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Gambling with the futures (primer on futures)
Petrino DiLeo, Socialist Worker
… speculators are driving up the prices of all commodities, including wheat, corn, soy, etc., because of intense trading on what are known as futures markets.
Such markets were originally designed to help producers and users of commodities manage the risk of price fluctuations. But another aspect of futures trading has taken on greater prominence in recent years. Futures are also traded by individual investors and financial institutions, based on a gamble as to whether the price of the goods will rise or fall.
Today, traders of exchange-traded funds, hedge funds and other speculators far outstrip the actual buyers and sellers of commodities. As a result, these speculators have generated a big demand for futures contracts, therefore helping send the prices of underlying commodities upward.
Furthermore, futures markets, once heavily monitored by governments, have been–like most of the rest of the financial markets–systematically deregulated to the point that trading is going virtually unchecked.
How do we understand what’s going on with the futures market today? Here are some answers to questions about how futures function–specifically, futures in basic commodities–and what role they are playing in the current food crisis.
(May 2008)
Very clear descritpion of futures. Mostly politically neutral, though it comes from a leftist analysis (Marxist-Leninist-Trotskyist).
Contributor Wag the Dog writes:
Lacking in this never ending debate over what is pushing up the price of oil, supply/demand vs. speculators, is a coherent explanation of the mechanisms that determine the price of a traded commodity. Petrino DiLeo attempts a straightforward explanation of the futures market and how small changes in supply/demand relationship can be exaggerated by an unregulated market in futures contracts. In my opinion, this article is far superior to the emotive writings in Engdahl’s blame the “evil speculators” piece.
Oil speculation
James D. Hamilton, Econbrowser
… At a higher price of gasoline, consumers will use less of the physical commodity. Not much less, I grant you, and that’s why I agree that speculators are able to have more of an influence than I might have expected. But I would insist that if you drive the price of gasoline sufficiently high, consumers will respond.
And that’s a problem for any “paper oil” theory– if consumers are buying less of the physical commodity, what’s happening on the production side? If production doesn’t change, then oil must be piling up somewhere in inventory, possibly some just idling in tankers in the Persian Gulf. But no one has an incentive to keep adding more and more oil to inventory forever. So ultimately, the “paper oil” theory is going to require a reduction in the production of actual physical oil.
And that leads you to the question, Why would producers want to cut production? If the answer is, they make more profits with lower production and higher prices, then they would want to make those same production cutbacks with or without the speculation, and you’d have to blame the whole phenomenon on the operation of those profit calculations themselves, with the speculators just a device that got us to equilibrium between supply and demand more quickly.
Now, I personally do accept the view that the “paper oil” speculation has made a contribution in recent months to the increase in the price of physical oil. I believe that this speculation has resulted in a slight decrease in the quantity demanded that has required some modest supply reductions or accumulation of inventory by producers. But I expect that producers will find these changes not to be in their best interests as the demand adjustments become more prominent, at which point the price must return to that governed by the underlying physical fundamentals.
Ultimately, the price must be such that the quantity of physical oil demanded at that price is equal to the quantity of physical oil supplied. Any speculator who promises on paper to buy oil for more than the physical stuff is actually selling for will find themselves at that point with a big, fat paper loss.
(23 May 2008)
Also at iStockAnalyst.
Ban on futures trading: Anti-farmer, not anti-inflation
Sharad Joshi, Hindu Business Line
The recent ban on futures trading in four agricultural commodities is against the interests of the farmers. The ban is a result of the compulsions of coalition politics and is unlikely to bring down inflation.
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On May 4, Mr P. Chidambaram, the Union Finance Minister, announced in Madrid (Spain) that the Indian Government might impose a ban on the futures trading in agricultural commodities, if there is a public perception, true or not, that futures trading led to inflation.
… In order to understand what the whole controversy is about, let us try to understand what commodity futures markets are and how they function.
Farmers, according to a schedule dictated by the monsoons, produce agricultural commodities. Most of the agricultural produce arrives in the market at about the same time. As a consequence, commodity prices sink during the the harvest time to their lowest level and start rising after that till the next harvest.
Unfortunately, farmers do not have the ability to store their produce and wait for prices to become more favourable. Similarly, during the harvest, prices are relatively higher at places farther away from the fields. However, the farmer does not have the capacity to transport his produce to such locations and take advantage of the higher prices.
As the counterpart of the farmer, who would like to take advantage of higher prices in future or at a different place, there are consumers, traders, processors who would like to take delivery of the produce at a future date or at another place rather than on the spot and at the time of the harvest.
Their objective is to avoid the expenditure of storage, preservation, and also the interest charges for storing the produce till such time. The futures market essentially performs the role of bringing these two parties together. Further, it offers a transparent system of matching offers and demands to discover the right price. Thirdly, it offers the contracting buyer or seller the assurance of receiving the contracted price.
Farmers benefit
The farmers are the main beneficiaries of the futures markets. Firstly, these markets give information at the time of sowing, the price that can be expected at the time of the harvest.
(21 May 2008)
Contributor Wag the Dog writes:
Adding to the debate over the role of the futures market in commodity inflation (See energybulletin.net/44560.html) this article is another primer but from a pro-speculator point of view.
