Business
|
Investment
14 •
The Lion King
• July - September 2015
By Olawale Hamed
G
lobal financial markets are
driven primarily by two factors:
demand and supply, which
ultimately determine price levels and
direction. Demand and supply are
further driven by several factors one
of which is speculation. Other factors
include the activities of hedgers, arbi-
tragers and investors.
Hedgers seek to offset pre-existing risk,
arbitragers seek to take advantage
of financial instrument price differenc-
es across different market segments,
while investors seek to profit through
long term ownership of financial instru-
ments or assets.
Speculation involves trading in finan-
cial assets such as stocks, commodi-
ties and foreign currencies in the hope
of gain, albeit with the risk of loss.
Speculators discount underlying gains
in financial assets such as interest,
capital gains and dividends and focus
largely on changes in market value of
the financial assets as a result of price
movements.
A speculator has only one goal – prof-
it. Given that he seeks to take advan-
tage of arbitrage opportunities in the
financial system, speculators often find
themselves at cross purposes with reg-
ulators and the real sector. In the pro-
cess of seeking to benefit from tem-
porary structural imbalances in mar-
kets, speculators are often accused
of destroying economic value usually
because their activities often aggra-
vate an existing, unwanted situation.
Career speculators analyse past and
present fundamentals in an attempt
to establish trends. Based on these
trends, they establish a view on mar-
ket expectation and take a position
based on their expectation.
Their exposures maybe as a result of
buying, selling or short selling any par-
ticular trade-able asset with the aim
of reversing (squaring) the exposure
at future profitable levels. Other spec-
ulators (scavengers) simply observe
structural imbalances within the finan-
cial system and seek to benefit from
the imbalances usually to the overall
detriment of the economy and often
against the wish of financial regula-
tors.
Despite being seen as undesirable,
activities of speculators actually do
have some beneficial impact on the
economy. Perhaps the most impor-
tant advantage of speculation to the
economy is the liquidity it brings to
markets.
Real demand and supply may not
always be available and cannot suffi-
ciently keepmarkets active at all times.
Since market efficiency is measured in
terms of effective pricing mechanism,
size and depth, the activities of specu-
lators become relevant in buoying
markets towards the desired levels of
efficiency as they provide “artificial”
demand when “real demand” is not
available and “artificial” supply when
“real supply” is not available.
The risk they take (funded by their
economic benefits
of speculation
capital) is against the expectation
that real demand and supply will help
push prices to equilibrium. It is a spec-
ulator’s ability to accurately guess
where the equilibrium price levels set
in that ultimately gives him his reward.
Speculators further enhance market
efficiency through their presence in
the markets by making it easy for asset
holders and exposed parties to mea-
sure risk by price discovery. A market
without speculators would only be
active periodically, i.e. when a real
buyer and a real seller exist simultane-
ously.
The price at which their trade is struck
would then be recorded as the refer-
ence rate. However, with speculators
in the market, trade volumes are high
and frequent thus making it easy to
record series of reference prices for
asset valuation and risk evaluation
purposes.
Finally, commodity speculators willing
to buy products up front (via deriva-
tives) actually indirectly boost the pro-
duction of that product by creating
up-front demand. This triggers pro-
duction with its attendant desirable
effects on the overall economy.
