Speculation is not manipulation
By Anil Mishra
Speculation is the practice of entering in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market price of tradable goods such as rubber, rather than attempting to profit from the underlying quality attributes embodied in the rubber.
For them rubber becomes a financial product and they are always focussed on the price trend of rubber. Many speculators pay little attention to the fundamental value of rubber and instead focus purely on price movement. Speculation can in principle involve any tradable good or financial instrument. Speculators are particularly common in the markets, commodity futures, currencies, for stocks and bonds.
Speculators are one of four pillars in commodity markets, along with Hedgers who engage in transactions of rubber to offset pre-existing price risk. Arbitrageurs seek to profit from situations where fungible instruments trade at different prices in different market segments. Investors seek to profit through long-term ownership of rubber’s underlying attributes. The role of speculators is to absorb excess risk that other participants do not want, and to provide liquidity in the marketplace by buying or selling when no participants from the other categories are available. Successful speculation entails collecting an adequate level of monetary compensation in return for providing immediate liquidity and assuming additional risk so that, over time, the inevitable losses are offset by larger profits.
Speculators get a bad rap, especially when rubber prices spike or fall. It happens in other commodities and currencies also and there also speculators are made the scapegoat. This blame is because the media, lawmakers, bureaucrats and public in general often confuse between speculation and manipulation. Manipulation leads to overall economic damage, whereas speculation performs several important functions that keep our economy healthy.
Speculator and middleman
A middleman handles the physical product till it reaches from the producers to the consumers and performs many economic functions like packing, transporting, warehousing, financing etc. In contrast, the speculator makes money through contracts that allow controlling commodities without ever directly handling them. Speculators don’t arrange shipment and storage for the commodities that they control. This hands-off approach has given speculators the erroneous image of aloof financiers jumping into markets they care nothing about in order to make profits from the producers – the salt-of-the-earth types that legislators are always claiming to defend.
The most obvious function that people overlook when criticizing speculators is their ability to ward off shortages. Shortages are dangerous because they lead to price spikes and/or rationing of resources. If a drought kills off half the yield of rubber globally in a given year and even if crop in India was good, it’s natural to expect the price of Rubber to spike in India as well. On wider economies of scale, these shortages are not as easy to spot early. Earlier you spot better you can manage the shortage and profit from it if you are producer or avoid losses if you are consumer. That’s why commodities speculators keep an eye on overall production, recognizing shortages and moving product to places of need (and consequently higher profit) through intermediaries – the middlemen who use futures contracts to control their costs. In this sense, speculators act as financiers to allow the middleman to keep supply flowing around the world.
More than merely financing middlemen, speculators influence prices of commodities and currencies by using futures to encourage stockpiling against shortages. Just because we want cheap rubber it doesn’t mean we should blame speculators when prices rise. More often, other factors, such as drought, torrential rains, tropical hurricanes, OPEC have raised the risk of a more volatile price in the future. Speculators raise prices now to smooth down the potentially larger future price. A higher price dampens current demand, decreasing consumption and encourages producers to invest in increasing production and building inventories. This price smoothing means that, while you might not appreciate paying higher price for rubber now but you will always be able to find rubber and your processing factory would run smoothly.
While people may recognise speculators’ importance in preventing shortages and smoothing prices, very few associate speculation with guarding against manipulation. In markets with healthy speculation, that is many different speculators participating, it is much harder to pull off a large-scale manipulation and much more costly to attempt it (and even costlier upon failing) like “Mr Copper” otherwise known as Yasuo Hamanaka, was a trader controlling 5 per cent of world copper market who lost over $2.5 billion for his employer, Sumitomo Corp. (in Japan) while doing manipulation. Even in silver the attempt to corner the silver market was made by Hunt brothers Nelson and Herbert Hunt. The sharp sell-off occurred on Thursday, March 27, 1980, once they were unable to meet various margin calls that were caused by short-term weakness in the silver price. A group of US banks needed to step in with a $1.1 billion line of credit, which helped bring stability back into the futures markets. Thus speculators help prevent manipulation.
In thinly traded markets, prices are necessarily more volatile, the chances for manipulation are increased because a few speculators can have a much bigger impact. In markets with no speculators, the power to manipulate prices swings yearly between producers and middlemen/buyers, according to the health of the crop or yield of a commodity. These mini-monopolies and monopsonies result in more volatility being passed on to consumers in the form of varying prices.
Even if we leave the commodities and go into one of the largest markets in the world, forex, we can see how speculators are essential for preventing manipulation. Governments are some of the most blatant manipulators. Governments want more money to fund programs while also wanting a robust currency for international trade. These conflicting interests encourage governments to peg their currencies while inflating away true value to pay for domestic spending. Its currency speculators, through shorting and other means, that keep governments honest by speeding up the consequences of inflationary policies.