Let me offer a brief, non-technical explanation of how commodity and futures markets work.
This is the characteristic of the commodities or futures market – it is a zero-sum game. For every profit, there is a corresponding loss – dollar for dollar.
Now, if this is true, how can speculators drive prices? They can’t – if they could, it wouldn’t be a zero-sum market!! If the price of wheat goes down, Mary cannot drive it up. If the price of wheat goes up, Jane cannot drive it down.
Only supply and demand can influence the market – and speculators cannot control either of those factors.
I’m not an expert on this, and certainly not on commodities. But consider stock for a moment, with which I am more familiar, and let’s think about it.
It is entirely possible for a person to manipulate a stock if he has the resources to do it and has good information about “normal” volumes and a good idea what the “specialists” who MUST “make a market” in the stock are able and willing to do.
Let’s say that normally there are about 1,000 people who regularly invest in XYZ. Let’s say XYZ volume is about 1000 shares/day. Right now the price is $30. Let’s say the normal amount brokers keep on hand is 100,000 shares, and the specialists keep about 2,000.
If I know XYZ has reasons to perhaps go down a bit, I “borrow” as many of the “on hand” shares from brokers as I can, and sell short. I sell short in ever-increasing increments, creating the appearance of a “run” on the stock. I will create the appearance that the stock is worse than it is. The “usual” investors may start to panic and start dumping too. Maybe the stock really is overvalued from its present $30. Perhaps a more realistic value is $20. But because of the panic, I force more shares into the market than I actually have to work with myself. It drops to $10. I then go in and buy the stock, deliver it back to the brokers and pocket $20. But because its realistic value is more like $20, I buy more than I had to deliver. I keep doing that, in increments greater than normal, thus creating the appearance of greater value than it really has. The stock goes to maybe $40 on the perception that there’s more intrinsic value to the stock than there really is. I then start selling out again, but in volumes that have a more “normal” appearance.
This is particularly troublesome when I buy and sell in increments greater than what I figure the specialists normally keep on hand, forcing the specialists into the market all the time to keep up the inventory they maintain in order to “make a market” in the stock; something they have to do to remain specialists. I thus keep “hitting” the price because the specialist, who has a regulatory limit on what he can drop the stock in one given session, will keep going down the maximum all the time.
In a small cap stock, and in a market that’s a little skittish anyway,. it’s not too hard for a manipulator with a lot of money to do this. If you look at it right now, small cap stocks in disfavored sectors have a lot more short sellers relative to total capitalization than large cap stocks in the very same sector, even those of the latter with worse fundamentals. That’s because it takes a lot more money to manipulate a big cap stock, and because it’s much more profitable to play games with small caps than it is with large ones. One can make the small cap stock look a lot worse, or better, than it really is and force the specialists to make abnormal moves more often.
Finally, there is “accounting”. Since fund managers are big forces in the market, they tend to “wash out” results on at least an annual basis. Even if they believe a stock is being “hit” abnormally, they will often get out of it if they can’t really see where the “game” will end, in order to get into something in which the “turnaround” is more foreseeable. In fact, as now, they will drop a volatile stock (often the small cap) and get into a less volatile one (often the large cap) even if it has less promise for the future, because the manager has to report fund results at a given point in time. He will “sacrifice” this year in order to look good next year. In a “bad” year, like this one is at present, everybody will forgive it. This actually increases a manipulator’s “leverage”.
Obviously, supply and demand puts limits on what even a strong manipulator can do, because there is an inherent value to everything. Still, by causing people to get distorted, even panicky views of what is going on in a particular market, a manipulator can make the highs higher and the lows lower than they otherwise would have been. And they can make the changes occur much more rapidly than would otherwise have been the case.
It’s not exaclty a zero sum game because some people “ride it out”. Just because what I own goes from $30 to $10, it doesn’t mean I lose $20 except on paper and for now. Nor do I gain when it goes the other way, except on paper and at this moment.
Again, I’m shaky on commodities because I never deal in them.
And, when it comes to commodity futures, there is a limit to “riding it out”. But if a producer is facing ever-increasing futures prices on an ingredient, he’s going to build that increase into his finished product price if he can, even if he is not, at that moment hedging with futures, because it will color what he thinks about his (name removed by moderator)ut costs down the road. That will tend to be true even if the futures prices are unrealistic.
But in a sense, I guess it is a “zero sum game” with commodities in that somebody pays the price of artificially high or low futures prices, even if it’s the producer or the ultimate consumer of the finished product.
