I dont know if people followed Delphi CDOs. The subscription to CDOs were much more than the underlying debt itself!! Hence, SEC agreed to settle the default with Cash instead of debt (delphi debt was appreciating after default because people needed to settle the derivative with actual debt!!). So, in a speculative environment, one can "bet" more than the actual physical quantity!!! This is what distinguishes speculation from hedging!!
Also, Milton Friedman opined that, in a capitalism, there is no destabilizing speculation. If there is speculation in a commodity, say oil, then the capitalists will unearth oil and quench the speculators profits. But the error in this argument is that - there is destabilizing speculation (Friedman later stopped opposing destabilizing speculation concept). In the destabilizing speculation, only prices go up, but the physical quantity does not go up very much. This is what is called the crack up boom (the speculation has to become ponzi for the crack up boom). Take the housing for example. The prices went up 300% in CA. The number of new houses went up significantly. Did the ownership increase more than new household formation? Hell no. Before even the house was constructed, it changed ownership couple of times!! If the housing contract changed 5 times before construction it does not mean there were demand for 5 new homes!! Instead, the demand was just 1 home (or even 0) - it is just that 5 speculators passed by!! Likewise, in commodities, the options to buy change hands and need not be ultimately converted to commodity!! Instead one can just cash the option!! That is how you can have more contract than actual quantity that is needed. i.e you dont need hold the 1mpbd in your garage!! It is all virtual!! This is what I believe is speculation. You are correct in saying, In hedging 1 mpd oil should be held in garage!! But in speculation and ponzi, 10 mpd or even 100 mpd can be held virtually!! (In Delphi's case the derivatives were 17 times the total debt!!). The actual producers must be seeing this speculation very well because the consumption is high but not as high as the price indicates!! i.e the commodity producers will not be seeing all the options being converted to purchase!! The producers will still be seeing some spare capacity!! Similarly, in copper, the LME currently has 3 weeks of supply in stock instead of 5 weeks supply in the past (who knows when!?). If the demand was so high, the stocks should be depeleted shouldnt it? i.e if the real world needed it, it will take it from the stock right? why is it not happening? Like the home builders (who sees 5 contracts signed in a preconstruction home), commodity producers will know that speculators are driving the prices. Hell, Delphi would have known that the derivatives were speculation (and not hedging) because the debt level was controlled by Delphi itself!!! |
