Friday, October 24, 2008

Where Are The Speculators Now?

Speculators were blamed for the housing bubble, the oil bubble, and, if you recall, the dot com bubble.

During the dot com boom, people invested in those stocks and retail traders jumped in to the market with both feet. Yes, that means you! Those people who opened up ETrade accounts and had no idea what they were doing but thought it was a good idea to start buying stocks. It was pure speculation and not based on any sound fundamentals. The transaction prices dropped significantly when trading started taking place on the internet. And eventually, that bubble burst.

After that, we had the housing boom. Oh, the glory days for property owners. Properties were being listed and offers would be submitted within hours. It was a buying frenzy. People would buy houses and turn around and sell them within weeks or even days at significant profit. Speculators once again were blamed for driving prices up to unrealistic levels. As it happens in all bubbles, it burst.

Then we had the oil boom. When oil hit the $100/barrel mark we thought it couldn't go much higher, but it did. $110! $120! $130! Finally it hit the ceiling at $147.25. Then, lo and behold, the bubble burst.

Today, despite the fact that OPEC has promised to cut production, the price of oil dropped.

Where are the speculators now? If the speculators really have as much power as the media and people like Greenspan and Bernanke say they do, the bubbles would not burst so quickly and prices would not fall so fast.

In reality, speculative buyers in any market must have speculative sellers. A seller sells because he believes that something he's holding will go down in value if he continues to hold it. Speculative buyers think it's going to continue to go up. Without willing sellers, speculators would have nothing to buy so why do we blame the speculators?

The oil speculators have no power to keep prices up. They are not sitting in huge conference rooms together figuring out how to keep prices rising. They are individuals, fund managers, etc. who are riding a wave of market emotion and trying to make a profit.

When market bubbles burst, someone is losing money. But who? Usually it's the people who got in to the frenzy closest to the end.

The oil bubble burst because we're entering a global recession and demand is falling rapidly. The speculators are shorting oil futures. Fine. They see the hand writing on the wall. But they're selling short to people who believe that oil will go back up. Again, there are two sides to a transaction but we only blame half of those responsible.

Some other time, I'll get in to the Keynsian boom/bust cycle and how it could be avoided.