It started last week with a 25% plunge in silver prices. Gold, oil, corn, and coffee followed in sympathy, and by the end of the week it was a full scale route across the commodity spectrum. These price declines will save corporations and consumers untold trillions of dollars. So why isn’t the stock market celebrating?
The power and abruptness of the decline caught the majority of investors unaware. After all, commodity stocks have led the market for well over a year. Stock investors were piggy-backing on what was happening over in the commodity pits. Up until last week, commodity speculators were minting money. They were able to borrow short term money for practically nothing (courtesy of the Fed’s QE 2) and were buying commodities, such as silver and gold, with the proceeds. Over time, as more and more traders jumped on board, commodity prices across the board spiked into the “bubblesphere”.
Silver for example, from $36/ounce to almost $50/ounce rose in less than two months. At that point the Commodities Mercantile Exchange (CME) decided (or was prodded) that enough was enough. On April 25th they raised the amount of money that investors had to put down as collateral (margin requirements) to guarantee their silver trades. It took five margin hikes in a row (an 87% increase in margin requirements) before speculators admitted defeat. And what worked to rein in the price of silver is now being applied to other more important commodities like oil and gas.
The Federal Reserve Bank has been targeting asset classes, such as the stock market, in their effort to spark a long-lasting economic recovery in this country. One fly in the ointment has been the spike in commodity prices, especially oil and food, as speculators borrowed money from the Fed at very low prices and made millions by betting on higher commodity prices.
Oil had reached as high as $112/bbl. and gas prices at the pump were skyrocketing in response. A similar trend was underway in food. The Fed is under increasing pressure and criticism as core inflation remains quite moderate, but consumers and corporations were paying more and more for energy and food (two non-core inflation items). The Fed’s Chairman, Ben Bernanke, has argued that prices for these non-core items are beyond their control. But are they?
Is it beyond reason to speculate that the CME may have received a call from Big Ben over at the Fed? If the Fed can target an upturn in the stock market, how difficult would it be to engineer a deflating of the commodity bubble through the stiffening of margin requirements?
Whether the CME decided on their own or had a little help, the downdraft in commodity prices has removed that problem from the Fed’s agenda. It will also produce an immediate and automatic boost to the economy across the board. Gasoline futures are already heading down on the back of a 21% margin hike on NYMEX gasoline futures. Corn was limit down (-5%) on Tuesday as well. Speculators are selling positions in anticipation that margin hikes on other commodities are just around the corner.
Over time, I believe commodity prices will stabilize and even rise, although not at the rate of the past. As the speculative froth comes out of this asset class, the real values will be set by supply and demand and not speculators. Many of these commodities are becoming increasingly scarce, whether in the energy, food or metals space, so the investment case is still viable. In the meantime, as prices come down to earth, I expect investors will begin to realize that this down draft is actually a windfall in disguise.