By Jerry Slusiewicz | June 25, 2008 | 10:55 AM | 3 Comments
There are hedgers - those that are hedging a future price because they have an interest in owning the commodity today or at a future date. For example, an airline industry is extremely sensitive to the price of oil. Obviously, the brokerage firms that make trades on behalf of hedgers are just representative firms and not speculators. Everyone else that doesn't own the physical commodity today nor has zero intention of taking possession of the physical commodity in the future is a speculator. Speculators are necessary to provide liquidity. However the margin requirement to allow access is where the problem lies.
This is not much different than the speculation that led to the recent run-up in the housing market. Instead of putting the long standing traditional 20% down to buy a house - people were putting up 5% or even no money down to make a house purchase. So an out of state investor (really a speculator who had no interest in moving there) in Las Vegas condos might purchase four properties at full price instead of one. And the poor sap who was moving there for a new job (a hedger if you will, because he wanted to live there), now had to pay an even higher price as the builder was now out of inventory because they just sold off their last four properties at top dollar. So the builder raised prices and the poor sap has to pay an all time even higher price because of scarcity of the product. This worked well until the lenders suddenly realized that the game was over, the market was way overpriced and the paltry 5% down didn't cover the decline. Now the banks are in trouble for allowing speculators to run up the price that had no real skin in the game, and they are back to prequalifying investors paying ability and requiring a higher margin (i.e. down payment).
In oil, an average uneducated Joe or pension fund, whatever the case may be, for just under $10,000 can control 1000 barrels of oil today. In today's prices that's $135,000 worth of oil. They only have to put 7.5% down. Now Joe might not have that many $10,000 bills in his wallet. But Cal Pers or any of these other huge institutional speculators out there do! Therein lies the problem. The cheap access to controlling large lots of oil with no intention of ever taking possession of the commodity! They are like the Vegas condo speculator, betting on the future increase in price, using their own money and other likeminded institutions are making this a self fulfilling prophesy by bidding up the price that requires very little down payment (margin). If the margin requirement were raise to say 50%, Joe would probably be out and only the serious institutions would be playing the game under much closer scrutiny, because they would have real "skin in the game".
Speculators are necessary to create liquidity, and definitely should not be banned. But with only a 7.5% margin (down payment) and with oil up 42% year to date, that is a 400% return on investment. And we individually are paying for it at the gas pump and in higher food prices. If you're happy about that say nothing. If you're not then you want higher margin requirements to battle speculators from competing with hedgers for the oil that will soon be refined into gasoline for your car. Yes there are other factors, like the falling dollar, that also affect oil prices. But YTD the dollar is down around 5%, so that is not that significant. I wrote another piece here on Green Faucet that goes over other parameters on oil, but I wanted readers to get a better understanding of who speculators are and how they are causing oil to be way overpriced today!
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