I’ve made significant money when I’ve guessed commodities price movements right -— and felt quite smart.
I’ve lost significant money when I’ve guessed wrong -— and felt pretty stoopid... and hopefully learned since then what the difference was.
You’re right about the mechanisms, and have done a good job trying to explain it. The commodities markets serve as a buffer for the producers and the consumers, who use the speculators (in the end) to absorb some of the risk of price movement between the start & end of production. I don’t know whether people here are pulling chains trying to act as if they can’t understand it, or if they really don’t.
I’ve got time to try once before I leave the ‘puter, and won’t be able to respond to replies: It’s probably more simple for people to understand how it works for a farmer who is engaged in growing wheat, and a mega-baker, say WonderBread who is using that wheat.
The farmer, before he plants, can “sell” a good portion (say 75%) of his expected crop on the commodities market -— and thereby “lock in” his price for the season, or next season. That allows him to plan his financial future. It could well turn out that as the season progresses, the “speculators” would drive the price higher (scant harvest expected, weather problems, etc.) or lower (good harvest expected), but the farmer doesn’t care much: he’s got his price locked in. He knows he’ll be able to pay his bills. Of course, he’ll have to deliver his xx,000 of bushels of wheat, but unless he’s wildly misguessed his production, that won’t be a problem. It gives him (and his creditors) some secure, fuzzy feelings. Of course, he hopes he didn’t sell for too little, but he realizes that his security is worth paying some “insurance” for. He also hopes that the price is a bit higher at the end of the season so he can get a good price for that part of the crop he hasn’t sold.
Meanwhile, a huge user of wheat will be buying wheat contracts. Again, that allows them to lock in a price, and plan their financial future in this respect.
This ultimate seller (the farmer) and the ultimate buyer (baker) are now insulated from the risk of how much the cost of wheat fluctuates due to vagaries of the weather or the government or whatever. That price risk falls on the speculators, who depending on how well they “guess” can either make or lose money.... but the real benefits go to the producer and consumer who have some price stability in what often are very volatile markets due to very volatile conditions. That volatility ALSO forces the ultimate seller to be willing to sell a little low as price insurance. The ultimate buyer often has a tougher job in trying to guess a price he should expect, but he’ll often be willing to pay a bit higher price in fear that there will be a crop failure and the price will skyrocket.
Usually, “ultimate sellers” will sell far in advance of production. “Ultimate buyers” will typically buy closer to when they need the item. So, the speculators have some “natural” price spread there, but their cost is the risk that they can be wildly wrong about the direction production or demand takes (look at the price of corn skyrocketing because of the ethanol story ... some people have lost a boatload of money as a result of that ... some have gained a lot)
I’ve got to run now... but the long and short of it is that the commodities markets serve both producers and consumers... but as far as “speculators” ... often the real winners there are the brokers who are charging to simple “place the bets” for the gamblers, and who can’t lose.
Excellent explanation.
Thank you.
I’ve got to run now... but the long and short of it is that the commodities markets serve both producers and consumers... but as far as “speculators” ... often the real winners there are the brokers who are charging to simple “place the bets” for the gamblers, and who can’t lose.
I understand how the commodities markets serve both producers and consumers and like how you separate out churn and burn speculators as gamblers. Those are the ones I’ve been talking about. And the gamblers are not always little players who have no effect on the product price itself - case in point the Amaranth fiasco.
Gambler heh ties in exactly with what a fellow trader said of him “The financial markets aren’t really like a casino... but Brian treated them like they were.”
I wonder what Adam Smith would think of Brian Hunter.
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“The financial markets aren’t really like a casino... but Brian treated them like they were.