According to the Times, the recent crash in the commodities market was caused in part by exchanges increasing their margin requirements:
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 $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 free fall. […]
Coffee, Cotton and Oil all took nosedives, but our elites know better:
Herman S. Kohlmeyer Jr., a commodities broker in New Orleans who is a managing director of Michael J. Nugent & Company, said that, in general, margins had little effect on speculators.
“The traders are not small,” Mr. Kohlmeyer said. “The traders are very well capitalized, very large funds, and I don’t think to the George Soros-type trader that margins are a focus at all.”
I really don’t know a lot about commodity markets, but I do know that people with a lot of cash tend to want to keep it, so they don’t sink huge amounts of it into speculative trades. People without a lot of cash, a huge risk tolerance, and the ability to make $100 trades with $10 of their money and a margin account, on the other hand, are probably the kind of investors who will run into a market and try to leverage themselves into a fortune. It just hurts the giant egos of our betters to admit that their market swings are powered by moochers and looters, and that the same kind of speculation and high margin trading that killed the stock market in 1929 is still going strong 80 years later.
Maude
It was said that some hedge funds got out of commodities and back into the market. To move commodity prices quickly, higher or lower, like last week, it has to be large amounts of investment money. Individual traders can’t make that large of a dent in the market.
MattF
There are countless jokes about commodity markets, I’ll offer one for the record:
Q: How do you make a small fortune in commodities?
A: Start with a large fortune.
Napoleon
That is BS that margin requirements have “little effect” on speculators. If you have $10,000,000 to play with at a 2% margin you can lock up $500,000,000 in contracts, at 10% only $100,000,000. That is bound to have an effect on prices.
aimai
I love this post, mistermix. You definitely do get the sense of offended pearl clutching in the quote you cite. Only a confirmed capitalist would tell you that the cost of doing business has no effect on how and when you do business. Guess we should increase taxes a whole lot, then, since the rich have so much money they don’t need to worry about the margins ’cause their so marginal.
aimai
alwhite
the theory on commodity markets is that they tend to stabilize prices over time. They actually can do that when they run as designed. But humans have a great propensity for finding ways to profit by gaming these systems.
Triassic Sands
Silver over $50 an ounce; reminiscent of the time when the Hunt brothers tried to corner the market. They took a beating. It would be nice if beatings for the greedy were both more common and more severe.
PeakVT
So raising margin requirements tamps down speculation? Huh. It’s a shame nobody suggested that course of action during the stock market bubble or the housing bubble (down payments function like a margin requirement).
Omnes Omnibus
@PeakVT: Either no one did or your link is borked.
MikeBoyScout
Just why should anyone care about what the Managing Director of Michael J. Nugent & Company has to say?
On the 9the of May is what Herman S. Kohlmeyer Jr said 2 weeks earlier really news?
And why would anyone care about someone who works for Michael J. Nugent & Company out of New Orleans?
PeakVT
De-borked link. (Warning: .ppt)
Joey Maloney
@Triassic Sands: It would be nice if beatings for the greedy were both more common and more severe.
I know that would improve my morale.
Eli Rabett
It’s not the margins it’s the margin calls. If there is a downward move you face the choice of double or nothing, you have to put up a second amount if your original investment gets wiped out). This has the effect of amplifying any downward move.
someguy
So we give a shit about this, but not about the fact that nothing backs the dollar except for Congressional promises… Really?
Omnes Omnibus
@someguy: Because they are entirely different things.
Cliff in NH
ThinkorSwim Doubled /Si margin to 30,000 … that’s a lot, but it’s a very powerful contract at $25 per $0.005 move in price.
grumpy realist
Who in the hell is Michael Nugent & Co, and why would we care what they have to say?
BTW, the Financial Times has covered the whole mess rather well, pointing out that there was a bubble in silver and now it’s popped. If it hadn’t been the margin calls, it would have been something else.
Shalimar
@someguy: If only we could go back to the days when our entire economy was backed by a metal with limited uses which only exists in large enough quantities to cover a small part of it. That would fix everything.
TheMightyTrowel
@Shalimar: no no no. what we need is special purpose money. Great big stones that sit in front of our homes and declare our wealth but are a waste of energy to move around so really they’re only useful for things like buying wives and cattle. Wait, what?
jwb
@Maude: My guess is that the hedge funds pulled out when they realized that the speculative bubble was about to burst due to the higher margin requirements. Yes, to move markets like that means taking a lot of money off the table all at once, but the amount of money it takes to drive a speculative bubble in the first place is not that really all that great, especially when the money is highly leverage and the demand for the commodity is relatively inelastic in the short term.
Omnes Omnibus
@grumpy realist: It appears to be a firm that employs commodities brokers; specifically, it is the firm that employs the particular commodities broker interviewed in the article. What is your objection, other than the fact that you are not familiar with the firm?
catclub
@someguy: “dollar except for Congressional promises… Really”
As libertarians will tell you, those promises are backed up by an armed system of taxation that will take your money by force if necessary.
So those promises are … good as money in the bank!
Halteclere
My Fox-loving father-in-law made a comment Saturday night about the drop in silver prices. He’s one of the people who jumped on gold in 2008 and later bragged about how much it’s value had increased (which, coincidentally, was the same increase as the S&P500 over the same time frame – i.e. in my opinion a risky bubble investment that didn’t outperform a much more stable market). So I wonder now if he though his good fortune with gold would carry over to silver? Had Beck or any other Fox personalities been pushing silver lately?
Omnes Omnibus
@catclub: Additionally, the money has value because people are willing to accepted in exchange for goods and services. A currency backed by silver, gold, or copies of Penthouse magazine from the early 70s would only have value if people had confidence that the notes could be exchanged for the item in question and if the item was something that people would be willing to exchange for goods and services. Ultimately, it comes to down to the public’s willingness to accept the item as valuable. Gold, silver, or Penthouse have value only if people value them.
Halteclere
@ Omnes Omnibus: If the dollar was suddenly put back on the gold standard, how much gold would banks, or the government, be required to keep on-hand so that people could exchange their dollars for gold at any given time? And in today’s electronic age, you wouldn’t even be exchanging dollars.
So all this gold, or a combination of other precious metal, would have to sit in storage, making resources even more scares for industries that rely on these same precious metals (computer industry, for example). I’m sure returning to the gold standard would cause every-day electronics to sky-rocket in price.
bkny
how curious that ‘the george soros-type trader’ phrase. kinda like someone wants to pin the speculation on a certain leftiecommiesoshulist nazi sympathizer…
Omnes Omnibus
@Halteclere: That is probably true as well. Gold does have value other than that which popular faith assigns it. Also, a return to the gold standard would be stupid as well as pointless. I was just emphasizing the pointlessness angle.
danimal
If the gold market implodes, I will make a killing. I just invested in a wingnut tear-catcher.
Origuy
Is Soros even in commodities to a significant extent? He made his fortune in currency trading and hedge funds.
Great movie reference in the title, BTW.
Roger Moore
@someguy:
Which are in turn backed up by Congressional power of taxation, which is backed up by the US economy. I guess given the current composition of Congress, I can understand skepticism about Congress’s power to tax.
catpal
so What is the benefit of allowing someone to Speculate in the Oil Market by Buying and Selling Millions of Barrels of Oil, that will NEVER BE DELIVERED to any person or location.
It is complete GREED if the Trader is Never Going to Take Delivery of that Oil. Why is that allowed?
When I ask that question to most people in discussion of Gas and Oil Prices, the light bulb goes off and they respond “Yeah Why are they allowed to Increase Prices by doing THAT?”
Roger Moore
@catpal:
Because somebody’s got to do it. People who actually use lots of oil in their businesses- airlines, for example- want to be able to estimate their costs well in advance so they know how much to charge for their goods and services. To do that, they buy some of their oil well in advance to be delivered at a specified time in the future (i.e. a futures contract). For that to work, somebody has to be willing to sell those futures contracts and there has to be an exchange where they can be traded. When you create those things, speculators will move in; they’re the price you pay for being able to do things like sell futures.
Villago Delenda Est
You know, the problem here is that history is for nerds, not cool people.
The assholes who run the hedge funds want to be cool people, not nerds.
So they won’t study history.
bjacques
It was the Dukes!
Martin
The futures and derivatives markets actually do help to smooth out prices. Consider that most commodity markets are cyclical – including oil. Home heating oil demand mostly exists in winter, increased gasoline demand in summer, etc. Futures markets encourage traders to buy commodities when the demand is low (which drives the price up a bit) and sell it when the demand is high (driving the price down a bit). The result, when everything is properly in balance is a much more stable price in the market – which is particularly good for all of those other folks that are dependent on these products for manufacturing etc. You don’t want the price of every petroleum based product yo-yoing around during the year. The flip side is that if there’s too much speculation, then traders can take commodities off the market completely and artificially spike prices. That happens in highly elastic markets. People are willing to go without their orange juice in the morning (reduce demand when prices increase) but they’ll still put gas in their car to get to work. Oil is very susceptible to price spiking. The only thing keeping it from happening more is that the market is so fucking big, that nobody can really do that much harm to it (small consolation, IMO).
The reason why the commodity and derivatives markets are so popular with traders is that you can leverage yourself to the hilt. I’ve made trades in the derivatives market that have returned well over 100x what I invested in less than 12 months. Drop $1K on a stock and walk away with a couple of new cars a few months later. There’s a lot of risk in individual trades there, but in a broad portfolio those tend to even out. If you can return 100x your investment in one trade, and 50 other trades of equal size completely blow up on you, you’ve still doubled your money. To the guys with large portfolios to manage, that’s damn attractive.
By increasing the margin requirements, traders can’t do that nearly as easily. And that’s a good thing. The benefits to commodity prices can still be achieved with higher margins. Traders will skip over the bets that have lower odds of return because they won’t yield a high enough return to justify tying up the money. That lowers volatility in the commodities market. If the price regulation is happening with less money in the market, then there’s no benefit to the market of having more money in there. I think it’s a great call that they made. Hope they do that in more places, and more often.
Pliny
In every article about commodities I read, there are always people defending commodities traders, and I think it’s because they don’t understand the difference between physical hedging and massive speculation. Futures contracts in commodities, and the physical hedgers that come with them, are exactly what the system was designed for: price guarantees for both producers and consumers. Speculation is allowed, but if you weren’t physically hedging there were position limits to prevent massive capital influxes from distorting prices. The CFTC, in their infinite Wall-Street serving wisdom, quietly lifted these position limits from sixteen huge banks and investment firms, giving them the green light to artificially drive up prices without any decrease in supply or increase in demand, by allowing the unlimited purchase of commodities futures.
There was a great article about this in Harper’s that the author has for free on his website: http://frederickkaufman.typepad.com/files/the-food-bubble-pdf.pdf
Thlayli
@bjacques:
“Lewis…?”
“Not yet.”
catpal
Thank you. There is a Huge difference in Futures contracts and the Total GREED of Speculation, where no one is on the hook for the Actual Payment and Delivery of Goods or Commodities.
Ozymandias, King of Ants
@alwhite: There was an interesting article a few months back in Harper’s about commodities funds’ influence on commodities markets. I don’t know how accurate it was but it scared the shit out of me.
Ozymandias, King of Ants
@Pliny: Beat me to it.