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5/9/2011

What the heck happened in the world of commodities last week?

Last week’s price action was ugly, chaotic, uber volatile, and yes very painful to commodity bulls, as a number of exuberant markets suffered massive losses, with Silver topping the cake. So what was the culprit?  We all pretty much know by now, it was those tricky exchanges that managed to raise margin requirements or increase the amount of collateral required to take positions in the futures markets.  What some investors probably don’t know is that in the case of the market that got hit the hardest (e.g. silver), there were multiple increases in the margin requirements, given that initial increase did nothing to slow the price appreciation of the metal.

Now the bulls will surely sound the alarm that the exchanges played dirty pool, however as an avid precious metals bull myself, I tend to think last week’s action was a nice cleansing of a market that got ahead of itself. Margin requirements were increased to actually reduce risk in the market over the longer term, although last weeks 27% decline in Silver was probably an unintended result by exchange officials.  Putting more stringent collateral standards on leveraged security assets can actually create a more healthy bull market over the longer term.

Remember, if fundamentals truly warrant higher prices for a given asset, then those forces almost always prevail.  If the price of an asset rises precipitously without the foundation of sound fundamentals then you’re looking at a bubble, and as we all know, bubbles burst.

So for all you bullish commodities players out there…you may not want to give up just yet.  The cash market for these assets generally will dictate their true value .  If there’s truly a bull out there, increased collateral will only affect things over the short run, but over the long run the bull will start running again.