Tuesday, March 1, 2011

Financial Markets: Like Cattle in a Thunderstorm

The financial market is a mirror of the economy, the guidebooks tell us. They may be right, at least in the long term. But in the short term other influences may rule, especially politics & psychology.

In recent days the markets are suffering again under a phenomena we see very often, the herding behavior of the market participants. Especially the managers of the hedge funds (big funds which follow no rule and are not controlled by any state agency) behave as a herd that gets in panic and runs in a stampede when lightning strikes.

Now a lot of hedge funds are buying oil just because the oil price is climbing and other hedge funds are buying it. The Australian newspaper "The Sydney Morning Herald" reports on its Internet site that "hedge funds oil bets soar to a record". The investments of the funds and other larger speculators  in oil on the financial markets have risen by 30 percent in the last seven days.

These speculators are betting that the unrest in Libya will spread to other countries and endangers the world supply of oil. This behavior sharply raises the oil price on the financial market. Other funds and speculators jump on the bandwagon just because they bet on oil prices further rising. This herding behavior is spiralling the price of the commodity even higher, a self-fulfilling prophecy.

We saw the same herding behavior in the year 2008. Instead of a sharp recession oil prices were rising steeply. Many hedge funds bought oil in the summer of 2008, because they were betting on further oil price ricess, and that increased the commodity price further.

Now the hedge fund managers, who are often called "smart money", act like a herd again. They react like cattle in a thunderstorm.

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