Are speculators to blame? - Views on News from Equitymaster

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Are speculators to blame?

Oct 14, 2008

This marriage's not made in heaven...
...but in the air. Companies that were fighting out a bitter battle for a higher share of the market are now talking of alliance to help them see another day. We are talking of the proposed association between India's largest and second largest airline companies - Jet Airways and Kingfisher Airlines. As reported in a leading news portal, the alliance is said to be 'of wide-ranging proportions that will help both carriers reduce costs, synergise operations and improve services'. Both Jet and Kingfisher have been accused of combining into a cartel to guide airfares in recent times. And now with officially combined operations, the bargaining power may further rise.

Mr. Naresh Goyal, the Founder Chairman of Jet Airways says, "It is not a cartel. We are coming together to cut costs. It is for the first time two major Indian carriers are coming together in difficult times." While the idea to combine might be right, the fact that the two together hold around 60% of the Indian airline market share, the actions might not be so.

Stocks up on rescue hopes
While central banks all over the world are busy injecting liquidity into the financial system to ensure its smooth functioning, whether the same will start yielding the desired results anytime soon remains to be seen. Global stock markets, which tumbled like nine-pins in the past few weeks, are however seem to be viewing the interventions in a favourable light. This was amply demonstrated in the way stocks moved yesterday.

The US Dow Jones Index jumped 936 points in yesterday's trades, its biggest ever single day gain. The effect is now seen in key Asian markets that are trading up in a range of 4% to 7%. The Nikkei (Japan) is in fact up by 13% currently.

So, is the worst over? We doubt! The current problem is a creation of years of monetary and financial mismanagement. And it will take some while for the issues to be resolved.

Are speculators to blame?
Commodity prices have been increasingly volatile in the past one year. And what probably stand out the most is the gyrations in crude price, which flirted with the US$ 147 a barrel mark in July this year. The cost of a barrel (approx. 159 litres) now stands at US$ 78. And the prediction now is that oil is likely to touch the US$ 50 a barrel mark.

Leaving crude aside, intense volatility in commodity prices per se has prompted various governments to ban futures trading as the problem was attributed to unabashed speculation. The major argument was that hedge funds and foreign investors were pouring in huge sums of money into commodities thereby inflating their prices and distorting spot markets for physical commodities.

In the last one year, the problem became more acute as risky debt instruments led many investors to run helter-skelter before zeroing in on commodities as an investment avenue. However, this is just one side of the coin.

The other one being that speculation cannot be the prime reason attributed to the surge in commodity prices. For instance, as has been stated by the Economist, many of the commodities in which prices have soared over the past few years, from iron ore to molybdenum, are not traded on exchanges thereby offering less opportunity for investors. Further, much of the rise in investments into commodities futures has been due to rising prices. Thus, without putting in new money, even if the price of a commodity went up, so did the value of a commodity-linked fund.

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