A well functioning market?: Has speculation broken down?

CNN Money had this note today:

Nearly everyone agrees that speculators have always been essential to a functioning market and that oil prices could be much higher without them.

What's harder to understand - and widely debated among buyers and sellers of oil futures - is the effect new speculators flowing into commodities from big-money funds like university endowments, pensions, and indexes are having on oil markets.

Some say they're good. In addition to limiting demand, they make it easier to sell oil contracts and create a larger market where prices are less susceptible to big swings following individual trades - known as liquidity in financial speak. This camp says $130 oil is justified since demand is rising faster than supply.

Others say big-fund money is making it harder for traditional oil speculators to do their job. This camp says big funds distort traditional models used to predict prices and think $130 oil is a bubble ready to pop.

Traditionally, a futures speculator bets on the direction of commodity prices and then guarantees that commodity at that price to a client. This removes some of the risk - and greases the wheels of commerce. . . .

The issue here is that if you had the price go up simply because of some people who didn't know what they were doing bidding up the price of oil, the experts would sell short oil stocks and help force down the price now.



Anonymous Anonymous said...

When most any market begins to show strong positive momentum, this attracts new capital to pile on to the momentum trade. Should this positive feedback loop become strong enough, good luck stepping in front of if, taking the other side and shorting. Ultimately, the short position will pay off but it's just way too easy for short sellers to get wiped out before the bubble finally bursts. Easier for capital to find positive momentum today than in the past, so I'd expect more of such bubbles to develop. -Mark in SoCal

5/16/2008 11:57 AM  

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