A deal is a deal. Unless, of course, you change the terms at the last minute.

That’s what happened on August 15, 2006, when the London Metal Exchange (LME) intervened to stop a precipitous rise in the nickel markets.

It happened during a classic short squeeze. Nickel prices, already up 100 percent on the year, jumped a further 6.4 percent in a single day to set a new all-time high of $29,200/ton. Rumor said that nickel inventories at the exchange were virtually depleted – down to less than one day’s worth of global consumption – and demand was insatiable.

People worried that sellers would default on delivery, or that prices for the last nickel in the warehouse would climb to unimaginable heights. Short-sellers scrambled to buy back contracts before it was too late. One analyst called it a full-on “panic”; others saw capitalism working its magic on a tight market.

And then the unthinkable happened: the LME intervened in the market and gave short sellers an out.

Specifically, the LME said that sellers holding expiring contracts could delay physical delivery by paying a fine of $300 per tonne per day, or about 1 percent of then-current market prices. It also imposed a limit on the spread between spot and future markets, in an effort to ensure that sufficient supply was available for delivery.

“Nickel stocks are at historically low levels and we now have a genuine material shortage,” said Simon Heale, chief executive of the LME, at the time. “Our first priority is to ensure that trading remains orderly and to prevent the risk of settlement defaults.”

In the end, the LME’s maneuver had its intended effect: three-month nickel futures prices fell 3.8 percent the following day, and the panic subsided (although prices later surged to even higher levels).

But the move left a bad taste in many market participants’ mouths. Monkeying with the market is an extraordinary move for an exchange; although it’s “legal,” it violates the assumptions of buyers, and changes the dynamic of the markets. The question on many commodities investors’ minds these days is: Could it happen here?

Could It Happen Anywhere

The short answer? Yes. Not only “could” it happen; it probably will.

Commodity exchanges have intervened in the markets before. The LME jumped into the zinc market in 1997, when supplies of that metal got tight. And the Chicago Board of Trade (CBOT) famously crushed the Hunt Brothers' attempt to corner the market for silver in 1980, by ruling that traders holding more than 600 silver contracts had to reduce their positions.

Conditions today are ripe for future interventions, especially in the metal markets.

Exchanges have a duty to ensure well-functioning markets, and that includes ensuring that the physical commodities are available to meet delivery. But with surging demand and the rising use of commodities for investment, supplies for many metals are at historic lows.

Consider nickel: While the immediate crisis has passed, inventories of nickel are actually well below where they were in August.

In fact, many experts believe that zinc is the next front in the supply shortage wars. Scotia Bank recently put out an analysis predicting that zinc inventories will fall to a critical level of two days of consumption in Q2, 2007.

Like many metals, there is a serious supply shortage for zinc. According to the International Lead Zinc Study Group, the world’s mines produced 8.6 million tones of Zinc from January to October 2006, while we consumed 8.8 million tonnes.

Silver is also a metal where many predict trouble, as it has been in a supply deficit for many years.

You get the picture. The truth is that there’s hardly a metal out there where inventories aren’t creeping closer and closer to zero. Traders know this – and they know that supply is not immediately elastic – and they may push their bets on certain markets, particularly for metals that are easy to store off site.

Which brings us back to the central question: will the exchanges intervene if inventories get too tight? Of course, the very fact that traders are asking this question will have an impact on the market, as they will be less liable to press their bets to try to create a short squeeze.

Should the LME, COMEX and other groups intervene in physical commodities groups? I suppose it depends on who you ask.