There has been so much writing about the state of economies of the world from the continents of US to Europe and to Asia. One thing that has been written about more than anything else in the last three years is the price of commodities, especially the prices of oil and gold.

In recent months, the prices of these two commodities have risen to stratospheric levels not seen in a long time. Again, a lot of writings have been given to explain these rises. From the economics perspective of basic demand and supply to reasons such as the threat of war and the depleting reserves of these commodities.

While some of these arguments may bear some truths, there remains one reason for such rises.

In simple terms, these funds are used to protect against the volatile shifts and movements in the capital markets by providing a protection against that investment.

For a long time, hedge funds bas been looking for arbitrage opportunities to provide returns on their investment. What has evolved from protecting their investment as become a primary weapon to “dictate” and “determine” the prices of oil and gold.

Basic economics theory dictates that demand must equal supply. What happens when the demands for oil and gold outstrips demands? The simple answer will be generally prices will be driven up a level where demand will equal supply and the cycle continues.

What happens when hedge funds say that oil and gold reserves are scare and depleting and that the demand of these will outstrip its supply? Again, quite simple, the prices of these commodities will rise where demand will equal supply.

What is not apparent in this story is that the real level of supply of these commodities has not been factored into this equation. The real supply has not been determined if it will actually run out in the near future.

Such distortions made hedge funds betting that as the supply of oil and gold are limited bets are taken out against these commodities by “buying-into-the future”. This kind of artificial thinking creates a “demand” for oil and gold.

For hedge funds to protect its investments in these commodities, these funds will buy into the future and in doing so create a situation of demand for oil and gold. For every contract taken out, another party will be willing to honour these prices to even-out and balance these supplies.

Because these demands are not “real” and the abundance of oil and gold are still a long way off from failing to critical levels, the sustainability of its high prices becomes apparent when these funds banks in its investment and cashes-out; all to protect the value of its investment in the first place.

So, the prices of oil and gold have been good, now will you bet that the prices of oil and gold will continue its march upwards? Perhaps it is time to switch to silver, copper or coal and determine if these commodities are indeed depleting.