Wait for it…that sound that you’re hearing is a collapse in the commodities markets. Funny how the price of oil has fallen by 10% in a week – what happened? Is it suddenly cheaper to get it out of the ground? What about Sugar – now there’s an oversupply, and of course let’s not forget gold and silver, especially silver which has fallen by 40% from it’s highs just two weeks ago. Damn, all those threats of inflation, global financial collapse, and social upheaval in the Middle East, terror threats etc. must all have just been a figment of an overactive collective imagination!
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Not so my friends. But first you must understand something about the markets, especially the commodities and currency markets. They are built on leverage, tremendous leverage. In these markets, one can control 10, 20 or even 30 times the amount of the underlying commodity with just 5% to 20% of the actual worth of the total amount being controlled. In the currency markets it’s even higher. This means that if the underlying commodity or currency moves favorably, the profits can be huge in a millisecond. Problem is that when one of two things goes against you, the losses can pile up just as fast.
There are two things that can go against the commodity or currency trader. First and most obvious is supply and demand…or the fundamentals driving the underlying commodity price.
Let’s take sugar for example. Recently a group of major sugar producers announced that sugar production was so high, there would be a surplus on world markets. Bam! If you were long sugar, you’d be in trouble. But, this type of announcement is quite benign compared to the second type of announcement. That announcement is about margin requirements. This refers to the amount of physical money you must put up to control the underlying commodity. The rules of the game are made by the various commodity exchanges, the biggest of which are in the US. Last week they announced higher margin requirements for trading commodities. Basically they said that if you want to play in the game you need to pony up more cash of your own. This had the effect of deleveraging the markets. Players had two choices. The first was to pony up more cash to meet the new margin requirements or they could sell their holdings to reduce leverage. Well, they chose number two – sell to reduce leverage. The effect was mass panic in the commodities
space as the initial wave of selling pushed prices lower, which in turn caused even more selling as speculators were forced out of positions…or scared out of them. Funny how this works isn’t it.
This mini crash in commodities is not over yet. Like most crashes, panic sets in and then things calm. What happens next will dictate the short-term direction of commodities. It will also dictate what you should be thinking.
If commodities do indeed collapse from here – I’m talking $20 per ounce for silver, $1,100 per ounce for gold and $70 per barrel for oil, then you should be prepared to buy, buy, buy!
These short term crashes need to be put in perspective with long term objectives and trends. The long term trend for commodities like oil are unmistakable – prices will continue higher for fundamental reasons – demand is not going away. In fact demand from the emerging markets will continue to accelerate faster than new supplies are found.
For gold and silver, especially gold, the bull market is still in tact and will continue to be intact as long as governments continue to run deficits and print money to cover those deficits. This trend is also unmistakable!
So, sit back, enjoy the carnage and look for that opportunity to buy when blood is running in the streets. You’ll know when the bell is ringing – it’ll be loudest when the mainstream media and the average investor believe that commodities are doomed.
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