Inflationomics

Hedgers vs. Speculators

Hedgers have a very different mind-set (and purpose) from speculators.  Hedgers want to transfer the risk of price change away from themselves.  They do not cherish the perpetual fluctuations in prices that stem from changes in supply and demand.  They prefer to transfer that risk of price change to others who are willing to assume such a risk.

Speculators, on the other hand, want to assume the risk of price change in an attempt to profit from it.  They realize that if they purchase something and the price goes up, they can profit by selling it at a higher price later.  Conversely, if they sell something short and buy it back later at a lower price, they can profit as well.

In the agricultural community, it is possible for farmers and grain elevators to transfer the risk of price change in their commodities by hedging with futures contracts and/or futures options contracts, for example.  More specifically, if a grain farmer believes that the price of his crop will drop between the time he plants it and the time he harvests it, he can hedge against the possible price decline by selling short with a futures contract (of the same quantity of grain as he is growing).  By selling short, he sells the grain with the promise to buy the contract back later or deliver his grain as satisfaction on the contract.  If he buys the contract back at a lower price, he pockets the difference and makes money on his hedge.  In effect, the farmer reduces his losses in his cash market position with a gain on his futures hedge.  This obviously assumes that the futures market prices parallel the cash market prices (and they generally do because the futures markets do eventually provide for delivery of the underlying cash market commodity).

In the mining industry and manufacturing industry (where metals are used), it is possible to hedge the risk of price change in their commodities by hedging with futures contracts and/or futures options contracts, as well.  There are futures contracts for gold, silver, copper, aluminum, zinc, tin, lead, nickel, steel billet, cobalt, molybdenum, platinum and palladium.

In the energy industry it is possible to hedge the risk of price change with energy futures and/or futures options.  There are crude oil, heating oil, gasoline, coal, natural gas, ethanol, gas oil, kerosene, electricity and even emissions futures.

It is also possible to hedge against the change in relative currency values in the futures industry and forex markets, by buying or selling foreign currencies and their futures contracts. There’s a wide variety of currency futures for major (and not-so-major currencies) available around the world.

Another way to hedge against the decline in value of a currency is to exchange that currency for tangible assets that hold their value against paper currencies or that can be used instead of a currency.  Two ideal substitutes for any paper currency are gold and silver.  They have been used far longer as money than any paper currency.

The important thing to remember with regard to hedgers and speculators is that:

Anyone who is not a hedger is a speculator.

If you aren’t protecting yourself from a price rise or decline in “your” commodity or currency, you are speculating that the price will either move in your favor or hold its value.

So which are you, a hedger or a speculator?

If you are holding U.S. dollars, for example, without owning gold or silver or some other currency or asset that goes up when the U.S. dollar goes down, then you are a speculator.  You are speculating that the purchasing power of the U.S. dollar will hold up in the future.  If you don’t believe that the U.S. dollar’s purchasing power will be maintained, then you could hedge against the dollar’s decline by purchasing tangible assets, including gold and silver.  It’s up to you:  hedger or speculator?

Robert Jackson Smith

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