Philosophy behind trading Commodity Futures

[LeeD]

Quote from jay21:

In fact, I would argue due to its universal demand, oil is inherently not a free market. Nobody can live without energy, and energy comes from oil. The demand will always be there, increasing, insatiable. Same argument with food and healthcare. Nobody can live without them. Oil, Food, and Healthcare are naturally not a free market. In contrast, Gold is a free market, because even a gold bug can still live without gold around. Stocks too.

Quote from heech:

Bizarre statement, and I have no idea where you're going with this. Of course you can live "without" oil and food... or at least you'd live differently.

Just to elaborate on what Heech wrote...

You *CAN* live without energy. This would through civilization a hundred years back... but you can. Further, energy is "generic". There are lots of replacements for oil. A number of cars use natural gas or electricity (which in turn is mostly produced from coal). Some drive on ethanol (Bill Gates and Goldman Sach invested in ethanol factories just under 10 years ago). The only application where oil is irreplaceable is making plastic and synthetic clothes... but then there is no fundamental reason why plastic rubbish bins should be cheaper than wooden ones or acrylic pants cheaper than cotton pants.

Same goes for food. You can't live without food at all but you can substitute bananas for earthworms (a few researchers claim these are exceptionally nutricious... and can even be consumed raw). If imports stop, after the day job you would go to a strip of agricultural lands and grow vegetables for personal consumption. (Potatoes are particularly rich in calaories.) A few countires survived a crisis worse than potenatial Greek default this way.

Healthcare is pretty much a free market. Look at the number of americans who travel to India to have an operation. The only exception is drugs. The US givernment is forbidden by law to negotiate prices with suppliers. That's one of the reasosn that Medicare is such a burden... and why the same drugs in Canada are so much cheaper.

 

[heech]

Quote from LeeD:

This explanation ignores the fact that a number of speculators do store the underlying commodity in expectation of price growth. They would rent a few ships, fill them with oil and put these offshore for a year or more.

Well, in the previous paragraph I said specifically I was referring to speculators who don't want to take delivery. As far as those that do, it doesn't change the long term picture: prices will still ultimately have to converge to fundamentals, and these guys pay a penalty (in storage fees) for as long as they hold stuff off the market.

The only other scenario we haven't talked about is the one where speculators attempt to corner the market. If you literally buy up nearly ALL of crude or grain, you as speculator will get to dictate terms to everyone else consuming it. This is of course why we have position limits (in the US).

 

[FightTheFuture]

Several times per year there are individuals like jay21-his writing style, attitude and even the same subject matter sounds familiar, banned previously I suspect. Or these market bashers are of the same genetics. These people seem to have their minds made up before they even start a thread. They have issues, grudges and I doubt few here have a psych major to help them.

Perhaps there could be a reference section of ET whatever, that these people can be referred to on the role and importance of the speculator, trader and even markets. Something that can be expanded, improved, references added to it. Something like that instead of the knowledgeable ones with good writing skills wasting so much time when it has been said so many times already. Threads can still be started with all kinds of arguments and bashing, but at least there could be something of permanent substance, facts, references, studies to refer to. I don't think most of us have the writing skills to express that, leaving the same members to repeat themselves if they have the time and energy for it.

Some very good posts here that took a lot of time to write.

 

[LeeD]

Quote from heech:

The only other scenario we haven't talked about is the one where speculators attempt to corner the market. If you literally buy up nearly ALL of crude or grain, you as speculator will get to dictate terms to everyone else consuming it. This is of course why we have position limits (in the US).

I understand the limits are only applicable to futures, not the underlying commodity.

In addition, although intorduction of position limits was legislated in 2009, CFTC intends to implement position limits on oil only in 2012 (that is assuming no further delays occur).

http://www.heatingoil.com/blog/cftc...-take-effect-until-2012-agency-announces0118/

Evidently, CFTC is not in a rush: http://www.nasdaq.com/aspx/stock-ma...cftc-to-impose-position-limits-on-oil-markets

To make it even more fun, I understand the proposed limits would allow a single speculator to control 1/3 of the oil supply. (In other words, 3 colluding speculators will be able to completely corner the market even after the limits are intorduced in 2012.)

 

[bone]

Commodities are only worth what people are willing to pay for them.

And that is an absolute.

 

[brownsfan019]

I'll just say what I tell anyone who gives me the 'look' when they learn I am one of those evil oil traders/speculators - I am more than happy to make money by driving prices DOWN as much as I do when it goes UP. I really don't care where the market goes, just as long as it's going somewhere.

I then explain how the media loves to blame the speculators for high prices, but conveniently moves on to another topic when those same jerks drive prices down.

So if you want to blame us for driving prices up, make sure to give me a call and say Thank You when prices come back down (as they have recently). But no thank you calls or emails (yet).

 

[LeeD]

Quote from brownsfan019:

I'll just say what I tell anyone who gives me the 'look' when they learn I am one of those evil oil traders/speculators - I am more than happy to make money by driving prices DOWN as much as I do when it goes UP. I really don't care where the market goes, just as long as it's going somewhere.

I then explain how the media loves to blame the speculators for high prices, but conveniently moves on to another topic when those same jerks drive prices down.

So if you want to blame us for driving prices up, make sure to give me a call and say Thank You when prices come back down (as they have recently). But no thank you calls or emails (yet).

As I explain in a different thread, high volatility results in higher consumer prices too. So, it largely doesn't matter in which direction speculators drive prices

The reason politicians don't credit speculators with falling commodity prices is they are busy taking credit themselves.

 

[heech]

Quote from LeeD:

As I explain in a different thread, high volatility results in higher consumer prices too. So, it largely doesn't matter in which direction speculators drive prices .

I don't understand your gas station example in that thread. Why wouldn't I just sell gasoline at the price I paid plus a small percentage premium? Why do I need to try to anticipate the "most" price could be in the following week? Or, why wouldn't I just adjust prices daily...?

 

[lynx]

Quote from heech:

I don't understand your gas station example in that thread. Why wouldn't I just sell gasoline at the price I paid plus a small percentage premium? Why do I need to try to anticipate the "most" price could be in the following week? Or, why wouldn't I just adjust prices daily...?

I think he was trying to say that the increase in price from week to week is greater than the net profit the gas station makes on the gas.

So say you were storing $50,000 worth of gas in your tanks. You sell it all at a markup of 1% for a total of $50,500. Take out say $250 for expenses and you've got $50,250. Net profit is 0.5%. But the next time you want to fill your tanks, gas has gone up 1.5% so you need to come up with $50,750 to buy the next round.

It doesn't take very many weeks of this before you can't afford to fill your tanks completely. Now you've got less gas to sell and consequently less dollars in profit. But your expenses haven't changed, so your percentage net profit is now even lower. You can see where this will end up.

You could get a loan to fill in the gap, but you've also got to consider the costs of that loan, and the ability to pay it back when your margins are so slim.

Your suggestion of adjusting the prices on a daily basis doesn't work because you have to raise them higher to get the same average price you would have gotten if you'd raised them earlier. Remember that you are competing with all the other gas stations too, so you can't just raise prices as high as you like at any time.

I'm pretty sure that the real secret to running a gas station is to postpone lowering prices as long as possible after gas prices go down. You've got a little bit of slack to work with because customers are used to paying a high price and they are less likely to notice a delayed price decrease then they are to notice a price increase.

 

[LeeD]

Quote from lynx:

I'm pretty sure that the real secret to running a gas station is to postpone lowering prices as long as possible after gas prices go down. You've got a little bit of slack to work with because customers are used to paying a high price and they are less likely to notice a delayed price decrease then they are to notice a price increase.

Haha, very good point! I guess the fact that wholesale gasoline price went down 20% or so but retailers are not in rush to lower their prices is what soem refer to as "gouging" in the other thread

Thanks for the illustration of why price volatility means retailer need higher mark-up.

Quote from heech:

I don't understand your gas station example in that thread. Why wouldn't I just sell gasoline at the price I paid plus a small percentage premium? Why do I need to try to anticipate the "most" price could be in the following week? Or, why wouldn't I just adjust prices daily...?

Because you sell gasoline every day but you buy it only from time to time.

Suppose like in Lynx's example, the petrol retailer starts with 50,000 worth of gasoline. For simplicity, let's ignore for a moment the cost of running the gas station... and assume the retailer just wants to break even. To simplify calculation, suppose the gas station is only opne 5 days a week and equal amounts of petrol are sold every day.

It's not uncommon that along with oil, gas would increase in price by 10% in a week. If the increase in price is gradual, it's 2% per day. Assuming the retailer sells gas at "the market" price on each day, the receivables:
(Scenario 1)
Day 1: 10,200
Day 2: 10,400
Day 3: 10,600
Day 4: 10,800
Day 5: 11,000
Tatal: 53,000.

However, the cost of refilling the gas station tank is 55,000. So, the retailer is $2,000 short. So, he needs to charge extra $2,000 (or approx 4%) so that he can afford to refill the tank in case prices rise.

Now, if the whole 10% increase happens on the last day, the receivables are
(Scenario 2)
Day 1: 10,000
Day 2: 10,000
Day 3: 10,000
Day 4: 10,000
Day 5: 11,000
Total: 51,000
and the retailer is $4,000 short to refill the gas station tank.

So, the retailer has to add substantial mark-up just so that he can afford to replenish the stock. He needs to add to the price extra $4,000 or astonishing 8% just so that he can affor to re-stock.

Now factor in that receivables less the original cost is considered profit for tax purposes. So, although the retailer can buy less petrol with the money, he still has to pay tax. So, the retailer has to add even higher a mark-up just to break even after taxes.