9.6.1-HEDGING AND OTHER OPERATIONS-INTRODUCTION TO COMMODITY SPECULATION
Introduction to commodity speculation
Commodity speculation is the purchase and sale of a commodity in the expectation that the reversal of the purchase or sale will yield a profit as a result of a change in the market value of the commodity. There is a certain amount of pure speculation in commodity futures, although its magnitude is difficult to gauge.
Throughout the 1970s high levels of inflation and exchange rate uncertainty were associated with a greater degree of nominal price volatility for primary commodities. This in turn gave a tremendous boost to futures speculation, sometimes referred to as the other side of the exchange. The participation of speculators in the futures market contributes to that market's liquidity, essential for avoiding undue price distortions that can be caused by laying on or lifting hedges.
However, excessive speculation can lead to wider price fluctuations - markets become 'overdone on the upside and on the downside' (prices move to greater extremes than expected) - until the excess of either the long or short positions is finally unwound. By virtue of an individual or firm's expectations and willingness to take risks, speculators aim to make an uncertain profit from their operations in the market. Speculators may form their price expectations on the basis of the futures prices, the spot price, both spot and futures prices, or perhaps on the basis of the price spread alone, and take positions reflecting their expectations in the markets.
Certain features of futures exchanges attract speculation. These include the standardization of the futures contract, the relatively low costs of transactions, and the comparatively low initial funding required (leverage).
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