The commodities markets, just like the bond or stock markets, are populated by traders whose primary interest is in making short-term profits by speculating whether the price of a security will go up or go down. Because speculators, unlike commercial users who are using the markets for hedging purposes, are simply interested in making profits, they will tend to move the markets in different ways. Although speculators provide muchneeded liquidity to the markets (particularly in commodity futures markets), they can also tend to increase market volatility, especially when they begin exhibiting what one Alan Greenspan termed “irrational exuberance.” Because speculators can get out of control, as they did during the dot.com bubble, always be aware of the amount of speculative activity going on in the markets. The amount of speculative money involved in commodity markets is in constant fluctuation, but as a general rule, most commodity futures markets contain about 75 percent commercial users and 25 percent speculators.
Although I’m bullish on commodities because of the fundamental supply and demand story, too much speculative money coming into the commodities markets can have detrimental effects. I anticipate that there will be times when speculators drive the prices of commodities in excess of the fundamentals. If you see too much speculative activity, it’s probably a good idea to simply get out of the markets. If you trade commodities, constantly check the pulse of the markets, finding out as much as possible about who the market participants are so that you can distinguish between the commercial users and the speculators. One source I recommend you check out is the Commitment of Traders report which is put out by the Commodity Futures Trading Commission (CFTC). This report is available online at www.cftc.gov/cftc/cftccotreports.htm and gives you a detailed look at the market participants.
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