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Commodities Sell Off as Speculators Head for the Exits
(May 8, 2011) Oil was likely the catalyst in last week’s stunning price debacles in world commodity markets, and as prices plunged in the crude market, silver, gold, and many other markets followed suit. Silver, one of the smallest of these markets, took the biggest hit, falling 12.9% on Thursday alone.
When news of Bin Laden’s death was announced the evening of May 1st, Tokyo’s precious metals markets had already weakened considerably, and when New York markets opened on Monday, the rout was on across a broad spectrum of commodities, from copper to cotton.

As Divyang Shah, a trader with IFR Markets said to the Financial Times on Thursday:

'It’s been a day dominated by a general dash for the exit. What started out as a correction in silver has now given way to a more general bout of paper profit protection. The current ‘risk off’ phase should be seen as a healthy correction, with those markets that had the most froth seeing the sharpest moves.”

Hands down, the market with the “most froth” was silver, which as recently as two-and-a-half years ago traded around $9, and a scant eight months ago could be had for $17 per troy ounce. Its meteoric rise since last August, capped off with a 28% increase in April alone to just shy of $49, made for a very parabolic looking chart. Much of the action in silver was generated by traders buying the exchange- traded silver fund SLV, and more and more of them hopped on board in April, a time when the silver market seemed invulnerable to any serious correction.

Which was true, of course, right up until the moment it wasn’t. A bevy of stunned investors (many of them ‘newbies’ in this market) were caught out during the plunge. A good proportion of them had been in the silver market for such a short time, that they had never known silver do anything but go up in value. Last week they got to see the other side of the coin as silver fell 31% over six trading days.

The reality of what Mean Mr. Market can do to the innocent is traditionally expressed via any number of clichés: trees don’t grow to the sky, pigs get rich and hogs get slaughtered, nothing goes straight up, and what goes up must come down. Most apt is the truism that markets tend to act in ways that inflict the maximum amount of pain on the maximum number of participants. In other words, if everybody is crowded into one side of a trade (for instance, being long silver), then it is inevitable that the crowd is wrong.

The fundamental story that is told about silver remains true: silver is a traditional monetary metal which serves as a hedge against inflation, and is also an industrial metal which should see increasing demand in a recovering economy. Eventually, the selling momentum will taper off, the speculators who drove the silver market for the past few months will leave to go find a new playground, and rationality will return to the silver market.

But until all that is settled, look for increased volatility in both directions as the market struggles to establish a valuation for what has been referred to as 'the poor man's gold.'


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