Monday, June 30, 2008

Scapegoating Speculators

I know it is the current fashion to blame "speculators" for the skyrocketing oil prices. Bill O'Reilly has made this a particular cause of his. However, there appears to be no clear evidence to support this assertion:

Speculators are often scapegoats, economists say
Once again, it's open season on speculators.

The popular tale holds that with the rise of long-only commodity index funds and increased interest in commodities from pension funds and other players, speculators must be to blame for surging oil prices and have probably been the prime culprit in the steep rice in prices for food and other commodities as well. Politicians are on the war path, promising to bring speculators to heel. There's just one rub: Economists say they have yet to see the commodity markets exhibit the symptoms they would expect to find if speculators were pushing commodity prices above levels dictated by supply-and-demand fundamentals and geopolitical concerns.

You see folks, it's one thing to make a claim, it's another thing to prove it. Destructive speculation leaves tracks in the market, such as more speculators bidding prices up than down, more long positions than short positions, that kind of thing. Unfortunately for the conspiracy theorists, these indicators do not exist in the market right now.
In a recent paper, Irwin -- along with Dwight R. Sanders of Southern Illinois University and Robert Merrin of the University of Maastricht in the Netherlands -- delved into the Commodity Futures Trading Commission's weekly reports on trader commitments and other data. Their task was to gauge whether speculative players in agricultural commodity markets were trading primarily with other speculators or with farmers and commercial interests who use the futures markets to hedge risk.

Speculators are crucial to futures markets. By taking the opposite side of trades with farmers, end-users and other commercial players, they help ensure markets are liquid. Without enough speculators, markets can become illiquid and increasingly volatile.

Speculation can get out of hand, however. If speculators are primarily trading with each other, bubbles can develop, Irwin said.

But the study found that levels of speculation in the agricultural futures pits were well within historical norms, despite a surge in participation by long-only index funds and other speculators in recent years.

In other words, the rise in speculative long positions -- bets that prices will move higher -- was equaled or surpassed by an increase in short positions -- bets prices will fall -- by commercial hedgers.
I repeat, speculative long positions were equaled or surpassed by speculative short positions. So more speculators are betting that prices will drop than go up. So there is no destructive speculation artificially driving prices up. No, the reason that prices have been jumping is no more complicated than supply and demand, and in fact the speculators are figuring that supply will catch up with demand pretty quick. So to the conspiracy theorists out there, especially Bill O'Reilly, who should know better, what say you?

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