What is Speculation?
By speculation is meant the purchase or sale of anything in the hope of profit from anticipated change in price. The essence of speculation lies in the forecasting of price movements and buying and selling for profit.
‘Speculation’ otherwise called dealings in future constitutes an essential feature of modern markets. It arises only in those markets in which demand and supply conditions are unpredictable and the prices are highly fluctuating. Speculators purchase or sell in anticipation of price changes and attempt to profit thereby.
Places where speculative transactions takes place
Speculative transactions takes places in
1. Produce Exchanges:- Markets for agricultural commodities like wheat, coffee, oil, cotton etc.
2. Stock Exchanges:- Markets for invested capital, namely stocks and shares; and
3. Bullion Exchange:- Markets for precious metals like gold and silver.
Example of Speculation Transaction
Suppose, the spot price (i.e., price prevailing in the market at a point of time when we want to buy the commodity actually) of raw cotton is Rs.1,000 per bale. The supply of raw cotton in the market may not be uniform and it may go up or down depending on climatic conditions and the harvest of cotton.
Suppose a speculator anticipates a fall in the supply of cotton in the market in three months time and believes that in all probabilities the price of cotton would go up after three months due to reduced supply.
On this calculation, the speculator will buy now at current prices (Rs. 1,000 per bale) a certain specified quantity of cotton, say 100 bales and the seller will be asked to deliver the commodity after three months. This means actual delivery of the commodity will not take place immediately. The price will be settled at the prevailing rate and the seller is given three months time.
Suppose after three months, at the due date, the price of cotton has increased from Rs.1,000 to Rs.1,020 per bale, the speculator will gain Rs.20 per bale and in the transaction he will profit Rs.2,000.
Suppose on the due date of delivery, the price of cotton is lower than the original price settled, the speculator will lose in the transaction. In practice, the accounts between the buyer and the seller will be settled only by paying the difference of amount between the agreed price and the prevailing price.
Kinds of Speculation
Speculative activity undertaken with genuine intention of dealing with markets as they are, may be called simple speculation. The simple speculator does not consider himself to have any influence on the market price and believes that the prices are changing quite independently of his own activities. He either buys or sells in an attempt to make profit depending on the prevailing prices and anticipated prices. This type of speculation is a constructive one and this is also called productive speculation by Lerner. Taussig calls this as mercantile speculation.
But there are other types of speculators who are called by Lerner as aggressive speculators. This speculation is done by a few rich and powerful operators who organize themselves into monopolistic combination in order to tilt the price in their favour.
In a sense, all businessmen and traders are simple speculators as their production activities include speculation. Simple and mercantile speculation is essential and also beneficial to the market.
Genesis of Speculation
There are different stages through which a commodity has to pass from the point where it is produced to the point where it is finally consumed.
Assembling, grading, standardizing, storing, transporting, wholesaling, etc., all play their part and specialized agencies have come into existence to perform these services in marketing. While these services are more conspicuous because of the significant push they give to the goods in their movement from producer to consumer, there are two important services which go rather unnoticed and which are perhaps more important.
The first one is the finance for marketing. Banks and investment houses come forward for financing the wheels of marketing. But risk-bearing is a special problem in marketing and forward markets undertake the risk-bearing through the operation of the speculators.
Risks that can be insured against, in the marketing process, are not risks at all. The pattern of economy and the element of time present certain risks in the marketing process which cannot be insured. Goods have to be produced, stored and transported before they are sold to consumers and it is the element of time between production and consumption which renders risk bearing indispensable.
Assuming the goods have to be stored for a longer time, somebody has to bear the risk arising out of a possible change in the price between the two points of time covering the process. Since certain type of goods take a long time to produce, the production cannot be started until an assurance is forthcoming that the goods would be sold profitably after they are produced.
Supposing there are wide fluctuations in the price of a commodity, the products are not likely to produce the commodity, fearing fall in the price and the consequent loss. This would lead to uneven flow of the goods. In order that all gains and losses may be evened out over a period of time and to ensure smooth and uninterrupted flow of goods, the service of risk-bearing has become essential and this is done by speculators in their forward contracts.
Risk-bearing and ensuring smooth flow of goods should be the objective of speculative transaction taking place in forward markets
Speculation is to be met within markets where there are possibilities of price fluctuations. In commodities like cotton, wheat or gold, dealers legitimately speculate on the probability of rise or fall in the prices of commodities. If they anticipate a rise in price in the future they buy long. If they anticipate fall in price in the future, they sell short. These dealers are experts and they posses specialized knowledge of the market conditions. They forecast demand and supply and thus perform a useful function to the market.
The transactions in stock exchanges are highly risky and there are great chances for making huge profits or heavy losses. Generally, it is only the speculation in stock exchange market, which has come to be called the speculation proper.
There are special class of speculators in the speculative market. They are called BULLS and BEARS. Bulls always buy long and they will be interested in rising or tossing up price. By their hectic activity in buying at a premium would set the market force to demand more and more and the price will be increased.
On the other hand, Bears are interested in pulling down price and they will always sell short. Their activity of selling at a discount would bring down the demand and with it the price will be brought down.