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Response to Volatility in Silver Takes Hold

On April 25, half a dozen officials from the CME Group, which runs many of the nation’s commodities exchanges, met via videophone to discuss the eye-popping rise in the price of silver, which had doubled in just six months to about $47 a troy ounce.

Silver bar and coins
Thomas Northcut | Photodisc | Getty Images
Silver bar and coins

They didn’t realize it, but they were about to take the first step toward popping a bubble in global commodities prices.

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.

Last Thursday, the rout spread to a wide range of commodities, including coffee, cotton and oil, as investors looked at silver’s 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,” said Richard J. Feltes, vice president of research of R.J. O’Brien, a large commodities broker.

Silver ended the week down 27 percent. Crude oil was down 15 percent, and most other commodities also fell significantly.

The futures exchanges have been struggling for months to cope with the challenges posed by rapid price increases and head-snapping 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 has made it much more difficult for them to use the markets.

Besides changing margin requirements, 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 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, said the recent margin changes in silver were intended to reduce risk for investors and the exchange.

The market’s measure of volatility in silver had been rising precipitously.

“That is a very good indication that losses they will suffer day-to-day tomorrow are higher than losses they suffered in the past,” Ms. 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 CME’s 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 year’s 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.

The final increase in silver margins is to kick in after the market closes on Monday. That will bring the margin to as much as $21,600 for each new futures contract, 84 percent higher than it was before CME began the recent increases.

One contract covers 5,000 troy ounces, worth about $176,000 at Friday’s closing price. (Commodity margins are typically much smaller than the 50 percent required for stocks.)

Mr. Feltes said that the repeated margin increases on silver were a warning sign.

“When you see almost a straight-up market, record highs in a market, as with silver, and successive margin increases, that’s a red flag for experienced commodity traders, an early indication that we could be topping out and getting frothy,” he said.

The financier Wilbur L. Ross Jr., known for his investments in distressed assets, said that speculation in commodities had obviously gotten a little out of hand.

“It’s pretty clear that, for example, $10 to $20 of the price of a barrel of oil was mostly due to speculators and there were probably similar proportions in other commodities,” Mr. Ross said.

Even though many policy makers in Washington, from President Obama on down, have complained that run-ups in commodity prices may have gone too far, there was no direct nudging from regulators to raise the silver margins, the CME said.

But regulators will soon have the power to lay down their own rules for trading in commodities and derivatives.

The Dodd-Frank Act, passed after the 2008 financial crisis, gave the Commodity Futures Trading Commission the authority to alter margin rules and set position limits to combat excessive speculation and manipulation in the markets.

The commission has proposed rules on position limits, which would restrict the maximum number of contracts any single investor or firm could control.

The agency has yet to propose any rules on margins, preferring to concentrate instead on dozens of other new financial rules it must set under the Dodd-Frank legislation. But the agency has come under pressure from members of Congress to act on margin requirements more quickly.

Senator Bill Nelson of Florida has led a group of about a dozen Democratic senators who have urged the commission’s chairman, Gary Gensler, to take steps to raise the margin requirements on oil contracts and other commodities.

The senators also urged fast action on position limits and blamed “Wall Street and the financial industry” with seeking to draw out the rule-making process, delay new rules or exempt broad categories of commodities.

Ultimately, the recent margin increases in silver and some other commodities may have been more of a psychological signal that the long bull market in commodities had run its course than a significant financial constraint for most speculators.

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.”

Edward Wyatt and Julie Creswell contributed reporting.

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