Just this last month, the Senate Judiciary Committee debased the integrity of our government and insulted the American people by harassing executives from some of the world’s largest oil companies. The premise of the hearings was that oil and petrol prices are high because of a global corporate conspiracy. Today, the Financial Times reports that a similar scapegoating effort is being directed by world leaders towards oil “speculators.”  Politicians are constantly on the hunt for quick answers to dumb questions, so let’s clarify a few things about the role of “speculators” in markets…

Commodities, such as oil, wheat, and gold, are traded on exchanges for a reason. Some of the reasons are hard to vilify, such as prudent farmers locking in wheat prices prior to harvest, or airlines locking in fuel prices in advance. Still others, such as exchange-traded commodities funds, offer the average Rob (or Joe) an historically unprecedented opportunity to participate in markets in which access has never before been granted. You might wonder why an average Rob, living in urban Los Angeles, would want to meddle in commodities for which he has no direct interest? Enhanced asset class diversification through commodities offsets some of the systemic risks of traditional equity and bond markets. Am I the evil speculator of which the global heads of state deride as greedily warping energy markets? No, I am a regular person behaving perfectly rationally to safeguard my life’s savings and retirement assets.

Commodities transactions boil down to risk transfer. Cautious farmers transfer the risk of falling prices to market “speculators,” who assume that risk for a fee. Other transactions, such as buying commodities through an ETF, offer the world the advantage of price stability, not instability. As prices fall, “speculators” again come to the rescue and start buying. As prices rise, the incentive is to sell. In effect, speculators act as safety valves – buying surplus during periods of waning demand and selling when the world needs it. This has often been the function of governments throughout history, except in this case, individuals assume all risk and there’s no need for a standing army of bureaucrats. I can assure you that individuals acting in rational self interest are far more efficient, in aggregate, than a government equivalent scheme.

Treasury Secretary Hank Paulson, was one of the few to abandon political rhetoric and speak the truth: “People want to look for short term solutions. But the danger of people saying this [energy price increases] is all speculators is that we won’t do what we need to do.”

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