Speculation is unlike arbitrage, because positive returns are not guaranteed.

Speculators derive income by buying something at a low price and storing it in the hope of selling it later at a higher price.

No one can predict the future with certainty, so this time delay makes speculation risky. Speculators who predict correctly can make fortunes, but they go broke and cease being speculators if they are frequently wrong.

 

      If speculators believe that prices will soon rise, then they expect demands to grow faster than supplies. They respond by buying now, increasing the current demand and price. For example, expectations that bacon prices will soon rise cause speculators to buy and store pork bellies (the source of bacon) right now, driving up the current price. Does this raise prices later? NO! If speculators are more often right than wrong, they sell when prices are high and add to the supply at that time. When bacon speculators sell the stored pork bellies, the price of bacon is reduced relative to what it otherwise would have been. Thus, successful speculation shifts the consumption of a good from a period in which it would have a relatively low value into a period when its value to consumers is higher. In the 1970s and 80s the Hunt family, a family made rich thanks to Texan oil and what many claimed to be the richest family in America at the time, along with wealthy Arabs and a couple of other wealthy Americans speculated on the silver market by buying on the market what amounted to half of the world’s deliverable supply of silver. Their actions pushed the price of silver up from less than 2 dollars an ounce in 1973 to an all-time high of 54 dollars an ounce in the early 80s. As a consequence, the price of gold (a close substitute in many of silver’s uses, from jewelry to dental fillings) catapulted from under 100 dollars an ounce in the first part of the 70s to over 800 dollars in 1980. In 1988, the Hunts were convicted of conspiring to manipulate the market. When markets crash and people starve because of one man or group’s speculation, it may turn into a crime.

 

      Correct speculation reduces price peaks and boosts depressed prices. Thus, successful speculators dampen price swings and, by absorbing some risks to others of doing business, raise net incomes for ultimate suppliers. Overall, costs fall because speculators absorb risks and the prices consumers pay are lower and more predictable. All types of intermediation tend to be very competitive, so on average, after adjusting for risk, incomes from these activities tend to be about the same as the incomes intermediaries could have earned in their best alternative employment.