What happens to financial markets if beleagured pension funds pull out of sagging commodities futures, or even dump only oil futures?

Pension funds are facing “the perfect storm” of longer lifespans, lower bond yields and investment returns, and new accounting standards.

The British government is already moving to reduce its future pension liabilities.  The government is also warning it may have to cap its contributions if costs rise beyond current projections. New recruits will have to wait until they are 65, and current members will have to pay increased contributions.

In the US, an analysis of government pensions says two Minnesota state pension funds are severely underfunded. The risk-management specialist who conducted the analysis says although the state said the pensions were nearly fully funded in 2003, they had only half the money they needed.

Private pension funds are also concerned about meeting future liabilities.  Mark Duke, principal at Towers Perrin, told Reuters: “Defined contribution rates are worth much less than typical final salary ones; it’s a big chunk of value that will go. The cost of providing pensions has risen greatly — it’s getting more and more expensive and employers are going to start saying: ‘enough is enough’. The tap is going to have to be turned off.”

The pressure on pension funds to move to limit or reduce their projected unfunded liabilities by reducing their exposure to commodity fluctuations by selling off investments in commodities futures is growing.  

Oil prices dropped to their lowest in 18 months on January 9th., copper fell to an eight-month low, and aluminum, lead and tin also declined. Crude oil futures fell to a six-month low as a continuing warm winter cut energy demand.  Lower oil prices will cut oil companies’ profits;  shares in Exxon, the world’s biggest oil producer, slid $1.39 to $72.72, and ConocoPhillips, the third-largest U.S. oil company, retreated $2.12 to $66.07.

Pension fund investors helped drive oil prices up; now they could drive them down by placing their funds elsewhere in the market.  If oil prices fall, oil companies will start selling reserves kept back in anticipation of further price increases which now appear unlikely.  This will mean even lower oil prices, and a further retreat by pension funds from oil futures.

Cheaper oil won’t compensate for non-existent or even reduced pensions.  But trying to salvage whatever pensions there are could mean lower oil prices. 

That gurgling sound could be the markets – and your pension – going down the drain, not gasoline filling your tank.

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