If I'm correct and the huge drop in many commodity prices is related to liquidity beginning to dry up this could be the canary in the coalmine. This could also signal other markets will soon become less stable or downright wild. It is very possible, "we ain't seen nothing yet." I have observed that up until now other markets appear relatively solid but much of that could be supply-demand related. Liquidity issues bring a whole new aspect into the mix.
Those looking for a future where deflation occurs will try to latch on to commodity price weakness as proof demand destruction has already put an end to inflation. The truth is some asset prices will fall and others will continue higher. A rebound in commodity prices will not mean liquidity has suddenly returned to the market it will only mean the current washout in prices has run its course. A temporary fall in prices is not necessarily an indication inflation is dead but more proof an investor can lose money even when they are right, it also highlights how leverage can increase an investor's risk.
Sadly, banks have a way of failing us when we need them most and
that is a big part of why liquidity is generally the first casualty in a financial
crisis. A huge
part of the problem is rooted in the economic tool known as leverage. The same massive gains leverage brings, also
showers us with huge losses that rapidly paralyze both individuals and financial
institutions. When volatility hits the markets any
person or group with less than stellar credit is likely to find they are unable to borrow new money.
|Liquidity Deteriorates Slowly Then Suddenly |
Liquidity has a way of deteriorating and evaporating slowly, then suddenly. Then liquidity falls even those with good credit may be forced to watch as existing credit lines are cut. The bottom-line is banks do not like to loan money to those that need it but prefer to line the pockets of those who dwell in their inner circle. Many of the credit lines that existed prior to 2008 have gone the way of the dinosaurs with banks claiming new government regulations are to blame for the way they do business today.
Much of the risk investors carry is hidden away in
that pesky small print that exists in all the paperwork we sign when
dealing with these institutions. This is especially clear not only in commodities and stocks but in
the commercial real estate market. As markets continue to bump around with no clear trend do not be surprised if those using margin money get sucked into overleveraging their position and pay a dear price for doing so. To be clear, when liquidity vanishes, those that are leveraged are the first to feel the pain. Be careful out there, and remember
capital preservation is job one!
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