Should Speculators Determine the Price of Goods Everyone Needs?

Growing up, my parents always emphasized the importance of working hard, saving money, and investing wisely.
Neither of my parents worked in finance so the only investments I grew up learning about was investing in the stock market and being able to pick certain stocks that were fundamentally undervalued.

The storyline sounds familiar to everyone, you search through a number of stocks, find and research more about a company that you understand decently well, purchase shares of the company. If the company does well, everyone is happy, the company's share price goes up, you reap capital gains on your investment, and management of the company is happy as well.

It wasn't until I started working in finance that I realized that stocks weren't the only place that I could invest. Suddenly I realized that you could invest in bonds, currencies, commodities, and real estate as well.

But unlike stocks, your investments rising to infinity isn't exactly beneficial to everyone anymore... the storyline changes a bit....

At least when it comes to equity investments, investing in particular stocks or the equity ETFs are at the end of the day still optional.

But the 1990s saw the rise of speculation on two particular asset classes: commodities and real estate.
Unlike equities, the rise to infinity does not come benefit everyone.
Equities only affects the people who have investments directly in the stock market or through their 401K/pension funds, but everyone needs to eat and everyone needs a place to live.

And the 1990s saw the rise of players in the market whose sole interest was to make capital gains on the underlying price, with no interest in the delivery or possession of the good itself. These are your REITS (Real Estate Investment Trusts), Commodity Index funds (DJ UBS and GSCI are the main ones), and the enormous growth of funds investing in both commodities and real estate.

Eddie posted this link previously in one of his posts and it's definitely worth posting again
http://www.foreignpolicy.com/articles/2011/04/27/h...
Inherently, none of the buyers of the commodities indices have any intention of ever taking physical delivery of oil, gold, silver, wheat, soybeans, or cattle unlike the refiners and farmers in the market, as the index will continue to roll its future exposure from month to month. Yet, people who have no actual physical stake in the market are able to determine the prices that consumers around the world will have to pay for them.

This is similar to an example where I convince thousands of people that cheese is a great future investment because of consumer's shifting tastes globally. If all of us begin to start speculating on cheese futures based on those notions, it doesn't matter that some of us don't even like cheese or that some members of the group are actually lactose intolerant. At the end of the day, my corner pizza shop's margins will drop or have to raise prices due to higher cheese prices.

In the same way, anyone living in New York can vouch for the absurdity of the real estate market here. The concept of paying almost $1500 (which anywhere else in the country gets you a castle comparatively) for a shoebox with no air conditioning makes no sense, but each year thousands upon thousands of young graduates will pay that money because they have no choice. And yes I know that people will argue living in cheaper more remote areas, but comparatively you still spend a decent amount. (I don't even want to get into trying to buy a place in Manhattan)

I watched with shock during the late 90s as houses that went for $300,000 in 1999 were suddenly selling for $1.1million in 2006. This never made any sense to me for the reason that for a 3.5x increase in home prices, people's incomes were definitely not increasing 3.5x in that time span. The rise certainly benefits the homeowners pre 1999 and "investors" who bought condos/houses for "storage of value" and "promising future returns".

Just look at how Chinese investors can affect the livelihood of Vancouver and it's residents. Sucks if you're a young couple living out there that wants to buy a nice house to raise a family in right now....
http://online.wsj.com/article/SB100014240527023045...
So what do you guys think, on things that every person needs to get by, should companies and individuals with no physical interest or stake in the underlying be able to speculate on them and influence their prices?

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Comments (40)

Jun 2, 2011

Stupid liberal/ignorant rant. Are you going to restrict who can and cannot buy real estate, commodities, etc? How do you decide who is allowed and who isn't? Who are you to say New York real estate is overpriced? Based on what objective factors? How else would you price the property, based on 'fairness'? Boo hoo for the young couples trying to buy a house and raise a family - owning a house is not a right it is a privilege. There are several factors at play here and you choose to single out "speculators" because they are apparently bad people.

Jun 2, 2011

NYC real estate prices are high because of:

High Demand- large population, constant influx of new graduates, professionals, immigrants

Low Supply- peninsula, zoning restrictions, rent control

"The American father is never seen in London. He passes his life entirely in Wall Street and communicates with his family once a month by means of a telegram in cipher." - Oscar Wilde

Jun 2, 2011
veritas14:

NYC real estate prices are high because of:

High Demand- large population, constant influx of new graduates, professionals, immigrants

Low Supply- peninsula, zoning restrictions, rent control

Couldn't have said any better/more concisely myself!

Metal. Music. Life. www.headofmetal.com

Jun 2, 2011
veritas14:

NYC real estate prices are high because of:

High Demand- large population, constant influx of new graduates, professionals, immigrants

Low Supply- peninsula, zoning restrictions, rent control

Forgot to add in Rent Control

Making money is art and working is art and good business is the best art - Andy Warhol

Jun 2, 2011
dwight schrute:
veritas14:

NYC real estate prices are high because of:

High Demand- large population, constant influx of new graduates, professionals, immigrants

Low Supply- peninsula, zoning restrictions, rent control

Forgot to add in Rent Control

You sure about that?

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Jun 2, 2011

Whose better at setting the prices?

Jun 2, 2011

wtf?

Jun 2, 2011

So quit complaining and sell futures. Sheesh. Next.

Cheese? Limit up!

Jun 2, 2011

So everyone benefits when your stock goes to infinity. What about that companies direct competitors. I assume they are not to happy about losing market share. There is a finite about of money. Money going into equities is coming out of somewhere; They are sad to lose this money. Remember cash is a flow.

If margins are down for pizza places what happens to margins for cheese manufacturers?

Jun 2, 2011

What you need, friend, is an introductory class in economics.

Jun 2, 2011

Financial markets facilitate price discovery. Price discovery is crucial in determining a supply and demand equilibrium.

absurdistan dan:

This is similar to an example where I convince thousands of people that cheese is a great future investment because of consumer's shifting tastes globally. If all of us begin to start speculating on cheese futures based on those notions, it doesn't matter that some of us don't even like cheese or that some members of the group are actually lactose intolerant. At the end of the day, my corner pizza shop's margins will drop or have to raise prices due to higher cheese prices.

It is irrelevant if some people are lactose-intolerant if the rest of the world increases their demand for cheese. If the global demand increases and the price doesn't go up, then the market will be inefficient. There will be more cheese demanded than is available.

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Jun 2, 2011

Take this shit over to Reddit or huffpo man

If I had asked people what they wanted, they would have said faster horses - Henry Ford

Jun 2, 2011

$5 says this is the same guy who posted the bullshit "How Do You Feel" posted under a different name.

Everything he said in this post is fundamentally, economically, and practically unsound.

Maybe we should just have a totalitarian government that makes ALL decisions and gets to decide who buys what.

Bullshit.

Jun 2, 2011

$5 says this is the same guy who posted the bullshit "How Do You Feel" post under a different name.

Everything he said in this post is fundamentally, economically, and practically unsound.

Maybe we should just have a totalitarian government that makes ALL decisions and gets to decide who buys what.

Bullshit.

Jun 2, 2011

I am going to quote myself from your other thread on feudalism : "What a whiner!"

Are you a fucking troll?

Since when is greed not good? Since when are we speculators and not arbitragers, market makers, investors? Since when is it acceptable to diss Goldman?

Whatever the fuck happened to WSO? This kind of shit consistently making the front page is reducing my feeling of belonging to the community.

Best Response
Jun 2, 2011

I'll start off by saying that this is one of the most ignorant posts in the history of this website.

Why? For one, your understanding of market history is non-existent. Speculation for the sake of capital gains didn't start in the 1990s, it began the moment a caveman decided the funky berries he found shouldn't be eaten right away, but kept to be traded for a rival cave's hottest dimepiece (or ten-berrypiece in this instance). Speculation has been central to all markets since the dawn of time, and that includes your precious stock market.
As far as REITs having no interest in the possession of the goods themselves, you are utterly clueless. REITs own and operate a great deal of this country's commercial real estate and to say they have no interest in possessing real estate is absurd. As far as the GS Commodity Index, it's away for companies to lower their transaction costs by using a minimal number of different contracts, particularly if they don't have to capacity to practically estimate their energy and raw materials needs.

The purpose of futures is not to take physical delivery, it is to lay off the risk inherent in the use and production of commodities. The delivery aspect is only there so that prices be tied to the actual physical goods and reflect the fundamental value of the underlying commodities.

As far as real estate goes, it's just like others on this thread said: supply and demand. It's the same in every large city that is also a financial center: the money is there but the supply isn't.

To go full circle, if it weren't for people with "no physical interest in the underlying," we'd still be living in caves and inbred as all get out to boot. The caveman had no interest in the berries (the underlying), all he wanted is the reward (the berrypiece). Do you think all the VC investors who invested in Facebook were dying to put profiles with pictures from their last rager and come up witty status updates all day long? Or did they just think the company could work and it was worth funding them considering the possible reward?

So unless you can wrap your head around why people speculate, I would suggest you go back to your cave and enjoy the berries I bring you when I decide to take your finest berrypiece, who wouldn't put out because you were so afraid of risk. Chew on that peasant.

Jun 2, 2011

Look at commodities where futures trading is prohibited by law (Onions are one of them): you see MORE volatility! Onions make oil and corn look like an annuity!

"The American father is never seen in London. He passes his life entirely in Wall Street and communicates with his family once a month by means of a telegram in cipher." - Oscar Wilde

Jun 2, 2011

To clarify, I never said that speculation began in the 1990s, but that overspeculation of real estate started in the 1990s followed by commodities this decade.

REITs and commodity index funds are inherently designed so that they are long-only. So when all these funds grow by several billions of dollars over the decade you certainly do have an effect on the cash price which also effects the physical market as well.

Just look back to 2008 at speculation in crude oil futures, where there was no sudden supply shock or massive growth in demand but crude oil prices spiked to $140/barrel on speculation. Do I think it's evil and criminal? No. But the spike in prices certainly inconvenienced every American in the form of higher gas prices, especially the lower class citizens who pay a larger % of their income on gas.

Yes, commodity futures were meant to "hedge" production... but as Aaron Brown, a former Morgan Stanley quant, described in his book "The Poker Face of Wall Street"

I find it incredible how many finance books explain futures markets with the fairy tale about a farmer and a miller reducing risk by fixing a forward price. This is historical nonsense, no farmers were involved in the creation of futures markets, in fact farmers have historically been opposed to them. It is empirical nonsense, farmers have never been major participants - Aaron Brown

And with the GSCI, the majority of the trading volume on the index as well as the UBS Total Return Commodity Indices and Swaps are all from broker/dealers and mutual/hedge funds not from producers.

At the end of the day, these small price increases just serve as minor inconveniences in the form of higher gas and food prices here, but for much of the emerging world where a majority of the world's population spends anywhere from 30-60% of their income on food, a 10% increase in food prices makes a significant impact.

They who are of the opinion that Money will do everything, may very well be suspected to do everything for Money. ~George Savile

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Jun 2, 2011

op is an idiot.

stop feeding the troll.

/thread

Jun 2, 2011

The fact is the fundamentals are the major reason prices are the way they are. REITs are publicly-listed companies and can be shorted. That article about the GSCI being long-only is complete poppycock. It's easier to short GSCI futures than it is to short a stock. And that Aaron Brown dude is off his rocker. There have always been plenty of ag and energy firms who depend on futures contracts to hedge their production.

You're blaming the wrong people for high food and energy prices. If you want to know where all these distortions are coming from, look to the Fed and their ultra-low interest rates, look to the failure of our regulators when it comes to the financialization of our country. There wouldn't be anything wrong with CDOs and CDSs so long as regulators had actually done their job and prevented widespread fraud (from the mortgage mills all the way to the ratings agencies) from poisoning the system.

Jun 2, 2011

No, not a troll, legitimately trying to have a discussion here about speculation and its effect on goods that people do not have a choice to consume in their daily life....

Yes, you can short REITS as well as the GSCI index, but the creation of funds whose mandates are to invest primarily in those sectors is creating billions of dollars in artificial long only demand. (And yes there are also funds in existence that are short those markets but they make up a very small number vs the number of funds out there)

In 2006 commodity index funds were about $80billion in AUM (http://hsgac.senate.gov/public/_files/SenatePrint1...) that number has quadrupled to about $340 billion in 2010 (not a small number considering that QE2 is about $600 billion) and I imagine that number has only grown larger this year.
(http://www.bloomberg.com/news/2010-11-26/commodity...)
A purchase of one contract from a pure financial institution is no different than a purchase from a producer/farmer since the financial firm could hypothetically take delivery of the good to their front door/storage facility if they really wanted to.

The point that I am trying to convey in the example of cheese is that, for many their sole reason for purchasing cheese futures is merely to make a profit from speculating on cheese as some of them could care less about the actual consumption of it. Whether higher demand for cheese actually materializes doesn't matter as the speculative purchasing of cheese futures is the same as consumers overseas consuming more. If speculators drive the price from 2cents/pound to 20cents a pound, then producers will pass that increase of cost to consumers that include your local pizza shop.

They who are of the opinion that Money will do everything, may very well be suspected to do everything for Money. ~George Savile

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Jun 2, 2011

REITs don't create artificial long-only demand for real estate. These people buy and operate properties using the money raised from public markets. Like any other company, except one that owns real estate.

As far as the GSCI, it's just an index that tracks the performance of a basket of commodities. Retail commodity exposure comes almost entirely from ETFs which obviously aren't long-only. Let it go dude.

Jun 2, 2011

Dan, with posts like these, I began to questions assertions like this:

absurdistan dan:

It wasn't until I started working in finance

Jun 2, 2011

rent controls create shortages --> higher real estate prices

Jun 2, 2011

1) Why exactly is investing in equities optional?
How exactly do people save for retirement? (Maybe you aren't and thus haven't considered the question)

2) Why exactly are equitiy prices rising to infinity a good thing?

If equity prices rise above fundamental then investment decisions are distorted, which has significant real-world consequences. Look at the tens of billions of real money invested in un- or under-productive enterprise during the dot-com bubble, where investors in the secondary market, and companies making direct investments, did some awfully stupid stuff, no different from using resources to dig a few million holes and fill them in again.And as far as the consulting and banking industries are concerned, they probably retrenched by what, 15-25%.

Do you post the first thought that comes across your mind?

Jun 2, 2011
NYC:

1) Why exactly is investing in equities optional?
How exactly do people save for retirement? (Maybe you aren't and thus haven't considered the question)

2) Why exactly are equitiy prices rising to infinity a good thing?

If equity prices rise above fundamental then investment decisions are distorted, which has significant real-world consequences. Look at the tens of billions of real money invested in un- or under-productive enterprise during the dot-com bubble, where investors in the secondary market, and companies making direct investments, did some awfully stupid stuff, no different from using resources to dig a few million holes and fill them in again.And as far as the consulting and banking industries are concerned, they probably retrenched by what, 15-25%.

Do you post the first thought that comes across your mind?

To be fair seeing that the S&P valuation today is the same as it was in 1999 equities might very well be optional for retirement savings :p

Jun 2, 2011
leveredarb:
NYC:

1) Why exactly is investing in equities optional?
How exactly do people save for retirement? (Maybe you aren't and thus haven't considered the question)

2) Why exactly are equitiy prices rising to infinity a good thing?

If equity prices rise above fundamental then investment decisions are distorted, which has significant real-world consequences. Look at the tens of billions of real money invested in un- or under-productive enterprise during the dot-com bubble, where investors in the secondary market, and companies making direct investments, did some awfully stupid stuff, no different from using resources to dig a few million holes and fill them in again.And as far as the consulting and banking industries are concerned, they probably retrenched by what, 15-25%.

Do you post the first thought that comes across your mind?

To be fair seeing that the S&P valuation today is the same as it was in 1999 equities might very well be optional for retirement savings :p

S&P performance reflects the paradox that our largest companies are often our most unstable. It is impossible for a CEO to be in control of every detail of a multi-national. The best large companies have a commitment to de-centralization. See: Market Based Management, Charles Koch.

"The American father is never seen in London. He passes his life entirely in Wall Street and communicates with his family once a month by means of a telegram in cipher." - Oscar Wilde

Jun 5, 2011

dude, canada used to regulate rent prices by setting a price roof.
however, than construction of new buildings stopped and shortage of rooms became apparent.
constructions dont happen if they dont make money

so the result in vancouver rite now is inevitable.

Jun 6, 2011

Dude wtf, aside from what everyone else here has tried to teach you about economics, the MAIN reason that housing prices got out of control up until 2007 and that commodities prices went through the roof in 2008 is the Federal Reserve. That great bastion created by who else? A few bankers and a few cronies in congress. When the Fed prints money it most go somewhere!

The one who does not fall, does not stand up

Jun 2, 2011
ProdigyOfZen:

Dude wtf, aside from what everyone else here has tried to teach you about economics, the MAIN reason that housing prices got out of control up until 2007 and that commodities prices went through the roof in 2008 is the Federal Reserve. That great bastion created by who else? A few bankers and a few cronies in congress. When the Fed prints money it most go somewhere!

A complementary complication to longer-lasting poor policies in NYC.

"The American father is never seen in London. He passes his life entirely in Wall Street and communicates with his family once a month by means of a telegram in cipher." - Oscar Wilde

Jun 7, 2011

Manhattan is not a peninsula, its an ISLAND.

Jun 8, 2011

I wonder what would happen if in order to speculate on the price of commodities you had to prove you had real economic interest in the good itself and its use, and not simple capital gains

Jun 2, 2011
Nyctola:

I wonder what would happen if in order to speculate on the price of commodities you had to prove you had real economic interest in the good itself and its use, and not simple capital gains

Volatility would increase, as it does in everything with trading restrictions (onions are the classic commodity example)

"The American father is never seen in London. He passes his life entirely in Wall Street and communicates with his family once a month by means of a telegram in cipher." - Oscar Wilde

Jun 28, 2011

Sure, minimal wages and substantial costs appear to be more fodder for press gloom, but this is ludicrous. The shortfall between flat salaries and out-of-control costs is way too large a chasm to bridge, according to ninety percent of United States workers interviewed.