did not make big headlines, but it has reverberated through the markets in the weeks since and some other investors who had been betting that gasoline would rise followed suit on their weightings.

“‘They started unwinding their positions, and those other longs also rushed to the door at the same time,’ said Lawrence J. Goldstein, president of the Petroleum Industry Research Foundation…

“Unleaded gasoline made up 8.72% of Goldman’s commodity index as of June 30, but it is just 2.3% now, representing a sell-off of more than $6 billion in futures contract weighting.

“Like many market indexes, trading in the Goldman Sachs Commodity Index is publicly available, allowing individual investors and third-party asset managers to participate in that market. The $100 billion invested comes from brokers, fund managers, and individuals, probably including some of the same people who were hurt by high gasoline prices earlier in the year…

“The week started with ‘everyone talking about $4 gasoline and ended with the market down sharply,’ said Phil Verleger, an independent economist in Aspen, Colo.

“In following weeks, ‘traders all tried to push themselves through that door,’ Mr. Goldstein added.

“‘We saw gasoline fall 82 cents in the wholesale market over a four-week period, which is unprecedented,’ he said. Mr. Goldstein said that the decline in gasoline prices helped send prices of the whole group of energy-related products down.”

On the blog The Mess That Greenspan Made, Tim Iacono (speaking about gasoline prices and the above Times article) writes about “Friends in High Places?”:

“So as far as conspiracy theories go, this is quite a good one. The motivation for the commodity index change and the impact on other energy prices will likely never be confirmed or corroborated, but it makes for an interesting story.

“Make a little change that causes $6 billion in unleaded gasoline futures to be dumped onto the Nymex, then watch prices tumble. Stand clear, watching for traders like Amaranth to implode, and get ready to mop up any other messes that arise during the process — all to relieve a little pain at the pump, prior to the polls opening.

“Some at the White House may be patting themselves on the back figuring that the best thing they’ve done in years was to get Hank Paulson to take the job at Treasury.

“It’s good to have friends in high places.”

Wait a second, says Greg Roberts on Minyanville in a well-written rebuttal entitled, “Gasoline Prices: Conspiracy Theory Running on Empty”:

“Goldman officially announced its reconstitution for the Goldman Sachs Commodity Index (GSCI) back in June for the rolling off its unleaded gas contract. As part of that press release, the GSCI said it was acting in response to the transition on Nymex from the New York Harbor unleaded gasoline (‘HU’) futures contract to the reformulated gasoline blendstock for oxygen blending (‘RBOB’) futures contract. While the contracts affected began with the August roll period, the futures contract rallied more than 10% post the press release. I’m guessing there might have been several other factors involved with the August decline.

“RBOB conforms to newer industry standards for reformulated regular gasoline blendstock for blending with 10% denatured fuel ethanol, whereas the old unleaded contract did not and consequently is getting phased out. The committee decided to amend the GSCI by rolling one-third of the overall weighting in each of the last three months leading into October/November transition. The unleaded contract weighting will ultimately fall from roughly 7% to 2.3% on a dollar-weighted basis with the remaining percent, nearly 5%, split up between crude and heating oil. Why just one-third of its previous size? This is mostly because of the illiquidity surrounding this new contract, according to the operating committee at the GSCI, and not a covert effort by the government to drive gasoline prices down. Currently, the total open interest is nearly 40% greater in the RBOB than the unleaded contract, and in light of the portion rolling over, confirming the roll is near complete.

“I believe these reasons, more than the conspiracy theories of government manipulation, [are] more to blame here than some politicians trying to win their seats back.”

Occam’s Razor

When confronted with issues like these, Occam’s razor states that the explanation of any phenomenon should make as few assumptions as possible, eliminating, or “shaving off,” those that make no difference in the observable predictions of the explanatory hypothesis or theory. In short, when given two equally valid explanations for a phenomenon, one should embrace the less complicated formulation.

In this case, the simple explanation was that pure market forces were in play. The question everyone has to answer is whether or not to believe that, and to what degree. Before weighing in on the matter, let’s turn to the second issue at hand: Whether or not the Fed, the Treasury, or some other influence such as foreign central banks has been acting to purposely prop up the U.S. stock market.

Strange World

John Succo, one of my favorite Minyanville professors, wrote an interesting article on Oct. 4 entitled, “Strange World.” This is what professor Succo has to say:

“In 25 years of trading, I haven’t seen stock prices act this way. On any disappointing number (ISM, for example, this morning), stocks react vehemently positively.

“And it’s not stock by stock, brick by brick, which is how a stable bull market is built. It is all index led. Tick data today is just another example. They hit +1,000 probably 20 times today and +1,500 twice. Surreal.

“I trade stocks and watch them heavy, only to be ripped up as futures are relentlessly bought.

“I have my own theories. In a world where geopolitical events are broiling, we have political structures desperate to remain in power. It is possible to believe that in such a world desperate measures like buying stocks by governments (we know Japan did this for quite a while) is certainly plausible. Given the action, I say it is probable.

“The last few years [are] all about liquidity. Who is responsible for that?

“And just in time for the elections.

“I made the big leap yesterday saying governments (no price sensitivity) were buying index futures in the U.S. This is the only answer I see for the odd behavior. Stocks not in an index are severely lagging.

“I am not necessarily saying the Federal Reserve of the U.S. is buying stocks. More likely, it is the central banks of other countries recycling dollars from trade ‘throwing’ them into U.S. stock indexes.

“It seems not to bother those invested in risky assets that central banks are printing money and buying things like stocks. In fact they welcome it as nominally at least they are making money as stock prices rise.

“But I warn everyone that this has vast implications that do not bode well for the future, perhaps the near future.

“What does it say when central banks become the elephant in the room and own risky assets? First, it interrupts the normal market mechanism of pricing risk. Investors are not putting their hard-earned money in the right places by discerning proper investments; governments are making credit easy for even the worst companies. Productivity will fall over time. Debt will continue to rise from this easy credit and will eventually crowd the economy out. We are already starting to see this, and a new development has passed most by: The net interest component of the trade deficit is now turning negative for the U.S. We are paying out more income than we are receiving on our investments. In addition, net disposable income, crankily not rising as we export that income to production overseas, is at an alarming level to debt service.

“Central banks continue to force credit down the throats of an already indebted system as a solution to continued economic expansion. The cumulative effects continue to get worse. Central banks are now delving into buying everything from mortgages to stocks. Can they own everything? I think not. There is a limit, despite what bureaucrats believe.”

When professor Succo suggests something strange is happening, I am not going to argue. I will take it as fact that something strange is indeed happening. For those not familiar with “tick counts,” it is a measure of stocks sold on upticks versus downticks. Here is my number interpretation (and it could easily differ from Succo’s): In a normal market, +1,000 is a very strong tick count that one might equate to near-panic buying, and tick counts greater than +1,200 would represent panic buying. -1,000 tick counts would constitute strong fear and -1,200 tick counts panic selling. Multiple tick counts of +1,500 used to be more or less unheard of, but they have now been occurring regularly. No doubt about it, either: +1,500 is not near-panic buying, but sheer panic buying. Most interesting is the fact that many of these +1,500s have been occurring in the face of what would normally be considered bad news. Like unheard-of plunging gasoline prices, these enormous positive tick counts are indeed strange.

Treasury Operations

A discussion about Treasury and Fed operations has been going on for several weeks now on Silicon Investor. Bart at has been wondering if Treasury and Fed monetary injections have been used to prop up the stock market. He has been posting his charts on Silicon Investor, as well as his own Web site. I asked him on Thursday evening if he would update his charts to make them current. Here is one of them:


The above chart shows the S&P (in green right scale) versus short-term repurchase agreements (repos) and term investment options (TIOs). Repos are short-term injections of cash to banks by the Fed. TIOs are U.S. Treasury operations. TIOs occur much less frequently than the almost-daily repos. Terms typically last from 1-19 days, but may last up to 90 days. Rates have been about 20 basis points below the fed funds rate.

The chart shows a distinct tendency for the market to rally when these cash injections are offered and a tendency to decline when drained. The correlation is not perfect, however, as evidenced by the action since the beginning of the month. Past charts also show some correlation, but not as strong as above.

The Fed and the Market

I asked Lee Adler at The Wall Street Examiner about the relationship between Fed actions and the stock market. He was kind enough to send me a copy of his latest liquidity report. Lee writes:

“While maintaining a growth rate of slightly over 5% in its asset base for nearly three years, since mid-year, the Fed has hewed toward the low end of the band that defined that growth rate. This acted to restrain liquidity growth. Suddenly, the Fed began pumping aggressively at the end of September, just when it appeared that they were breaking the 5% growth channel.

“The level and direction of stock prices has correlated closely with the level of the Fed’s system open market account. The market sometimes gets ahead of the Fed, or it can lag behind from time to time, based on investors’ liquidity preferences, but it tends to move in the direction of the SOMA, with varying lead or lag times. The market follows the Fed not in terms of rate targets, but in terms of the amount of liquidity the Fed pumps into the financial markets through its daily open market operations. Over the last two years, the Fed has kept the SOMA growing at an annual rate of around 5.35%, with only seasonal exceptions for year-end pumping parties. Stock prices have risen at a similar rate. Since the 2004 high on Jan. 26, 2004, the stock market’s total percentage gain has been virtually the same as the percentage gain in the SOMA.

“Coincidence? I’ll let you look at the chart below and decide for yourself:”


The relationship is clear to see, but correlation is not the same as causation. Furthermore, there is nothing to suggest anything out of the ordinary was recently done in support of the idea that intervention is happening to support Republicans in midterm elections.

On the other hand, lack of proof does not mean that it is not happening. Clearly, we have seen some rather “strange things,” to put it mildly. Some of those strange things seem to have plausible explanations, and others do not.

Inquiring minds may now be asking, “OK, Mish, who is right? Was there a ‘conspiracy’ to manipulate gasoline prices lower and/or the stock market higher?”

Before attempting to answer that question, let’s address another question first: “Is it conceivable that this administration, or someone acting on behalf of this administration, might consider manipulating stock market prices higher and/or energy prices lower?”

The answer is certainly. I have no doubt that Wall Street wants Republicans in control, simply because they want less regulation and less people snooping around where Wall Street does not want snoops peeking. I also have no doubts that if this administration thought that a higher stock market would help his cause, that it might be tempted to “help things along.”

On the other hand, wanting something and doing something about it are two different things. Judging by the number of players loaded up in commodities after a five-year run, some speculators just might have been begging for a little “tough love.” The economy is also slowing. Industrial commodities in general were due for a sell-off.

Finally, place me in the camp that says that a primary trend cannot be changed by manipulation. Trends will run their course. Does anyone remember Japan attempting to stop the rise in the yen by selling yen on the open market and buying dollars? Did it work? Ironically, the yen did not collapse until AFTER Japan stopped its currency manipulation.

Add that all up and perhaps the simple explanation is that the market just came along and punished speculators for being greedy. That is what Occam’s razor suggests.

Besides, would a firm like Goldman go way out of its way just to help Bush out? That might be stretching it. Was a “conspiracy” involved? That might be stretching it even more. But what if the opportunity came along in which Goldman needed or wanted to change gasoline futures in its index? Might not that be timed at a point to cause maximum effect for a certain someone? How about two someones? Why not put the maximum amount of bucks in your own pocket, while giving a nice friendly push to your buddy in the White House?

One thought keeps nagging me. Lowering gasoline from 8.72% to 2.3% seems more than a bit extreme. Yes, I have seen the explanation, but I do not buy it. What I do buy is the idea that gasoline prices and commodities in general were due for a tumble, were likely ready to fall on their own accord, but were given an extra push in the right direction at a time of maximum speculation, and, thus, maximum effect. This is not exactly a conspiracy theory, but not exactly Occam’s razor, either.

As for the Treasury actions, I am struggling to see much of anything going on that is far different from what has been going on for quite some time. We do see a more positive correlation since April, but is that manipulation? If it is manipulation, was it cleverly timed just to help the Republicans? It does not look like it to me. And how does one explain panic buying since Oct. 1, when the TIOs and repos are down?

What we do know is that the action is very strange, but hard to pin down. I do not dismiss the election theory — I just cannot find a lot of hard evidence that TIOs and repos are driving it. While we cannot out and out dismiss the idea that our government is purposely manipulating the stock market on a day-to-day basis, the most likely explanation at this point in time is either panic by hedge funds chasing every uptick (perhaps purposely trying to force up the prices of what they already own) and/or indiscriminate buying by foreign central banks, as Succo suggests. Whatever it is, try not to get steamrolled by it, or caught up in the euphoria of it, either.

Mike Shedlock ~ “Mish”
October 6, 2006