Thursday's broad sell off suggests that funds leveraged to commodities and commodity-stocks were selling what they could, probably to cover margin calls and/or raise cash for redemptions. It wasn’t just gold — virtually every commodity from corn to cotton to copper got destroyed. Thursday’s market report from Plexus Cotton explained:
Credit market jitters led to a broad based sell-off in the world’s financial and commodity markets this week and the cotton market got pulled down with it. Since making an intra-day high of 68.80 cents exactly one month ago, the December contract has now given back nearly 1200 of the 1700 points it had gained during the previous move. The same forces that boosted the market a couple of months ago, namely hedge and index funds, are now causing the market to retreat as some of these long positions are being sold in order to meet rising margin calls and redemptions.
What is currently happening in the credit markets is really stemming from a chain reaction that started with the implosion of the subprime mortgage market. After years of low credit spreads and low volatility, which led to a perpetuation of this credit bubble via imaginative structured financial products, the subprime issue has now forced a re-pricing of risk, a tightening of credit standards and much higher volatility. This in turn has caused a liquidity problem for hedge funds, banks and insurance companies alike as they were suddenly faced with escalating margin calls for some of their highly leveraged bets. Since the market for these credit products has dried up, hedge funds and banks resorted to selling other assets, such as commodities, to come up with the needed cash.
While it may be a bit early, I used the sell off to start to rebuild a position in gold shares. I re bought my full position in Western Goldfields (WGDFF.OB) — that I had sold only a few weeks ago above $2.70 — for only $1.94. I also added shares of Goldenstar Resources (NYSEMKT:GSS) at $2.66. Even if there is a further drop, I think six months down the road these prices will look incredibly cheap.
DISCLOSURE: Long WGDFF.OB, GSS.
WGDFF.OB, GSS 1-year chart