Taking The Shine Off

06/05/2011 at 2:02 pm

If you are reading this by the window, take a look outside. That object hurtling towards the ground at breakneck speed is the silver price. Six days ago, it peaked at $48 an ounce; at the time of writing an ounce is worth $34, a fall of about 30% (it has fallen 2.5% this afternoon alone).

The trigger seems to have been an increase in margin requirements for futures trading in America. This evidently led to an unaffordable drain on available cash for many participants who were forced to close out positions. It must also have deterred new entrants from putting in extra money.

There has been a knock on effect in oil markets (Brent crude is down about 12% since silver peaked), and to a lesser extent in equity markets and other commodities. Comment has accordingly focused on supposed investor nerves about the economic recovery.

On  a longer term view the story is less concerning. Silver remains up on the year, as does oil. In the latter case, the fall in price has merely seen it return to levels consistent with the upward trend established during the second half of 2010 (i.e. before the “Arab spring”). And investors should expect high short term volatility in the commodity space as a matter of course. Precious metals may well be in a bubble at the moment, but we should be cautious about interpreting these events as a popping sound.

However, this blog cannot help but wonder if there might be someone standing underneath the silver price waiting to be squashed as it lands. Readers may recall that in the autumn of 2006 a $9bn hedge fund called Amaranth collapsed after losing $6.5bn in a month purely by betting on the price of natural gas. The fall in silver may end up amounting to nothing. But it may be a cause – and effect – of similar distress right now.

Amaranth’s demise had little external significance, and if there are similar casualties over the coming days and weeks they may well be similarly manageable. That said, being long of silver (and gold) is a crowded trade. Some investors have taken physical delivery of their futures positions for extra security: if everyone tried that, physical supplies of precious metals would soon run out as the face value of futures contracts is a multiple of what is available. And Glencore’s IPO prices in 13 days.

These are, as ever, interesting times …

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