Is the commodity bubble burst ?

And pop goes the commodity bubble

NEW YORK: On April 25, half a dozen officials from CME Group, which runs many of the United States' commodities exchanges, met via videophone to discuss the eye-popping rise in the price of silver, which had doubled in just six months to about US$47 a troy ounce.

They did not realise it, but they were about to take the first step towards popping a bubble in global commodity prices.

Worried about the speculative run-up and the increased volatility of the silver market, the officials concluded that it was time to raise the amount of money that buyers and sellers had to put down as collateral to guarantee their trades. The first increase in so-called margin requirements took hold the next day, effectively making it more expensive for speculators and other kinds of traders to play in the market.

But the price kept going up, reaching nearly US$50 a troy ounce on April 28. Over the next week or so, the exchange decided to raise collateral requirements even higher, in four more steps that would kick in every couple of days.

Silver prices finally halted their ascent - and went into freefall.

Last Thursday, the rout spread to a wide range of commodities, including coffee, cotton and oil, as investors looked at silver's plunge as well as global interest rate trends and other economic news, and concluded that the year-long boom in commodity prices was ending.

'The tremors felt in silver started reverberating throughout the entire commodity patch,' said Mr Richard Feltes, vice-president of research of RJ O'Brien, a large commodities broker. Silver ended the week down 27 per cent. Crude oil was down 15 per cent, and most other commodities also fell significantly.

The futures exchanges have been struggling for months to cope with the challenges posed by rapid price increases and head-snapping volatility in many commodities. Those who rely on the commodity exchanges to hedge risks in their businesses, like farmers, foodmakers and mining companies, have complained that increased betting by speculators has made it much more difficult for them to use the markets.

Besides changing margin requirements, exchanges are taking other steps in reaction to the volatility. The Intercontinental Exchange, for example, is using computer programs to make the markets more efficient by better matching buy and sell orders in sugar and other commodities. It is also looking at strengthening various types of circuit breakers to halt or slow trading during volatile periods.

Some players in the markets say the exchanges use margin requirements to actively push down prices. But the exchanges say they are not price-setting tools.

Silver is not the only market where margin requirements were increased recently. CME also boosted margin requirements on corn, crude oil, ethanol and other products. The Intercontinental Exchange increased cocoa margins in February, March and April, and cotton margins went up twice in February. The Brent crude oil contract, the benchmark oil traded in London, has seen margins increase eight times this year.

Even though many policymakers in Washington, from President Barack Obama on down, have complained that run-ups in commodity prices may have gone too far, there was no direct nudging from regulators to raise the silver margins, the CME said.

But regulators will soon have the power to lay down their own rules for trading in commodities and derivatives. The Dodd-Frank Act, passed after the 2008 financial crisis, gave the Commodity Futures Trading Commission the authority to alter margin rules and set position limits in order to combat excessive speculation and manipulation in the markets.

The commission has proposed rules on position limits, which would restrict the maximum number of contracts any single investor or firm could control. The agency has yet to propose any rules on margins, preferring to concentrate instead on dozens of other new financial rules it must set under the Dodd-Frank legislation. But the agency has come under pressure from members of Congress to act on margin requirements more quickly.

Ultimately, the recent margin increases in silver and some other commodities may have been more of a psychological signal that the long bull market in commodities had run its course than a significant financial constraint for most speculators.

Source: NEW YORK TIMES