There is only one error that I can see -- index funds don't always bet on rising prices. There are exchange-traded funds that take the short side.
Here's the chart that accompanied the article:
Posted on 07/03/2008 7:32:43 PM PDT by USFRIENDINVICTORIA
Politicians who try to make oil cheaper by restraining speculation will just make things worse
ALTHOUGH the price of oil continues to hit new records, it has in one respect been a quiet week on the oil markets. America’s lawmakers are celebrating Independence Day by taking a few days off. That has led to a brief interruption in the torrent of proposals aimed at curbing speculation.
Ten different bills on the subject are in the works in Congress. Before the House of Representatives shut up shop, it approved one by a vote of 402-19. America’s politicians are not the only ones to have fingered speculators for the feverish rise in the price of oil and other raw materials. Italy’s finance minister believes that there is a “magnum of speculative champagne” included in the price of each barrel. Austria wants the European Union to impose a tax on speculation. Saudi Arabia and other big oil producers routinely blame the price on frothy markets, rather than idle wells.
The accusers point to the link between the volume of transactions on the futures markets and the price of oil. Since 2004 the near tripling of trading in oil on the New York Mercantile Exchange (NYMEX), the world’s biggest market for the stuff, has neatly coincided with a tripling in the price.
What is more, investing in oil has become something of a fad. Commodities traders and hedge funds with long experience have been joined by less expert sorts, including pension funds and individuals. All this, the theory runs, is contributing to a bubble in commodities. The rush of punters betting on higher prices is begetting a self-fulfilling prophecy: it is the tide of new investment, rather than inadequate supply or irrepressible demand, that is pushing the price of oil ever higher.
Follow the oil, not the futures This reasoning holds obvious appeal for those looking for a scapegoat. But there is little evidence to support it. For one thing, the surge in investment in oil futures is not that large relative to the global trade in oil. Barclays Capital, an investment bank, calculates that “index funds”, which have especially exercised the politicians because they always bet on rising prices, account for only 12% of the outstanding contracts on NYMEX and have a value equivalent to just 2% of the world’s yearly oil consumption.
More importantly, neither index funds nor other speculators ever buy any physical oil. Instead, they buy futures and options which they settle with a cash payment when they fall due. In essence, these are bets on which way the oil price will move. Since the real currency of such contracts is cash, rather than barrels of crude, there is no limit to the number of bets that can be made. And since no oil is ever held back from the market, these bets do not affect the price of oil any more than bets on a football match affect the result.
The market for nickel provides a good illustration of this. Speculative investment in the metal has been growing steadily over the past year, yet its price has fallen by half. By the same token, the prices of several commodities that are not traded on any exchanges, such as iron ore and rice, have been rising almost as fast as that of oil.
Speculators do play an important role in setting the price of oil and other raw materials. But they do so based on their expectations of future trends in supply and demand, not on whims. If they had somehow managed to push prices to unjustified heights, then demand would contract, leaving unsold pools of oil.
The futures market does sometimes signal that prices are likely to rise, which might prompt speculators to hoard oil in anticipation. But it is not signalling that at the moment, and there is no sign of hoarding. In the absence of rising stocks, it is hard to argue that the oil markets have lost their grip on reality.
Some claim that oil producers are in effect hoarding oil below the ground. But there is also little sign of that, either among companies or countries: all big exporters bar Saudi Arabia are pumping as fast as they can.
It takes two to contango Despite their dismal reputation, the oil speculators provide a vital service. They help airlines and other big oil consumers to hedge against rising prices, and so to reduce risk—a massive boon amid the economic turmoil. By the same token, they provide oil producers with more predictable future revenues, and so allow them to expand more confidently and borrow more cheaply. That, in turn, should help to lower the price of oil in the long run. Any attempt to curtail speculation, by contrast, is likely to make life harder for firms and oil more expensive.
Even if we bloc speculating here, Dubai or worse, Nigeria will open a bourse there with even less regulation.
The article mentions iron ore, a commodity not traded on the futures market.
Rio Tinto recently raised prices for ore to China by 85%, Korea 97%, and Japan by 95% .
Does anyone think they’ll eat all of the increases?
When will they ever learn that you can’t regulate functioning markets?
It's essentially an auction, where there's not enough oil to keep everyone happy. People still need to get to work, or drive the kids to the beach, etc., and they all want that last barrel of oil. The oil will go to the bidder who wants it the most.
The Dems want to pretend Supply and Demand isn’t real. If you like $5/gal, Thank Congress.
Pray for W and Our Troops
The Democrats are banking that the voters won’t learn that, until at least the second week of November.
Speculation in the futures market is not the ONLY cause of high prices, but it is one of the factors driving the price up. The primary rise in prices has been the negligence in both the White House and in Congress on energy policy.
The DC Oil Barons are worse then even the OPEC Oil Barons. Perhaps citizens should sue the US Government for price gouging. Or perhaps an anticompetitive lawsuit is in order. The US Congress and Presidency control access to vast amounts of oil and they are restricting access to this oil and are partly responsible for the high prices and price gouging (simple Supply and Demand physics). And through Royalties, the US government is by far one of the highest percentage profiteers in the leasing of producing US oil resources.
Speculation has, as we have been learning to our great detriment, driven housing prices to very high levels, and a lot of folks who thought they had no choice if they wanted a house are stuck with bankruptcy as a consequence.
Speculators can have very very strong influences on markets. If you really need a barel of oil, and supply is inelastic, then a well healed speculator can make you pay well above the marginal cost of producing that barrel of oil.
Contact your Congress critters to let them know that you are tired of high gas prices.
Politicians will regulate anything they can get tax money from. California taxes by percentage, not on gallons. Think they want to see gas prices come down. Pelosi doesn’t care if people go broke, as long as she can get the tax money for her friends.
Demand doesn’t have to double for the price to double. If there is a shortage of something that is in very high demand then buyers will keep outbidding each other bidding the price higher and higher and the price will rise. As long as supply does not meet demand there is a shortage and prices will rise. There is no linear mathematical formula for telling how much the price should rise in relation to demand and supply.
“We” are not going to regulate the speculators. If the speculators are regulated then the only thing that will happen is that the government will get more power over the economy. That doesn’t work and is against freedom and the constitution. Why do people say “we” every time they want to give more power to the government with a new law to regulate the economy or our lives. We have much too many laws as it is. The government is not “we” . The government is the enemy of the people and of the individual.
You are right that speculation is going on in other countries and those countries have different laws and regulations than here in the U.S.. Funny how all these speculators in different countries with different laws agree on the price. It’s not the speculators that are causing the price to rise but that supply has not kept up with demand.
Interesting
Blame the speculators, at least in part. Repeal the “Goldman Sachs Loophole” right now. Don’t believe the B.S.
Please explain what the “Goldman Sachs Loophole” is & why it needs to be closed. I’m not familiar with it.
In the case of real estate, use one of the bubble states as an example. Let's pick Florida. Using ballpark numbers, Florida has about 16 million residents. Of those, perhaps 10 million are home owners. At any given time, perhaps 5 percent of homes are for sale. So, at any given time, 500K homes are for sale. Some people will be planning on moving out of the State but that will be offset by people wanting to move into the State. The majority will never-the-less be, in-State sellers selling to in-State buyers.
Now, If suddenly from around the world 100K speculators descend upon the state, there will suddenly be far more buyers that sellers and the market will bid the prices up. Prices being bid up will force normal buyers sitting on the fence to buy and will attract new speculators.
So, this is a very simplistic example of how just a few speculators can drive a market bonkers.
The oil futures market is very different from the real estate market.
For instance, the world’s stockpile of houses isn’t burnt up and replaced every day.
Unless you’re a major oil producing nation — it simply isn’t possible to hoard a significant supply of oil. Speculators aren’t hoarding the stuff — they’re simply betting on the future prices.
This is not true. If you really need a barrel of oil, you buy it on the cash market. The futures market does not drive the cash market. In fact, if futures prices get too far out of line from the cash market, arbitrageurs will step in and profit by bringing the prices back into sync. So-called “speculation”, which is how people are incorrectly describing the participants in the futures markets, has little, if anything to do with the direction of prices. According to the futures industry association who oversees the markets, 70% of trades in the oil futures markets are by hedgers - people who actually intend to take delivery (eg airlines) and people who actually intend to deliver (eg oil companies). Plus, the shorts and longs are about even, so there is no lobsidedness pushing prices upward.
The analogy to the housing market doesn't work because futures contracts are created and destroyed as positions are entered and exited. A futures trader can put on a position and then sell it at either a profit or a loss (or a breakeven) without having to actually receive or deliver any oil. A speculator in the housing market, however, can only go long, and can only do so with a real house. If the house speculator wants out, they have to sell the house on the cash market. This is not the same as the commodity futures market. In places like Las Vegas, there are countless houses sitting vacant, with speculator-owners who may or may not be able to make their mortgage payments. In other words - housing speculators created a glut. Oil futures speculators are not storing barrels of oil in their backyards, nor in warehouses, nor anywhere else. There is no glut being created. You have to compare the housing market to the CASH commodities market. In the cash oil market, demand exceeds supply, and will continue to do so unless there is a severe worldwide recession, or some other external event that changes the dynamics of the market.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.