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The COMEX has raised the margin requirements for gold
and silver futures contracts. Additionally, gold is trading in minor
backwardation but this is probably not serious. The margin requirement rise
validates the strength of the bull market. There will likely be additional
margin requirement increases during this upleg.
MARGIN REQUIREMENT
A margin,
or performance bond, is collateral that the holder of a position in
futures contracts, securities or options has to deposit to
cover credit risk. The use of margin greatly amplifies either the gain
or loss with a position. The higher the margin requirement the more
capital is required to control the same amount of the underlying asset.
One consequence that can result from using margin to
purchase assets is a margin call. If the margin posted in the margin
account is below the minimum
margin requirement then the broker or exchange issues a margin call.
The investor has to either increase the margin deposited or close the
position and can be accomplished by selling the securities, options or
futures if they are long and by buying them back if they are short.
If they do not do any of this the broker can sell his
securities to meet the margin call. If the exchange is unsuccessful in
executing margin calls and receiving enough capital then the exchange could fail.
The COMEX has recently raised the margin
requirements for gold and
silver contracts.
The result of these increases in the margin
requirements will likely be somewhat bearish for the metals in three to six
months. This is because it will require more capital to control the
same amount of the commodity and will serve to dampen some of the speculative
hot money which has been flowing into the metals lately.
Margin requirements and other exchange rules are
what put a damper on the Hunt brother’s plans. Overnight the
rules were changed without notice and it resulted in tremendous losses and
margin calls to the Hunts. The effect of margin requirements on the
instruments of the gold price suppression scheme does cause some questioning.
For example, are they even subject to the requirements?
GOLD AND SILVER BACKWARDATION
As of 16 December 2009 there has been some minor backwardation appearing for both gold and
silver. For example, gold for delivery in December 2009 was higher than
the January, February and April contracts.
Likewise the LBMA silver forwards have been showing
some particularly interesting activity since about 24 November 2009.
For example, the SIFO for one month was higher than all other months on
15 December 2009. The 16th showed similar unusual activity.
Silver only recently slippped out of significant and
prolonged backwardation in June 2009.
This bout of both silver and gold with backwardation
is likely minor or immaterial. With gold it is likely due to delivery
considerations. With silver there would need to be a prolonged
condition to merit much more attention. Either way this is a condition to
observe. Backwardation in the monetary metals implies loss of
confidence in the paper instruments and both the desire and ability to take immediate
possession without the use of margin.
PRECIOUS METALS BULL
As the gold, silver and platinum precious metals
bull continues gaining intensity it will gather in more capital. With
their use as currency in ordinary transactions, through services like GoldMoney, it will continue to increase the percentage of the
total market that is owned outright. Already, most physical gold
bullion is owned outright without any attaching liabilities in jewelry, coin
or bar form by either individuals or massive central banks. This adds
stability to the market because when an asset is owned outright then the
owner cannot
be margin called.
By analogy one of the reasons the US residential
property market, which is heavily purchased on margin, is in such dire
straits is because of the constant ‘margin calls’, the surplus
inventory which is put on the market after foreclosure which results in
further declines in market prices and more margin calls. In contrast,
real estate in Argentina is 93% owned outright with only 7% encumbered.
This adds tremendous stability to prices.
The increase in margin requirements on the precious
metals will only serve to strengthen the bull market. But in the short
term the effect could be to depress the price because of margin calls to speculative
hedge funds.
CONCLUSION
There is old advice that the market can remain
irrational longer than you can remain solvent. But this advice applies
if margin is used. Gold, silver or platinum that is completely paid for
becomes sovereign wealth, cannot be margin called and therefore the owner can
hold it indefinately without fear of insolvency. Unlike with a margin
call there is no forced selling. Holding the monetary metals in such a
way is in harmony with provident living principles and a safe way to buy gold.
DISCLOSURES: Long physical physical gold, silver, platinum and no
position the problematic SLV or GLD ETFs.
Trace Mayer
RuntoGold.com
Trace Mayer, J.D., holds a degree in Accounting from Brigham Young
University, a law degree from California Western School of Law and studies
the Austrian school of economics. He works as an entrepreneur, investor,
journalist and monetary scientist. He is a strong advocate of the freedom of
speech, a member of the Society of Professional Journalists and the San Diego
County Bar Association. He has appeared on ABC, NBC, BNN, many radio shows
and presented at many investment conferences throughout the world.
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