In Celebration of the Speculators, Who Bless Society With Significant Benefits
1. "Nothing sparks spasms of poor economic commentary like rising oil prices.
From left to right, pundits and politicians outdo each other at accusing
evildoers of hurting good people. This week, a Democratic congressional
committee held a hearing on the issue of high gas prices and excessive oil
speculation.
Speculators are easy targets. They seem to produce nothing. They merely buy
and sell and hope for prices to move in directions that will bless them with big
profits. In fact, though, speculators also bless the rest of us with significant
benefits -- although too few Americans understand this truth.
Speculators should be celebrated -- not so much for their motives (which are
no better or worse than normal) but for the socially beneficial, if largely
invisible, consequences of their activities. Speculation makes resources more
abundant when there is great scarcity by encouraging people to use those
resources more sparingly when there is relative abundance."
~Don Boudreaux in Newsday
2. "Speculators anticipate shortages and buy up commodities early, thereby removing them from the market. This alerts consumers to the oncoming shortage, fulfilling the important financial market role of providing information and allowing them to reduce consumption as prices rise. Later, the speculator sells, ameliorating the shortage while making a profit.
Speculators anticipate and warn others about shortages—they do not cause shortages. As a result of their trades, price swings are less severe than they otherwise would have been. We do not blame doctors, police, or firemen for profiting from the misfortune of others because it is understood that they help a bad situation. Speculators deserve the same consideration."
Speculators anticipate and warn others about shortages—they do not cause shortages. As a result of their trades, price swings are less severe than they otherwise would have been. We do not blame doctors, police, or firemen for profiting from the misfortune of others because it is understood that they help a bad situation. Speculators deserve the same consideration."
Joetta Forsyth, Learning to Love Financial Market Barbarians
3. "People who argue that speculation is destabilizing seldom realize that this is largely equivalent to saying that speculators lose money, since speculation can be destabilizing in general only if speculators on the average sell when the currency (commodity) is low in price and buy when it is high."
~Milton Friedman, Essays in Positive Economics (p. 175)
~Milton Friedman, Essays in Positive Economics (p. 175)
MP: In other words, speculators who continually lose money by buying high and selling low (which would increase volatility and be destabilizing) will be forced to leave the market eventually, and only rational speculators – those who will actually help to stabilize prices – will survive.
31 Comments:
In general, I agree with these sentiments. However, there are some commodity markets that may not be free markets. but which are characterized by huge institutional imperfections.
The NYMEX oil market, and the role of speculators is interesting. Unlike in equities, speculators are able to cloak their identities, even as they trade in the billions or tens of billions of dollars. The CFTC has found that the majority of trades on some trades are controlled by one or a few entities.
There is the ability to be both a large producer and speculator--Russia for example.
Take Russia and Putin. Putin lives if oil stays high. If oil goes down and stays down, so does Putin. Russia has crap else to sell. Yeah, those fine Russian electronics and cars....
It is in Putin's interest and Russia's interest to game the NYMEX higher. It is patriotic of Putin to game the NYMEX. It would be stupid if him if he did not game the NYMEX. So we can spume that Putin has billions of dollars at his disposal and is gaming the NYMEX, if possible. I think Putin is fairly crafty.
Given that demand for oil is inelastic, gaming prices higher is a win for Putin and Russia.
In the long run---but we are talking 10 years or more--I think we see oil collapse, in part because it is overpriced now.
But in the meantime, hundreds of billions of dollars will be siphoned out of Western economies and into terrorist-backing monkey-thug nations.
Didn't you read the entire post?
"It is in Putin's interest and Russia's interest to game the NYMEX higher. It is patriotic of Putin to game the NYMEX. It would be stupid if him if he did not game the NYMEX. So we can spume that Putin has billions of dollars at his disposal and is gaming the NYMEX, if possible. I think Putin is fairly crafty."
How, exactly, does Putin pull this off? Does he buy oil from himself?
If you bid high enough, you will get what you bid for.
Only someone who can store large quantities of oil could keep it off the market, and Putin could as easily control production if his evil plan is to reduce supply to drive up the price.
"But in the meantime, hundreds of billions of dollars will be siphoned out of Western economies and into terrorist-backing monkey-thug nations."
What nonsense!
Benji,
Explain to me please, in detail, how a mere market participant can manipulate (which is what I assume you mean by "game") the market. Particularly a very liquid market (which means it has lots of participants and lots of volume) such as crude futures.
Since the devil is in the details, you're going to have to be very specific.
While I have no doubt at all that it is to this or that person's or group of people's benefit to be able to control a great many things, the ABILITY to do so is another, usually unattainable matter.
hmmm
‘Enron loophole’ enables oil speculation
"“Oil prices would collapse if regulators increased” the cash requirement for oil futures contracts to 25 percent from the current 7.5 percent, he said. Other analysts suggest raising the cash requirement as high as 50 percent and imposing an overall limit on participation by financial players in oil trading on the New York Mercantile Exchange.
The commodity commission imposes minimal standards on speculators in New York and allows as much as 30 percent of oil trading to escape U.S. regulation altogether by exempting trades routed through overseas electronic exchanges. The commission has given control over those transactions to regulators in London and Dubai who have been granted jurisdiction over the leading U.S. oil contract for West Texas Intermediate crude."
thoughts?
Only someone who can store large quantities of oil could keep it off the market, and Putin could as easily control production if his evil plan is to reduce supply to drive up the price.
True. And to what benefit? Storage is not free. The higher price is a signal to other producers who will produce more oil and drive the price of what you have stored or have yet to produce down. Higher prices are also a signal to more efficiently use the commodity you're producing and to look for substitutes, lowering demand.
By withholding the oil - either by reducing production or buying stock and storing it - in order to keep prices high, you are in effect buying high and increasing your odds of selling low.
It's not very crafty to bid up the price of a commodity you already own and you think is overvalued. If you've bought enough to materially impact the price, when you turn around to sell it, you have enough to materially impact the price in the other direction.
That's not crafty, that's buying high and selling low and that kind of strategy is a very easy way to impoverish yourself.
Uh, Lar, are you aware that those contracts are traded in different parts of the world and the CFTC is a U.S. regulator with zero power in any other country? Apparently not.
Are you also aware that if the U.S. starts imposing stupid rules in the U.S. market all trading will move to foreign markets?
Are you also aware that I can trade on the Singapore exchange (or any other electronic exchange) without so much as scooting my butt over one millimeter? So, the cost of moving your trading to foreign exchanges is extremely low.
Do you also realize that the magical CFTC you are clearly relying on to protect you from some calamity you can't define is the same regulator that was charged with ensuring that MF Global kept its customer's funds segregated and that it didn't violate its haircut so it doesn't blow itself up?
No. Of course not. Awareness is not your strength.
As long as you want to cut leverage, we should go ahead and eliminate credit entirely. Imagine how much cheaper cars and houses would be if you couldn't buy them on credit. And stock prices would also tank. Dude. Let's go for it.
The govenment castigating oil companies or speculators is particularly ironic/hypocritical as roughly 1/3 of the price of gas is state and local taxes. The margins for oil companes are razon thin as are the margins for speculators, most of whom lose money as studies have shown. Speculators serve a valuable function. If speculators drive up prices corectly say for corn, farmers plant more for the next harvest and the shortage ends. If the speculators and wrong and create a bubble, then they lose severely when the bubble ends.
Methinks,
"If you've bought enough to materially impact the price, when you turn around to sell it, you have enough to materially impact the price in the other direction.
That's not crafty, that's buying high and selling low and that kind of strategy is a very easy way to impoverish yourself."
And so by extension, if you are successful enough to control price-changing quantities, you probably aren't that stupid.
Exactly, Ron H. And even if government does what it does best - redistribute resources from those who can put them to a higher use to those who can't, I can't imagine that what you say would not be true. In the hands of a fool, assets are less productive and lose value. And that must be true even of a commodity such as oil. If an oil field is poorly managed, the amount lifted is lower and the value of the oilfield declines. Thus, in the hands of the inept Soviets, Russian oilfields were much less valuable.
My "favourite" response to Don Boudreaux's op-ed was the one that obnoxiously complemented on a "nice try" while saying that a speculator could buy large quantities of wheat and limit distribution, keeping prices high.
Because storage is free, there are no borrowing costs, no more wheat will ever be planted and producers don't respond to incentives.
Jeeenyussss!
"“Oil prices would collapse if regulators increased” the cash requirement for oil futures contracts to 25 percent from the current 7.5 percent, he said. Other analysts suggest raising the cash requirement as high as 50 percent and imposing an overall limit on participation by financial players in oil trading on the New York Mercantile Exchange.
There are two bets on any transaction in the futures market. One side is betting that the price will go higher and the other that it will go lower. Both would be effected by a margin requirement change.
Of course, if the US regulators tried to play games and manipulate the paper markets they would find that many of the players would go abroad and will have to deal with defaults on the physical side.
The commodity commission imposes minimal standards on speculators in New York and allows as much as 30 percent of oil trading to escape U.S. regulation altogether by exempting trades routed through overseas electronic exchanges. The commission has given control over those transactions to regulators in London and Dubai who have been granted jurisdiction over the leading U.S. oil contract for West Texas Intermediate crude."
thoughts?
If you want to see the problem with the arguments that speculation only causes prices to go up take a look at the silver market. In that market a handful of big players are short more than half of the world's annual production of silver at a time when there is very high demand on the industrial side. Most of the margin changes were conveniently implemented to drive prices lower but the short positions never went down in a material way. Eventually the physical market will be all there is because there will be no way for the shorts to cover their bets.
"My "favourite" response to Don Boudreaux's op-ed was the one that obnoxiously complemented on a "nice try" while saying that a speculator could buy large quantities of wheat and limit distribution, keeping prices high."
Oh yes! I saw that one. I wanted to respond, but didn't want to take the time to register, and as the exasperation drained out of me, I realized nothing I could say would make any difference. If Don B. hadn't penetrated that thick skull, I sure couldn't.
And then there was "I don't care what you say, those people are evil!!"
If Don reads those comments, he must wonder "why do I bother to write these things?"
The vast majority of contracts expire worthless. No commodities trade hands.
Speculators dominate the NYMEX, and only a minority of trades are by earnest hedging (airlines etc).
Tell me, how did the Hunts, with far less money and sophistication, corner the US silver market, if it is so impossible?
Any system can be gamed. Bid prices up at end of day---lose money on the NYMEX and make huge amount on your actual physical stock of oil (Russia).
Here, maybe this will work for you: Imagine evil environmentalists and Al Gore and George Soros and Warren Buffet want people to use less oil and suffer so they are rigging the price of oil higher. on the NYMEX.
How would they do it?
And then there was "I don't care what you say, those people are evil!!"
Yeah. I think just came back from straight a Wal-Mart protest. He resents them Chi-comms touching his stuff before Wal-Mart forced him to buy it. Like Benji, he's pretty sure speculators somehow siphoned tons of money out of hard-working Americans' pockets. Yessireee.
Just can't figure out how them wily rascals done it. They just know they done it and they're 100% sure they can stop them wily rascals even though they have no clue how they're doing it.
Vange,
Technically, an exchange can hike up the margin on longs and not on shorts. Note that in 1981 the CRIMEX....sorry, old habits...the COMEX got the okay from the CFTC to manipulate silver prices downward (conveniently, the members of the exchange were short silver contracts) by jacking up margin requirements (putting all longs into call) and refusing to accept any new buy orders unless they were buy to cover.
The unequal margin treatment of longs and shorts is the norm. The risk of a long position is much lower - you can only lose the difference between the purchase price and zero. The risk of a short position is literally infinity because there is no upper limit on prices. Brokerage houses deal with that by imposing larger margin requirements on short positions. In general, the probability of an upward jump is lower than the probability of a downward jump, so the margin requirements aren't hugely different, but they are different.
I agree 100% that in the long run, prices are not determined by leverage (even though in the short run, cuts in leverage will result in downward pressure on prices). An increase in margin requirements will, as you say, drive trading to other exchanges or result in thinner, choppier, more volatile markets.
And where was the magic of leverage and speculation when oil price dipped below $10/bbl in the late 1990's and oil companies were struggling for years? Where is this magic now in the natural gas market where prices are at historic lows? Surely there were lots of people in the late 1990's who were very interested in higher oil prices then and surely today's natural gas producers would prefer higher prices.
The vast majority of contracts expire worthless. No commodities trade hands.
Say what now? You've never heard of "cash settle"?
Go look it up so you can misunderstand it better.
Benji,
As usual, you present us with an impressive tsunami of total bullshit.
I'll explain the Hunt Brothers story to you tomorrow when I have more energy.
You still haven't provided a detailed explanation of how manipulation by a market participant - be it Soros or Putin - would work.
Don't try to throw the ball in my court hoping I'll draw you a picture, honey. I didn't make the stupid claim. You did.
So, if you're so sure it can be easily done and any market can be gamed by anyone other than government, surely it's virtually no effort for you to provide us dummies with a step-by-step guide for how such a market gaming would work.
Here's your chance to impress. Don't miss it.
Bid prices up at end of day---lose money on the NYMEX and make huge amount on your actual physical stock of oil (Russia).
This is profoundly stupid. It's difficult for me to even dream up a more idiotic scenario.
To drive up the price, you'd have to buy so many futures contracts that to (assuming it's possible - and it's not) turn around and immediately sell a compensating amount of physical commodity would mean dumping such an enormous amount of oil on the spot market that you'll immediately drive the price right back down. You won't make it up in the physical commodity and you'll immediately lose an enormous amount of money on your contracts.
This is a fantastic way to lose money. If you don't believe me, Benji, I urge you to try it. And get all your friends to do it too. Just please wait until I start trading crude futures. Every time you and your genius buddies come around looking to overpay, I'll be delighted to sell you as many contracts as you want.
if you are the supplier of the oil... tell me why it causes you harm to reduce production and keep the oil in the ground waiting for higher prices to pump it?
Isn't that what Enron was doing with electricity?
Tell me, how did the Hunts, with far less money and sophistication, corner the US silver market, if it is so impossible?
On what planet do you live? The Hunts could not corner the silver market because there was far too much physical metal in storage and because the rules were changed to favour the big players who were short. The Hunts wound up in bankruptcy and the established players survived to rob ordinary speculators for decades to come.
Vange,
Technically, an exchange can hike up the margin on longs and not on shorts. Note that in 1981 the CRIMEX....sorry, old habits...the COMEX got the okay from the CFTC to manipulate silver prices downward (conveniently, the members of the exchange were short silver contracts) by jacking up margin requirements (putting all longs into call) and refusing to accept any new buy orders unless they were buy to cover.
I agree that could happen but that was not the suggestion being made. The way I read it the idea was to hike all margins in order to reduce volatility.
The irony is that the law of unintended consequences would come in and volatility would increase as the typical glut/shortage cycles would appear whenever there are no price signals to dampen the effects.
And where was the magic of leverage and speculation when oil price dipped below $10/bbl in the late 1990's and oil companies were struggling for years? Where is this magic now in the natural gas market where prices are at historic lows? Surely there were lots of people in the late 1990's who were very interested in higher oil prices then and surely today's natural gas producers would prefer higher prices.
A very good point. We both know that the ignorant commentators who mindlessly and opportunistically attack the futures markets have no logic on their side and are just pandering to sentiment. They somehow forget about the issues when prices collapse. Do you see them preach against the evil speculators who have driven the shale gas producers into bankruptcy? I don't.
Before I end this let me point out that I have a problem with the futures market but not because speculating on price movements is somehow wrong. My problem is with the manipulation that goes on in the exchanges as insiders are allowed to change the rules to bail themselves out every time the price trend goes against them.
Oh yes, Larry. Enron. The most valuable and successful company in the world...oh no, wait. That's Apple - a company that doesn't withhold its most valuable products from the market. Enron spectacularly collapsed. So, it seems yours is a winning strategy for losers.
I addressed your first question already.
Explain how withholding desired commodities could be a successful strategy in a market that was not regulated the way the California electricity market was regulated.
if you are the supplier of the oil... tell me why it causes you harm to reduce production and keep the oil in the ground waiting for higher prices to pump it?
If the reserves are privately held or belong to a nationalized company, prices for oil are rising, the revenues are not needed, and there isn't a lot of spare capacity around there is nothing wrong with the strategy. In fact, I expect that the strategy will be very important to producers once it is evident that we are in a post peak environment.
Isn't that what Enron was doing with electricity?
Enron took advantage of California's regulatory environment, which made it possible for it to manipulate a tight market by getting utilities to take production facilities off line to perform scheduled maintenance rather than postpone the maintenance until quieter periods. The tight supply was created by the regulators and could easily have been taken care of by allowing actual market competition among the utilities.
You could easily see a very similar situation once supply capacity falls a bit further. As supply falls towards demand any disruptions could create massive price fluctuations that could turn out to be very profitable for the producers. Of course, once you get the windfall profit tax legislation I would expect even more supply to be taken off line so that the price increases can pay for the added taxes.
Vange, you and I have the same problem with the futures market and with financial markets in general.
You're absolutely right that a thinner market (which is what these "analysts" are advocating) would result in more volatility. A large buyer or seller (a large producer or refiner) could move the price around quite a lot in a thin market just because of liquidity imbalances.
As for the Hunts.....
First of all, the silver market is small and was even smaller in the 1970's when the Hunt brothers became alarmed by inflation and attempted to hedge their large oil fortune by purchasing silver.
I don't know what "corner the silver market" means - except that it's another idiotic attempt to claim that not monetizing something valuable that you own a lot of somehow makes you rich. The moment you begin to monetize it, the market understands that you're dumping your position and the price goes down even if you're dumping slowly.
At first, the Hunts bought only the physical. Later, they bought futures contracts as well - but they always took delivery. They bought silver instead of gold because in 1973, when they started, it was still illegal for American citizens to own gold and they thought the gold market was too easily manipulated by government. So, silver it was.
As inflation climbed during the 1970's so did silver AND gold prices (gold ownership by U.S. citizens was decriminalized in 1974).
By 1980, the Hunts owned a lot of silver. I forget what percentage of total world silver they owned, but it was a lot for a single entity. Makes sense - they had a very large fortune to hedge. Also, by the late 1970's, they were buying a lot of contracts - and always taking delivery of the physical. They didn't settle the contracts for cash because currency is exactly what they understood to be devaluing quickly.
The sellers of the contracts were huge cronies and these cronies convinced Volker at the Fed to bully the banks to cut off credit to speculators. At the same time, they convinced the CFTC to allow them to change the rules to manipulate price in their favour. When cronies lose, the rules change.
The the two biggest exchanges for these contracts, the CBOT followed by the COMEX hiked margin requirements, refused to take any new buy orders (you could only buy to cover a short position) and longs were suddenly limited to holding contracts on no more than 3 million ounces of silver. In other words, it was a forced liquidation for everyone long silver. Not only did longs wake up to find themselves in call, but even if they weren't in call, they would have to sell any amount above 3 million ounces.
The price plummeted - to the advantage of the relieved cronies. Interestingly, although the same drama was not playing out in the gold market, gold tumbled as well. The gold price saw an almost identical run-up and for likely the same reasons. When the gold market saw the manipulation in the silver market, gold sold off. The market's expectations changed.
And that, my friends, is how market manipulation is done reliably. You change the rules in the middle of the game with the blessing and backing of the monopoly on violent force - the U.S. government.
The short cronies literally robbed the longs.
Taking giant risks to bid up contracts and other stupid shenanigans will only put you in the poor house. Unless you're a crony.
Really, speculators with cloaked identities control 81 percent of NYMEx trading, but you are cool with that? And when OPEC and Russia badly want higher oil prices?
A Few Speculators Dominate Vast Market for Oil Trading
By David Cho
Washington Post Staff Writer
Thursday, August 21, 2008; Page A01
Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.
But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel. Even more surprising to the commodities markets was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.
The discovery revealed how an individual financial player had gained enormous sway over the oil market without the knowledge of regulators. Other CFTC data showed that a significant amount of trading activity was concentrated in the hands of just a few speculators.
The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders
Read more: http://www.city-data.com/forum/business-finance-investing/412016-news-speculators-hold-81-oil-contracts.html#ixzz1rOrITnRu
What's the matter, Benji? Is your genius failing you? Can't come up with a plan to rip everyone off? But, I thought it was so easy and obvious that even you see through it.
Cloaked identities? LOL!!!!
Now, I've heard everything.
Listen, Benji, when you give your order your Chuck Schwab or whoever your broker is, your identity is not revealed. Your order goes to the exchange under your broker's MPID. I'm just shaking in my booties because I don't know it's you on the other side of my trade.
I'm not concerned about the number of speculators and who they are because I don't like to concentrate on irrelevant crap (I get the irony as I keep answering you). If a few players want to take big risks or if they happen to be so good that they can arb the contracts successfully, then bully for them. I applaud it.
If you think there isn't enough competition, please....get some backers and start trading crude futures. After all, the implication is that these guys are making excessive profits, right? So, get in there, Benji. Take advantage of it.
I'll be waiting for you.
OPEC wants higher oil prices?
Not according the the Saudi oil minister.
http://www.moneynews.com/Economy/Saudi-Lower-Oil-Prices/2012/03/29/id/434260
OPEC wants higher oil prices?
Not according the the Saudi oil minister.
I think that it is more complicated than what the Saudi minister says. First, he has been talking up the ability to produce 12.5 mbpd for years now but has failed miserably to increase production materially, even after investing very heavily. Second, SA wants the US to attack Iran. To do that its ministers have to try to convince the US that the kingdom is willing and able to replace lost Iranian production. Third, if the opposition groups believe that SA is in a post-peak environment they may rise up against the ruling elite as they see weakness and an inability to keep bribing the bulk of the populace into obedience.
This comment has been removed by the author.
Vange,
The Saudis learned their lesson about what high oil prices can do to demand in the 1970's. You're focusing on their ability to effect price.
The ability and desire to do something are vastly different things. In the late 1990's, SA would have loved to cut production enough to elevate the oil price, but wasn't able to do so.
Our friend, Benji, is rabbiting on about how much OPEC would like to see the price rise. Clearly, that's not true.
And that sort of busts up the whole theory that it's always in the producers' interest for price to increase. Historically (when I covered the petroleum industry almost two decades ago), the Saudis preferred a price of around $22/bbl. That was high enough to meet their annual budgets and low enough to discourage substitution and conservation. Certainly, a very high price was as uncomfortable for them as a very low one. Perhaps they're not able to manage production to decrease the oil price anymore, but that's a different topic from the one Larry and Benji keep harping about.
'The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders'...
Yeah just what I thought, excessive government over reach and pure BS politics in action...
"Didn't you read the entire post?"...
You know ron h I don't think it would've mattered one little bit if someone had taken the time and energy to read the entire post and explain it word by word what it all meant to the pseudo benny, we could still be assured that these 'untethered to reality' comments would spew forth...
The ability and desire to do something are vastly different things. In the late 1990's, SA would have loved to cut production enough to elevate the oil price, but wasn't able to do so.
If SA stopped producing the cost of oil would have shot up again. It wasn't because it needed to fund the security apparatus and social welfare programs. But keep in mind that in the late 1990s spare capacity stood at more than 6 mbpd while demand was 74 mbpd. Today we have much lower spare capacity even though demand is 10 mbpd higher. This allows any disruptions to have a much greater effect over a longer period of time. And let us not forget that the Saudis are somewhat concerned that most of their reserves are in USTs and USDs at a time when the Fed is trying to print as much as possible and is purchasing more than half of all US government paper. A rise of oil prices in USDs has to take place over the longer terms no matter what the Saudis want. This does not mean that real prices will be much higher.
Our friend, Benji, is rabbiting on about how much OPEC would like to see the price rise. Clearly, that's not true.
Our friend Benji is not very smart but I agree with him that OPEC would rather have higher prices as long as the price levels can be sustained. I do not believe that OPEC would be happy with flat nominal prices as the currencies lose purchasing power because that would mean the end of most of the regimes.
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