Risk Management vs. Speculation
Risk management is identifying and mitigating exposure. Speculation is creating and maintaining exposure. Both of these processes can happen intentionally or unintentionally, and both can happen precisely or imprecisely. They can both coincide or not, and neither of them is easy.
At Quartzite Risk Management LLC (Quartzite), we'd argue that successful speculation is extremely difficult. To be a successful speculator over the long run, one needs to have an edge (more about edge) or advantage. Even then, that advantage can be fleeting. Markets are always changing, and what worked yesterday might not work today. So, we won't say speculation is impossible, just that it's hard.
We'd further argue that successful speculation cannot happen using a single system within a limited number of markets. Even if one had a profitable system confined to a small group of markets, that system could not be positioned in those markets all the time. Any given market is rarely, if ever, predictable. So, one's system would necessarily be out of the markets most of the time. Limiting one's speculations to one side of the market further compounds this problem. If a speculative system is limited to only profiting when markets go up, it's even less likely to be in the market at any point in time.
One commonly-held belief that might contradict the above opinion is investing in the stock market. We'd argue that investing is either a unique sub-type of speculation or a different thing altogether. Generally, the stock market is a collection of profitable businesses. Not all stocks represent profitable companies. Though in general broad market measures like the Dow or S&P reflect the performance of productive enterprises. It's this productivity that makes long term investments in the stock market seem like a good bet. The profitability of these businesses results in what traders might call a positive cost-of-carry. If a company is profitable, then the longer one owns it, the more profits one accumulates. The long term accumulation of profits can offset mistakes in the short term.
Unlike successful companies, commodities exhibit a negative cost-of-carry. Commodities need to be stored, insured, and handled - this costs money. Nor do commodities produce anything of value on their own. Corn in the bin, for example, does not create profits without favorable market moves. Because of this, we'd argue that outright ownership of commodities is necessarily speculative. Owning commodities cannot be an investment the same way owning a productive business is an investment. All else being equal, commodity ownership incurs expenses as time passes, and business ownership accumulates profits - these headwinds and tailwinds are significant over the long run.
All of this brings us to risk management. At Quartzite, our job is to help producers minimize their exposure to the commodity markets. We won't say that a given market cannot behave predictably from time-to-time. We will, however, claim that no market is predictable all the time, more so when that predictability is limited to one side of the market. We are not in the business of predicting. Instead, Quartzite is in the business of measuring and mitigating risk. We're experts in the field, and we find it a more productive use of our time and our customers' time than guessing where markets are going. We're not against speculation - there are times and places for it. However, we see no reason that a producer's business should live and die with rises and falls in the markets. Instead, we want to give our clients the stability to invest in themselves and their businesses. We do our best to take the market out of the equation, and that is risk management.
