What's Bad About Speculators
July 20th 2008 17:23
Once again "speculators"are being blamed for high oil prices. In fact one blogger recently wrote that the oil price dropped because suddenly oil traders got a conscience and realized their activities were hurting people and sold to take their profits. This blogger even went so far as to say:
To me, the Law on Supply and Demand, only applies when the "buyers" are the "consumers."
Now suppose you need oil to make your product. You want to protect yourself from rising prices so you buy some futures that give you the right to buy oil at today's price for some time into the future. Now you are protected for a time from price increase and you have protected yourself.
Or suppose you are a farmer. Your corn crop is in the field, prices are great right now, but what will they be a harvest? You have a choice, bet that they will be the same or higher when you harvest or sell your crop now in the futures market. If prices go down you have protected yourself.
In the case of oil, you need to find someone who will sell you oil at today's prices and bet they will go lower. In the case of corn you need to find someone who will buy your corn today betting that corn will go higher. Those people offsetting your trade are speculators. How could trades go through without someone making the opposite bet as you?
The same thing happens to you and fire insurance. You want protection from fire. The insurance company speculates that they can sell you protection and nothing will happen.
So let's stop denigrating speculators. We need the speculators and gamblers. If they win big, that's great. We want them to have incentive to stay in the game.
For more on hedging see The Beginners Guide to Hedging
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