Speculators make the world go round

Excessive Risk Assumption!

In the battle over speculation, I truly believe that many do not understand what is going on. Perhaps it is the word “speculation” that is causing some of the confusion. When the word “speculator” is used it conjures up the images of Wall Street Fat Cats in a sushi filled room hatching evil, deceptive plans to corner a market and doom us all.  The truth is that the only reason the economy exist is because we have people who are willing speculate with the hopes of making a profit because it carries considerable financial risk. Farmers speculate that when they plant a crop that it will grow and they will have someone who will want to buy it from them. Airlines speculate everyday hoping that people will want to travel and they can charge enough for their plane tickets to cover fuel costs. Even the guy who delivers your pizza speculates that you will tip him enough to cover the cost of his gas. Some speculations carry little risk and some carry considerably more and the potential for profit and the size of profit are all tied back to the amount of risk the speculator assumes by his actions.

Now sometimes these speculative thoughts may not pan out, especially if the guy who delivers the pizza gets a cheapskate and thus no tip. Or the farmer that either can’t grow the crop due to drought or perhaps he chose to grow what ended up being the wrong crop a particular year where demand was not what he thought it might be. Or an airline that fails to get as many passengers as wanted because of stiff competition or surging fuel costs. Every one of these speculators is taking a risk because if this event happens or that event doesn't happen, they could go out of business.

Sadly, going out of business happens more than you might believe and yet many airlines and farmers and pizza guys have not gone out of business because there was someone to assume the risk. Now many might call these people “speculators” but to make things more clear let’s call them the “risk assumers." Because in reality, producers and users of any commodity are speculating all the time. They speculate on whether prices will rise or rather, will fall. We all speculate on whether to fill up the car now or wait until next week thinking the price of gas might fall.  

The risks that users and producers of these commodities take are substantial. We've seen wild price swings in grains for example, as the harvest comes in, prices could plummet if it’s a huge harvest and there would be an oversupply. Grains would rot because there were no buyers. Then potentially in the winter we could see prices soar and shortages become rampant and many could not afford to eat.

These inefficiencies in the system demanded that someone figure a way to assume these potential risks. First came forward contracting and then the futures markets came along.

For the market to function correctly it needs someone to assume the risk so both the producer and user cannot only be assured of supply but also a fair price. Who was there to assume that risk? Here come the Risk Assumers!

The Risk Assumers today are assuming more risk than perhaps at any time in the history of the globe. With the possibility of sovereign debt defaults and the printing of paper money, perhaps now more than ever we need people to assume the risk that others are not willing to assume. These risk assumers do not increase cost. By removing the risk, they actually lower costs. Costs that would fall squarely on the shoulders of the producers and users. The risk assumers help those that may never even trade a commodity because they are the real reason that when you pull up to the gas tanks you can buy some gas. Without these risk assumers the economy would freeze and ultimately collapse.

We saw how that looked in 2008 after the failure of Lehman Brothers. We saw the world hurdle toward a deflationary depression. We saw credit freeze up and the economy grind to a standstill. Now some blame speculators and credit default swaps for the crisis. I blame Fannie and Freddie who were the great enablers of this crisis by encouraging banks to make more and more bad loans. Loans that could not and would not have been made if the government wasn’t ultimately on the hook for the bad mortgages. But with the government involvement in the market, trying to pick winners and losers in housing, they distorted the marketplace and allowed the bubble to begin. The banks were stupid enough to ignore common sense because the flood of government money buying these bad mortgages looked like too good of deal to pass up. It inspired more building and the politicians loved it because of all the jobs it created as house after house and condo after condo tower went up.  Of course the banks would never normally assume that risk unless Daddy Warbucks for Fannie and Freddie were buying up all of those risk mortgages so the banks could lend again and again and again.

So remember this when the politicians look to blame “Wall Street” and the Risk Assumers for the economy. Remember what they won’t tell you that they made the economic crisis possible by messing with the market in the first place. Now in their infinite wisdom they are trying to tell you that they are going to help us out again by getting involved in the market by controlling out of control risk assumption in a world that needs risk assumption more than ever. So I guess that means the government wants to assume that risk like they did in the housing market. In other words it will mean that you and I will be assuming that risk.

The oil markets have Iran off its mind as the macroeconomic events take control. Today the jobs report will make us or break us than in the end of the day we can starry worrying about Iran again.

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.

 

Futures and options trading involves substantial risk of loss and may not be suitable for everyone. The information presented by The PRICE Futures Group is from sources believed to be reliable and all information reported is subject to change without notice.


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