Two weeks ago, half a dozen officials from the Chicago Mercantile Exchange Group, which runs many of the top U.S. commodities exchanges and holds a 5% stake in the Mexican Bolsa, 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.
All indications are that they didnt realize it at the time, but they were about to take the first step toward popping yet another bubble in global commodities prices.
Admittedly 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.
Thus, the first increase in so-called margin requirements, which is essentially collateral, took hold the next day, effectively making it more expensive for speculators and other kinds of traders to play in the market.
Against all odds, silver prices 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.
Its always lovely to witness a market mechanism that actually works, and so silver prices finally halted their ascent then went into free fall. Last Thursday, the rout spread to a wide range of commodities, including coffee, cotton and oil, as investors looked at silvers plunge, as well as global interest rate trends and other economic news, and concluded that the yearlong boom in commodities prices was ending.
The tremors felt in silver started reverberating throughout the entire commodity patch, Richard J. Feltes, vice president of research of R. J. OBrien, a large commodities broker, told Bloomberg News. Silver ended last week down 27 percent. Crude oil was down 15 percent, and most other commodities also fell significantly.
These and other futures exchanges have been trying to figure out for months how best to cope with the challenges posed by rapid price increases and head-spinning volatility in many commodities. Those who rely on the commodity exchanges to hedge risks in their businesses, like farmers, food makers and mining companies, have complained that increased betting by speculators had made it much more difficult for them to use the markets.
In addition to modifying their margin rules, exchanges are taking other steps in reaction to the volatility. The InterContinental Exchange, a rival to the CME Group, 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 global 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.
Kimberly S. Taylor, president of CME Clearing, which processes transactions in silver futures and other commodities, says the recent margin changes in silver were intended to reduce risk for investors and the exchange.
A key issue in detecting a bubble, the markets measure of volatility in silver, had been rising beyond rhyme or reason. That is a very good indication that losses they will suffer day-to-day tomorrow are higher than losses they suffered in the past, Taylor said.
As prices for commodities go up, exchanges routinely increase the margin requirements, which function as a deposit on contracts bought and sold. When prices move up or down quickly, it increases the possibility that some traders will have to put up more collateral unexpectedly. If they do not have the money, they have to sell their positions.
Silver, which is traded on the CMEs Comex unit in New York, is not the only market where margin requirements were increased recently. CME also raised 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. Margins on the Brent crude oil contract, the benchmark oil traded in London, have increased eight times this year.
In sugar, however, where prices have declined for much of this year after last years sharp rise, margins were lowered in March.
CME says it makes margin changes regularly. Silver margins were raised five times and lowered once in 2010, for example. Corn margins were raised 36 percent in one day last October. After Mondays session, silver margins are as high as US$21,600 for each new futures contract, an 84-percent jump in two weeks.