By Samad Shaikh
MUMBAI (Commodity Online): In the previous dispatch, we have noticed how speculation works. If you have missed it, click the links below. In this issue, we will farther the scope of speculation and its impacts.

Speculation is not a new phenomenon invented by great investing brains of New York, Chicago or Dalal Street. It is as old as the world itself. Those who have read Bible must have read this in Old Testament.

Read previous parts of the series on speculation

Should you trade in commodities or stocks?

Speculators: The demon and the angel within

The first hoarding that took place was on a speculation that the prices of food grains would increase and this was done by an Egyptian King who day dreamed that seven abundant harvests would be followed by seven poor harvests thereby leading to starvation. The king created the first government-aided fund stockpiling grains, which led to large-scale price rise.

Speculation is nothing by hysteria or panic reaction. It is not a real world scenario. At times it is hard to believe how prices of commodities increase despite huge production data. This is what is called destructive speculation, which upsets the demand supply ratio. This is the scenario whereby the governments starts its crack down campaign on hoarders, speculators etc. upon which the common perception towards Futures trading changes.

There are instances where commodities lie unsold with the farmers and the price of same commodity tends to increase. This has happened with Cotton as well as Maize. All of a sudden you realize the prices have crashed. So why in the first place the prices got jacked up? This is speculation and the price rise and fall is the result of a knee jerk panic reaction of the market.

For producers or farmers, these commodities are underlying assets to which they try to get maximum price. For speculators these are abstracts with many of them have never seen or touched the commodities they have traded. So there are two horizons altogether with one partially benefitting from a speculative activity and the latter making a kill out of nothing. So basically speculation is not a bad thing. But when it turns into gambling, huge barriers rise between the hysterical figures and actual beneficiaries, which leads to friction.

The question now is whether the commodity Futures exchanges are casinos? There is no concrete answer to this as interpretations of Futures trading differ from one to the other. But the plain vanilla answer is that they are not Casinos. They are the pillars of price discovery mechanism – but which doesn’t benefit those who should have got benefitted.

Now the very purpose of a Futures exchange is to enable the producers (read farmers) to sell their harvests at a price that benefits them. So irrespective of market dynamics, they get the value for their harvest, which can only go up from the point they have entered the market. The farmers can hedge against various adversities they face in their day-to-day farming cycle. But this doesn’t happen always because the farmers don’t have volume to enter into the Futures market.

Speculators play with volume. They purchase commodities at relatively lower prices with the sole aim of making fast bucks. Sooner they realize this profit, earlier they can exit and get their money. When they play with volumes, the real producers cant help but see the price rising for the same commodity, which they have sold at a cheaper price.

It is only with the help of speculators that the exchanges and traders can buy or sell commodities, which actually doesn’t exist at all. So if you take the entire volume of agri commodities traded in any exchange, it is much higher – as high as 30 or 40 times – than the actual production. When squared off at the end of contract period, either the seller or the buyer benefits depending upon the market situation. In most cases the sellers and the buyers are not from the farming community but mere traders or speculators.

Real delivery of commodities hardly takes place in any global exchanges. When actual delivery is at stake, speculators role in predicting prices or playing hide and seek with prices minimize.

Like barter system, which was a norm in the age-old traditional civilization, speculation also existed centuries ago. But those markets were not regulated by any government agencies. Many kingdoms in Europe and Asian civilization had to pay heavy price because of speculative activities. But the subjects of those kings thought this as a curse from the Almighty and suffered due to the poverty and artificial famine that followed.

Today’s Internet savvy and twitter following population are not the same. Any such move could be disastrous for the government in power. But still no government could control the speculators in the 21st century. So the current rulers follow what their predecessor kings did. Ban the Futures trading. As a poor workman always blames his tools, the government always finds scapegoat in the system itself and instead of improving, eradicates it.

A country falls into depression because of failed speculation. If the market becomes a bubble by itself by the sheer power of unrealistic speculative dynamics, it is bound to explode and then finally collapse. This is the beginning of the end of market theory of demand and supply.

Every economic bubble that has been recorded is attributed to speculation. Whether it is the great depression of the twenties or the recession of today, it is a speculative activity that has gone wrong which led to this collapse. As a human being with an average life of 60 years, you are destined to see at least two bubbles.

Is speculation the cause of economic distress? Write to us at news@commodityonline.com with your views

This is Part – I I of series, Speculators: The demon and the angel within

Series will continue 

EXTRACTED FROM COMMODITY LEARNING SERIES BY www.commodityonline.com

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