“A hedgehog came to the edge of the asphalt, looked both ways, saw nothing was

coming and was half way across when a jumbo jet landed on top of him”

The initial wave of liquidation in metals has hit the market with the largest broadside

imaginable as one sector after another has succumbed. Having survived the initial

collapse, the market is attempting to find some stability, but it is premature to sound the

all clear.  We are in the eye of the storm; the second wave is about to hit.

The first indications of problems in the credit market started out innocuously enough. 

Following the decline in housing prices, it took several months to grasp what was going:

a lot of money had been lost. Similarly the losses incurred in the metals are yet to be

tallied.  More importantly will they be paid?

The exposure to default has become immense. Unlike the default of the International

Tin Council that didn’t pay its losses when its support program failed, or the Hunts who

couldn’t cover all their silver losses, the current exposure to the metal markets is much

broader. The dealers and market makers trading over the counter in metals also have

exposure to other commodities such as oil as well as counterpart credit exposure. To

put it into perspective, according to the International Bank of Settlements, open over the

counter commodity transactions are in the region of ten trillion dollars.  That is about ten

times bigger than the value of contracts cleared through the exchanges. 

An early sign of problems was the Shanghai Metal Exchange’s decision to “close” open

positions at a non-free market price. Exchanges enact such draconian measures only

when fear of insolvency and the need to preserve the market overwhelm the inequity of

penalizing the winners (the shorts) because the losers (longs) cannot pay. It’s an

ominous sign when China—the poster child of planned expansion cant, or more

probably won’t, pay for its losses.

The only resolution to the credit collapse was for governments to assume the losses. 

This will not be the case in commodities. When voters are losing their homes, a bailout

is politically palatable.  Hedge funds, CTA’s, and quasi-buffer stock managers will not

garner any sympathy; the market will have to work it out on its own.

David Threlkeld

President