How Speculation Affects the Commodities Market

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How Speculation Affects the Commodities Market

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Basic economics will tell you that the price of a commodity is based on the amount of supply made available by producers, and the demand for it by the buyers. It's the simple case of supply-versus-demand. But this is economics 101, and an introductory course to economics will hardly show you the real situation above-ground.

Many commodities today (notably oil) have their prices sky-rocketing. Although there is a demand-side justification for these appreciation in prices, another great contributor is speculation in the commodities market. Yes, folks, most of the time it is not actually demand or supply that dictate the prices of commodities, but guesswork coming in from a bunch of traders who are in the market to get some profit.

The commodities market was set up in order to estimate demand while at the same time ensure that there is enough supply for everyone. Contracts for crops are bought from farmers a few months in advance, way prior to harvest season. The gap between the conditions today and the conditions in the future lead to traders speculating the price of future goods and affect current conditions consequently.

For example, if traders speculate that the price of a certain crop is going to rice because of their predicted reduction in production, they will buy up more contracts, more than what they probably should in a bid to have increased profits. Then there is now a shortage in contracts, which will push up the price of that crop. In effect, the speculators made into fruition their own speculations.

The bad thing here is that all these speculation and appreciation in price is just artificial. There is no guarantee that buyers will actually buy up those goods since the "high demand" was just made up by the traders. When selling it to users don't pick up, the prices crash down and we have a correction scenario similar to the US housing crisis of 2008.

Over time the market corrects itself in order to remove price bubbles, but while this is a normal occurrence, this is not exactly good from a social and political standpoint.

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