If anyone ever needed a proof of the power of speculative bets in commodity markets, the last three days of silver's price action should settle all doubts. Silver's almost $12 dollar drop, a massive 25% correction in less than 72 hours (!) is a direct result of chasing the weakest retail customers and traders of this "poor man's gold." The avalanche of unwinding positions was initiated by the increased margins assigned to silver futures by the Chicago Mercantile Exchange in the last week.
But now we've got to ask the question: What could measures to chase that kind of speculative money out of oil futures do for all of us regular Joes paying through the nose at the gas pumps?
The answer is -- probably as much as a dollar a gallon, although it won't be quite as easy as raising margins in futures -- speculative oil money isn't as easily attacked as the bets being placed on silver.
Let's imagine that the price of silver, or oil for that matter, is represented in layers of money. There is hedging money from producers and commercial end-users, representing the "real" fundamental participants who have set prices for commodities since futures markets were created. On top of that, we have a layer of speculative interest from bigger institutional investors and traders, from pension plans and university endowments and dedicated commodity hedge funds. Add to that a layer from smaller trade groups and funds that only dabble in commodities -- a smaller amount of interest individually, but collectively their force can be as great. Finally, let's add that last layer of purely speculative interest, from day traders and other retail investors working through commodity ETF's.
What you have, if I can push this analogy, is a seven layer cake of capital, all voting on the price of the underlying commodity. Sometimes, it may be tough to see just how thick each layer in the cake is, but there is no question that increased money in any layer will lead to a thicker cake and a higher price.
When the Chicago Merc raised silver margins four times in the last week, raising them almost 85% in total, they took aim at the most capital sensitive layer of our cake -- the day traders and small retail investors. In addition, silver ETF's which use futures like the Powershares DB Silver (DBS) were forced into liquidating as well. A market that has moved parabolically as silver had in the past several months was particularly vulnerable to a sell-off, and all that was required was a tipping point -- which these margin increases provided.
Going back to our cake, much of the top layer in silver has been sliced away -- and that 25% selloff indicates just how thick that layer of money was.
And what about oil? If margin increases could be a tipping lever for a big sell-off in silver, could we do the same to crude oil and slice the costs that people are paying at the pumps?
Increasing margins would be an excellent start, and one of the arguments that the CFTC is waging among itself as part of their rule writing mandate from the Dodd-Frank bill.
But that big top layer of retail speculation fueling silver is a relatively much, much smaller layer in oil's "cake" and slicing the thicker layers of investment interest in crude will require a much, much bigger knife. An enormous amount of capital, perhaps as much as $300 billion, is engaged in energy through index investment, the speculative proxy of institutional and private wealth investors. Getting at that layer of speculation will require restricted access to the commodity markets from these instruments, owned and run by powerhouse funds like Pimco, Oppenheimer, Blackrock and Goldman Sachs.
Being able to remove that capital from the oil market might drop the price that consumers pay for gas as much as a dollar a gallon as quickly as money has fled from silver. It would, however, require a more concerted effort from Congress and the SEC, as well as from the overseeing exchanges.
Still the silver move provides the lesson of just how much speculative money has been fueling the price rises we've seen in all commodities in the past year -- and just how quickly prices can come down if some available tools are used to chase some of that money out.