Originally Posted by
Joe Mioux
Commodities Futures trading provides a means for businesses to protect themselves from rising costs or dwindling profit. It is called hedging.
For Example I could hedge my Natural Gas needs for next Winter's heating season. If for example the price of Feb Natural Gas contract is selling at a price that I find affordable, I could buy a contract and lock in my NG at that price. Come January, I would sell back that contract. During the spot month, the futures price and the cash price merge together.
That model of commodity futures trading works quite well indeed, but it's based on the assumption that most of the people doing the hedging/speculation/whatever are (eventually) consumers of the commodity at some level. In other words, the assumption is that, next January, you will exchange those futures for natural gas, hopefully at a better net rate. But when pension funds start treating the commodity futures themselves as long-term investment vehicles (as opposed to a way to stabilize future needs for the underlying commodity), it effectively removes that amount of the commodity from future consumption, reducing tradable supply: come next January, if the price is still headed up, they have zero incentive to sell because they have no use for the actual commodity. And that, in itself, exerts upward pressure on the price. (In engineering terms, that's called "positive feedback", and it's not a good idea if what you're aiming for is a stable system.)
Another (much less verbose) way of looking at it: at sufficiently high investment levels, "hedging" is indistinguishable from "hoarding".
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