Daily Speculations

The Web Site of Victor Niederhoffer and Laurel Kenner

Dedicated to the scientific method, free markets, ballyhoo deflation, value creation, and laughter. A forum for us to use our meager abilities to make the world of specinvestments a better place.

 

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4/11/2005
Mark Mahorney on Squeezes

People chase high returns wherever they are. Always have, always will. Sometimes this leads to bubbles, sudden decline in interest and price collapse. But really, though no one ever sees it this way, bubbles can be formed on the short or long side and a short squeeze could be viewed as the bursting of a short bubble. Excessive demand for shorting followed by a sudden shift in expectations for the underlying security or contract, or in the expectation of how other speculators will perceive the value of the underlying security. The latter often having more to do with price in the short run where excessive speculation occurs, and supply and demand dictating the long run.

Farmers are not exempt. They are likely to chase beans en masse next year, depressing bean prices, and appreciating corn. Though I suspect that the gradual increase in large scale corporate farming will serve to reduce such wide price swings in the long run.

Ironically, I think the independent farmers inability to weather drastic price fluctuations leads to actions that increase them, and in turn has led to farmers going belly up and selling out to corporations that can better weather such price fluctuations. But corporations probably also mute them, because they can stick with a crop and not be as quick to chase prices.

I also think market forces move over time reduce drastic swings and damaging bubbles. For one, after every major implosion regulations are created or upheld and peoples expectations are altered. Accounting improves, etc...

You should think of the ability to speculate as a service and the securities and contracts as products. There is demand from speculators for these products and services and the markets supply them.

Vegas has continued to grow drastically even in the face of alternatives and substitutes because instead of taking away business riverboats and online gaming have served to grow the market, breeding new gamblers.

It's high prices that reduce demand. And all the additional supply of gambling alternatives and substitutes is serving to keep prices in check.

In the mid 90s all the most esteemed business experts thought computers would replace paper. They couldn't have been more wrong. Computers increased peoples productivity, despite what conservative old business gurus like Drucker think, and personal desktop laser printers has led to vastly more paper usage, not less.

The Internet has made it easier for individuals to do research, lowered commissions, increased competition among brokerages and simplified the process of opening accounts. This has served to grow the market for speculation.

In fact, when I got Vic's first book when it was first published and even when I got on this list, I guess it's been four years ago now, the word speculation was virtually a dirty word. Some of the early postings on this list involved defending speculation and the purpose that speculators served in the markets. But, it was also a word long fallen out of favor. A word brought back from the dead and put to use by Vic alone, as he so often does with words that I'm quite sure all of us including even the most intellectual snobs (I love intellectualism, despise closed-minded intellectual snobbery) secretly find ourselves looking up the meaning of. Today Google brings up 10 million hits on the word speculation!

The Internet has also made it much easier for people to find jobs in other locations. The result has been that in popular markets like Denver housing builders haven't been able to keep pace with demand. Prices rose even as Denver was hit harder than most cities by recession. Many of those laid off at some point in the past few years are still struggling to find regular permanent work and are settling for salaries half what they used to be, while competing with the many people still migrating to the area despite its struggles. They are paying premium prices for the modern equivalent of shoddily built row / track homes and fighting congestion that the city is short sighted in solving.

The digressions are leading to the point that the markets are responding to a rapidly growing market for speculative goods and services. You can see this in overall volume growth and stock price of the CME, for example. But speculators don't care whether a contract is fiat in nature or not. By that I mean whether a contract is tied to say a car load of beans or a contract on a nondeliverable such as interest rates. That can lead to more demand for bean contracts than there are beans to contract possibly causing prices to be exaggerated either long or short relative to fundamental supply and demand. In the long run the markets will counter this demand with new products that will serve to reduce volatility.

I believe that the growth in interest in the commodities and futures markets is due to both the uncertainty in equities and the growth in the gambling market. I believe that the interest in online gaming is spilling over into the markets as another alternative or substitute for gambling. That gaming is creating a new breed of speculator, making these markets a very dangerous place for amateur investors and really everyone. These markets are acting just like stocks were in the mid to late '90s when I was one of those crazed stock gamblers.

But there will always be speculators seeking out the wildest volatility. Hence the interest in buying the stocks of Chinese communist government owned utilities and manufacturers. I would include the gold bugs in this category of speculators, but for different reasons. They are not a very rational bunch and not quick to run scared even in the face of a sudden interest in the dollar (several major financial institutions have shifted to a bullish stance on the dollar in the past week or so), because they believe so resolutely in their 'end of civilization' scenario.

Buffett seems to be in this camp with his comments in his annual report about Americans soon becoming share croppers to the rest of the world and shorting the dollar to the tune of $22 billion. Of course, for all we know he could be selling or already sold many of his foreign currency contracts after luring billions of dollars out of his Buffettopian followers into foreign securities, leaving them out to dry. But that would be giving him too much credit.