There has been a lot of talk
on the chat recently about "cornering" the market in Chinese coins. I've heard badon mention that it would only take a relatively small amount of money to corner a particular coin. In this article, I wanted to talk about what cornering is, and why it pretty much never works.
First, what do people mean when they talk about cornering? A corner occurs when a buyer gobbles up a major portion of the supply of a particular good. It doesn't have to be the whole supply, but it must be enough to become a market maker rather than a market taker. In other words, the buyer must control enough to be able to set the prevailing price. Let's look at a hypothetical example:
If you've ever seen the movie Trading Places with Eddie Murphy and Dan Aykroyd (a fictionalized tale of the Hunt brothers exploits in silver), that's what the Duke brothers were trying to pull off in frozen orange juice. They thought they had inside information on the production figures for the upcoming season so they bought every available contract on the commodity. Through continual buying, they planned to be able to restrict the supply and name their own price when they would turn around and sell.
In the movie, the Duke brothers were actually fed false information, and their plan blew up in their faces.
In reality, it is market dynamics that dooms cornering to failure. Let's examine the issues that make cornering nearly impossible.
Issue #1: Supply is not fixed. If a buyer takes up all the available supply at a given price, that indicates to the suppliers/producers to create more. If you are buying tons of orange juice, then orange growers will grow more for next year.
Issue #2: Cornering demand drives up prices. If your plan is to buy and buy and buy, then the prices of the goods will go up and up and up. In part, that is the plan. But the natural consequence is that the one doing the cornering must have extremely deep pockets as the market value keeps rising.
Issue #3: Rising prices attract competitors. Markets are well-known. If a particular stock or commodity rises 300%, then people notice. Other buyers will come in to compete with the planned cornerer. Other sellers will come in to expand what is seen as insufficient supply.
Issue #4: Artificial demand can (and usually does) outstrip natural demand. This is probably the most important problem with cornering. It raises the question of who are you going to sell to? Let's say for the sake of argument that a particular buyer has indeed managed to control 100% of the supply of some good. Now what? If the price of the good has gone beyond what free buyers will pay, then the market collapses. It must always be remembered that the market is not some static thing. If a buyer wants a particular good, but the price goes up too much, the buyer will find a substitute or just not buy that particular thing.
Essentially what we see here is that cornering creates a bubble in a market, and we know how those turn out. The main difference between a bubble and a corner is that a bubble has a massive amount of buyers and a corner has only one. However, the nature of this market action does not mean money can't be made in a cornering operation. The losers are those who are left holding the bag on the collapse. A smart market operator will be selling into the rising prices as competing buyers come into the market.
Here's an applicable quote from the Wikipedia article:
James Fisk, Jay Gould and the Black Friday (1869)
The 1869 Black Friday financial panic in the United States was caused by the efforts of Jay Gould and James Fisk to corner the gold market on the New York Gold Exchange. It was one of several scandals that rocked the presidency of Ulysses S. Grant. When the government gold hit the market, the premium plummeted within minutes and many investors were ruined. Fisk and Gould escaped significant financial harm.
Note the last statement. Jay Gould was one of the best market operators of his day, and got out before the crash.
In the long run, market corners fail because the long run price will reflect overall supply and overall demand. Corners are an attempt to manipulate the demand, but this nets out to zero when the cornerer turns around and becomes a supplier. But because none of this is instantaneous, it creates time periods in which there is opportunity to profit.
A smart trader keeps nimble feet and is ready to go in which ever direction momentum develops.