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Deutsche Bank closing exchange traded note

Sam Fletcher
OGJ Senior Writer

Citing new limitations on the New York Mercantile Exchange, Deutsche Bank AG said in early September it would close and redeem its popular $425 million PowerShares DB Crude Oil Double Long Exchange Traded Note (DXO)—one of the largest leveraged commodity products in the US.

“We expect the Commodity Futures Trading Commission and US commodity exchanges are on the brink of imposing a more stringent interpretation of accountability levels and position limits,” explained Michael Lewis, head of commodities research at Deutsche Bank in London. On Sept. 2, there was the first joint meeting ever of the CFTC and of the Securities and Exchange Commission to discuss how best to “harmonize” financial regulations to protect the American public.

DXO “is likely only the first head to roll; we'll have to wait and see what other funds are affected by the new CFTC limits,” said analysts in the Houston office of Raymond James & Associates Inc. The process of Deutsche Bank unwinding its long oil positions “could put some serious short-term downward pressure on oil prices,” they said. Deutsche Bank will continue to roll out commodity-linked products within the new guidelines.

Lewis said, “Although we do not believe this will have an impact on other exchange traded funds or exchange traded notes in the marketplace, we believe it has sent a minor shock wave through commodity markets.” The bank—Germany’s largest—quit issuing new shares on DXO in mid-August.

Redeeming the fund could have implications for commodity prices, forward curves, and volatility. “For example, assets under management of the DXO fund stand at roughly $400 million as of Sept. 2. Since the ETN has a two-for-one exposure in the oil market, it has approximately $800 million invested in the West Texas Intermediate July 2010 futures contract,” Lewis said, adding, "Assuming an oil price of $68/bbl, this is equivalent to 11,750 futures contracts and consequently exceeds the position accountability levels governing the WTI sweet crude oil futures contract listed on NYMEX.”

Government control
Governments have a history of trying to control energy and agricultural prices. “Not only do these commodities constitute a large share of consumer spending baskets, particularly in the developing world, but swings in gasoline and food prices can have a significant effect on headline inflation and consequently aggravate monetary policy objectives of the central bank,” Lewis acknowledged.

So he’s not surprised the administration of President Barack Obama is focusing on weeding speculators from the agricultural and energy markets. “In contrast, the precious metals and industrial metals markets have so far not been a priority for regulators and, in our view, may be offering a place of refuge for investors in the current environment,” he said.

In the wheat market, already regulated by the CFTC, there has been a growing dislocation between cash and futures prices. US authorities blame much of this distortion on an increase in futures trading via indices as a result of hedging exemptions.

In recent months, Deutsche Bank has been close to the center of the CFTC’s push to curb speculation in commodity markets. In August, CFTC revoked exemptions that allowed the bank to exceed federal speculative limits on agricultural futures contracts. It gave the bank until the end of October to reduce its corn and wheat holdings to within federal limits.

Until now comparable data on index trading in nonagricultural markets such as oil and natural gas have not been reported by the CFTC, but that is likely to change with improved data collection. However, Lewis said, “An examination of the basis in other commodity markets suggests the experience of the wheat market is unique. Indeed, one could argue that a much larger increase in crude oil futures trading has occurred over the past few years, yet the basis in this market has not moved to the same degree as that for wheat.”

Still, he said, “We doubt the absence of a dislocation between cash and futures prices in energy markets will deter regulators from exploring steps to curb what they believe is an excessive increase in investment activity in these markets.”

Lewis noted, “If this tightening in regulation occurs, we expect the appeal of investing in physical commodity exposure will be enhanced, particularly for commodities that are cheap and easy to store such as gold. Ironically we believe the CFTC’s steps may therefore increase the appeal for investors to take delivery of commodities. As a result, what has tended to be a financial exposure to commodities becomes more physical with, in our view, a more direct impact on commodity prices.”

(Online Sept. 7, 2009; author’s e-mail: samf@ogjonline.com)


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