Reducing Leverage

Reducing Leverage

Scary moment last Thursday.

Like many commodity investors, I was feeling good about the fact that commodities are not highly correlated with other asset classes. Or so I thought.

My account had been holding up well throughout the credit crunch. Then all hell broke loose on Thursday. Many hedge funds had margin calls, and were forced to close out positions to stay afloat. This included high quality blue chip stocks, and of course commodities.

My account opened up the day around $51K. By mid-morning Pacific time, it was down to $40K. I closed the window – couldn’t bear to look. After the market closed, it had dropped all the way to $33K. $18K in one day. Ouch.

I was downright nervous heading into Friday morning. I still had all my positions, and no way out. I only had about $6K in margin buffer – another day like Thursday, and I was going to be hit hard with margin calls. The entire thing looked like it could unravel.

Fortunately, Helicopter Ben opened up the money faucets Friday morning. My account gained a bit back. Disaster was averted for the time being.

It was irresponsible of me to be so highly leveraged. It works great when prices are moving up. But you run the risk of being completely wiped out when things turn against you. I imagine this is why most people get creamed trading commodities.

So this week, I pared back a couple positions. Sold Natural Gas, which is a huge position. I bought after the Amaranth debacle originally. I still love NG long-term, but I don’t have enough $$$ to stay liquid through potential swings. Also sold a coffee contract – coffee is just too damn funny in how it behaves.

After this housekeeping and a nice market recovery, I’m back up to $40K in the account, with $20K in margin excess. Still probably not enough, but I think I will hold pat here for now. In an ideal world, you save cash for days like Thursday. Because all the grains got creamed – and promptly rebounded within a week. Great buying opportunity if you have cash – which I didn’t. And most don’t in this environment – so cash is truly king.