June 13, 2008

Speculation, schmeculation

Filed under: Economics — Bottom's Up @ 9:03 pm

The NYT has an article on the role of speculation in the commodity markets. The article goes on to talk about various opinions on the same. It even mentions Mr Masters view that speculation is only on the buy side. However, it does not address the contradiction with the first principle of futures markets – that contracts expire and unlike stock and bond markets , unless you dump your holdings you end up with a barrel of oil or a sack of grain or whatever at the agreed to delivery point. And if speculators are indeed forced to dump their holdings pre-delivery (I assume they do not want to hold on to their sacks of grain), there is only so much and so long that speculation can drive up costs. Now, speculation if existing would result in hoarding of commodities. However, as Ajay Shah points out and as Martin Wolf’s graph below shows, global inventories in food grains went down not up.

That and there is this other problem with the speculation on speculation

Thus, a pension fund that wants to put no more than 2 percent of its assets in commodities will have to sell some of its stake when its value rises above that percentage limit.

So, as in other markets, these investors “are stabilizing forces because when the asset goes up in value, they sell some to put their portfolios back into balance,” he said.

As for Mr Masters assertion, when asked about it he said that hedge funds and such were indeed starting to buy commodities for real (and I guess hoard them). So far, we’ve not seen much evidence of this but if he is indeed correct, then it would be a lot easier a problem to fix than if he is not.


1 Comment »

  1. Nice writing style. Looking forward to reading more from you.

    Chris Moran

    Comment by Chris Moran — June 13, 2008 @ 9:07 pm | Reply

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