Jan 11, 2009

Kevin Duffy on the dreaded "speculator"

Ah, the dreaded “speculator,” the perennial whipping boy of anti-capitalists. What is so evil about the speculator? Just like the entrepreneur, he makes judgments about the future, risks his own capital, and is the bearer of uncertainty. If his crystal ball is clear he profits and expands; cracked and he incurs losses and eventually works for someone with better vision. He allows the farmer, oil company, and refiner to offload uncertainty and risk. He is a hero, not a villain.

Co-managing a hedge fund makes me a speculator I guess, and as a short seller, one of the most dreaded kind. Last spring we began shorting crude oil around $100/bbl and backed up the track at $145/bbl. I remember friends complaining at the time that speculators were driving up gas prices ever higher. It was a conspiracy of Big Oil, OPEC, and those “greedy” speculators. I simply replied, “if you’re so concerned, put your money where your mouth is - buy a futures contract.” And I reminded them I was doing the same, taking the other side of the trade.

What caused the bubble in oil prices? A variety of economic actors - consumers, producers, and yes, speculators - bet wrong. Some bought into Peak Oil theories, others believed in the “decoupling” theory which extrapolated growing demand in the BRIC countries despite a retrenching U.S. consumer. Many underestimated the severity of global recession and ignored conservation measures crimping demand. Also forgotten is the role of Fed policy which was aggressively easing in order to arrest the bursting of a massive credit bubble. Investors and speculators feared inflation and bid up inflation hedges - not just crude oil, but grains, precious metals, and other commodities. Platinum, for example, jumped 77% in just 6 1/2 months after the Fed began cutting interest rates in August, 2007.

That the future is uncertain and human beings are prone to error is a given. The question is, who is better at this endeavor, the entrepreneur/investor/speculator risking his own capital or the politician/bureaucrat/regulator influenced by special interests and risking taxpayer money? The free market - as the oil spike and collapse shows - has a feedback mechanism for correcting error. The political system has a way of ensuring the worst come out on top, as the recent presidential primaries make clear.

~ Kevin Duffy, Bearing Asset Management, January 11, 2009

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