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Silver Tumbles on Bin Laden News, Margin Requirement Increase, Technical Factors

By: International Business Times
Posted: 5/2/2011 12:53:00 PM
Referenced Stocks: CME

Silver saw a steep 10% plunge in today's trading, falling from its perch in last week's trading, after failing to move above the $49.50 level.

The news that Osama bin Laden was killed overnight  helped to spur some gains in the USD, weakening oil and commodities, and lowering the risk premium that has been underpinning commodity prices.

Another important factor was the increase in margin  requirments for those trading silver.

From Wall Street Journal : "Exchange operator CME Group Inc. ( CME ) raised margins for Comex silver futures for the second time this week as silver prices soar amid much volatility .

The higher margins take effect at the close of trading Friday, the exchange said. The CME revises its margin  requirements as a normal course of business, and has previously raised bond requirements during times of high volatility  to guard traders against additional risk. The operator owns New York Mercantile Exchange, which trades silver on its Comex division.

For speculators in the benchmark 5,000-ounce silver futures contract, the exchange is raising initial margin  requirements, or the deposit required to purchase a contract, to $14,513 per contract, up from $12,825. Maintenance margin  requirements, or the additional capital needed to keep the contract overnight, will increase to $10,750, from $9,500."

The combination of a reduction in risk premium plus the increase in margins came together to cause a strong reaction in the market. With silver rallying so strongly recently (170% over the last 12 months), professional traders scaled back silver exposure by 26% as of last Tuesday. That shows us that the recent gains may have been too strong, and that silver takes a break from its recent rally  even as gold surged higher to end last week.

The preference for gold over silver may be shifting.

From Reuters : "Some traders put down silver's spectacular fall to an unwinding of a short gold-silver ratio position, compounded by automated stop-loss orders.

The gold-silver ratio, used to measure the number of silver ounces needed to buy an ounce of gold, rebounded to about 35 from below 32, its lowest level since the early 1980s."

The macroeconomic and political picture still favor previous metals, as long as the Fed continues to send signals that it will pursue a loose monetary policy, and that rates are not likely to move until early 2012. That makes selling USD and buying commodities a strong bet as metals and most other commodities prices in USD climb as a result of a weaker USD.

Issues regarding Euro -zone sovereign debt, US budget deficits and monetary policy, and the war in Libya, are just several factors that have kept gold and silver well bid in the past few months.

Today's session did see lower liquidity  and so these moves may have been exaggerated. Still, an increase in volatility  is seen when we get to market tops and bottoms, so this is an important time to monitor how the battle between bulls and bears plays out this week.

Some other rumors for the possible volatility  in silver today, and recently.

From the Business Spectator : "The conspiracy theorists have had more than one theory.

The biggest is that a couple of the big US investment banks had long held massive short positions in silver and were caught out when the price started to move, creating in effect a short squeeze  that has forced them to try to cover their positions.

Another is that China has been buying precious metals to try to diversify away from its exposure to US Treasuries, and yet another that Chinese traders are replicating a strategy they adopted with copper and using imports and stockpiles of silver as a way of circumventing China's restrictions on credit as it attempts to keep inflation under control. The traders can borrow against their commodity holdings.

At a more prosaic level, apart from the exchange-traded funds, there has been plenty of hedge fund and carry trade  activity generally in all the key commodities, which may have helped fuel the price rise and which would unwind rapidly at the first hint of the price cracking."

We have key events on the schedule this week including interest rate decisions from the RBA, ECB, and BOE, as well as the April Non-Farm Payroll report. The ECB decision and the NFP especially will be important market movers, and will have a direct impact on risk appetite for commodities.

Nick Nasad
Chief Market Analyst