Silver: canary in the commodity coalmine?

May 4, 2011: 11:43 AM ET

No one ever said playing the commodities markets would make it easier to sleep at night.

The ferocious silver selloff went into its fourth day Wednesday, taking the poor man's precious metal almost 20% off last week's post-Hunt brothers peak. Those who bought silver in January are still ahead by 30% or so -- but they surely aren't the only ones getting a little nervous.

What goes up...

The question now is whether those who spent the past year showering billions of dollars on the latest sure-thing asset class -- buyers of commodity index funds and exchange-traded funds that aim to cash in on demand for food, metals and the like -- are cruising for a similar bruising.

So far, most commodity futures classes remain firmly in the black, courtesy of the short-Bernanke trade that has prevailed since the Federal Reserve chief said last August he would stop at nothing to get the U.S. economy going again. That trade remains in what some wags would call full effect, with the dollar index near a three-year low.

Even so, many of last year's scorchingest performers have cooled off lately. The turn has left cocoa up 8% for the year -- in line with the S&P 500 -- and cotton and orange juice up just 5%. With questions mounting about the strength of the economic recovery, could silver be the canary in the commodities coal mine?

"As QE2 comes to a slow end, the passive investors need soon to take the decision whether to cash in on the commodity returns of the last six months or stay the course as in 2008 with the risk of losing it all again," says Olivier Jakob of commodities trading adviser Petromatrix in Zug, Switzerland.

The gains of the past six months are nothing to sneeze at. Since the Fed actually started buying Treasury bonds in the second round of its quantitative easing program, silver futures have risen 53%, coffee futures 42%, crude oil 27% and corn 23%.

The effects of those increases have not been lost on consumers, who have seen the tax break that was supposed to boost their flagging spending power eaten away by rising energy prices and, to a lesser degree, food prices.

At his press conference last week, Bernanke repeatedly characterized those increases as "transitory," drawing an endless rain of brickbats from the usual suspects. But if it's fair game to blame the Fed chief for commodity prices running up, is it such a stretch to expect they will start coming back down when he pulls back from the market?

And it seems clear that the Fed would like to do just that, with the likes of St. Louis Fed President James Bullard saying recently that it's "reasonable" to expect the central bank to start unwinding some easy money programs by year-end.

Those comments and the surprise interest rate hike by India's central bank are probably less important in silver's fainting spell than the decision by big exchanges to raise silver margin requirements, forcing those betting on a further silver rally to pony up more cash. But what comes around goes around, and less liquidity worldwide is quite likely to crimp free money bets like commodities and resource currencies.

With any luck, a full-scale 2008-style meltdown isn't in the cards this year. But it doesn't take a genius to see that all you'd need to get a decent-size commodity bust would be a few pieces of news that spell doom for the latest round of economists' projections, which uniformly expect 4%-plus global growth for the next few years.

And then we could all go back to blaming Bernanke for something else he has next to no control over, the parlous state of the U.S. economy.

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Follow me on Twitter @ColinCBarr.

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