For a profitable punt, join the commodities hunt

MUMBAI: Yes. Commodity speculation is alive and kicking, resulting in commodities futures rising 54% more than what could be explained by the normal equation of supply and demand in a given commodity.

Merrill Lynch says this, based on a study done by measuring speculation based on spot prices of industrial commodities that trade listed futures versus spot prices of commodities that don’t trade listed futures.

Of course some may discredit such an approach, but it is an old fact that futures markets are places where speculation money routinely comes in, in search of a quick buck.

Such money doesn’t usually go to the spot markets where the physical deliveries can be time-consuming and cumbersome.

Speculative money also frequents futures markets because of lesser initial cost.

Commodities, like stocks, can be bought on margin. However, unlike stocks — where an investor has to often put up up to 50% of the price of the shares — the margins on commodities are often as low as 5%.

This means that while you need to pay $50 for every stock purchase worth, you may buy $100 worth of gold by paying as little as $7. And here comes the rule of the enhanced margins: if gold goes up just by $7, you’ve doubled your money.

Of course the most important reason for speculators has been the gains in prices of virtually all commodities. They have offered some of the most stunning returns of 2005L: Natural gas went up by 93.87%, sugar: 60.09%, heating oil 44.94%, crude oil 44.92%, silver  40.89%, copper  37.90%, soybean meal 21.70%, cotton 21.04%, gold 20.85%, and soybeans 14.57%.

The Bank of Nova Scotia commodity price index enjoyed a gain of over 26% in 2005, its biggest jump since 1979, and third biggest since the Arab oil embargo drove it up almost 43% in 1973.

Even though some commodities have experienced a pull-back in prices during May 11, 2006, meltdown, the returns they are set to provide during 2006 are still phenomenal.
No wonder more investors are piling their money into the commodities. According to a recent study by Barclays Capital, about 40% of survey respondents in Europe emphasised that their portfolio will surely contain some commodities during the next three years.

As can be understood, while some of these respondents will be long-term players, many might be just speculators, getting in and out at the drop of a trend-driven hat.
There is yet another reason why speculators are attracted by the commodity futures markets: they volatility they offer. It is a known fact that during past few years the commodities have been volatile, and there is nothing the speculators love more than volatility-driven swing in the prices.

Volatility has been more in silver than gold. Last year, while gold appreciated by 20%, silver went up by 38%. In 2004, the story was same; gold up by 4.8%, silver up by 13.2%. And 2003 was also similar, with gold rising 22% and silver 28%.

The same trend has continued in 2006. A comparison of gold and silver prices year to date (December 24) shows that while silver has appreciated 38%, gold has risen only 19%.

Speculation is, in fact, ingrained in futures markets. Although the regulators continue to battle against it, they haven’t been able to eradicate speculation from the futures markets.

Of course, it must be mentioned that speculation is also necessary. Speculators provide good depth to the market, by their participation they reduce the bid/ask spreads which make trading decisions easier for other traders.