Friday, September 23, 2011

Mr. Gold's Wild Ride

(for the vast majority of you who don't live in Disney's shadow, there's a popular kiddie ride there called "Mr. Toad's Wild Ride" - consider this homage...or pun)

The past three days depicted on this Kitco chart show a precipitous drop in gold prices, from about $1815 opening on Wednesday to a $1657 close today - and that price was after gaining some ground back from an intra-day low of about $1630.  Silver didn't escape, either, going from over $40 to an intra-day low of nearly $30/oz:
So what's going on? 

To some degree, it's a "perfect storm" of the market pressures from the impending European collapse, the reaction of worldwide stock markets to the Federal Reserve's "Twist" (bond swap) announced a couple of days ago, and a repeat of something which happened a few months ago and brought silver down from about $50/oz to closer to $40: an increase in margin requirements. 

According to Zerohedge, CME announced large increases in margins required.  The document from CME is there. 
And there you have it: CME just hiked gold margins by 21%, silver by 16% and copper by 18%. Mystery solved.
from a slightly more recent update:
Everyone knew they (ed. - the margin hikes) were coming... Just not when. Now that the gold liquidation frenzy has struck we still don't know much if anything: who was it, why, and where did the money go? Some rumors have it as a bank in Central, Eastern Europe unwinding massive PM positions, which if true is paradoxically bullish for gold and silver as reported previously, as it means the already tight liquidity situation in Europe is about to come to a head, possibly as soon as this weekend. Others speculate it was a plain vanilla satisfaction of collateral requirements by a big funds who may or may not be liquidating and who have sizable gold positions. Or, the simplest explanation, was it simply an expectation (and leak) of a gold margin hike?
Interestingly, this writer put out a newsletter 10 days ago predicting gold would go back to "the 1650s".  In other words, he felt this would be the price level just on his technical analysis and without considering changes in margin rates. 

While it can be argued that the Fed's recent actions really can be interpreted as more money dumping (QE666), the stock markets really didn't take it that way.  I've heard two different explanations for the stock market crashes, both of which make sense.  First, there's no doubt that the EU is in deep crisis, and the commitment of Germany to not let Greece - and the EU - fail, just might pull them all into the abyss, and markets are scared of that.  Second, the US stock market in particular (Europe to a lesser extent) was expecting a real QE from the Bernank and are throwing a temper tantrum over not getting their free money.  Yeah, it's the behavior of two year old spoiled child, but that pretty much describes Wall Street most of the time. 

For longer than I can remember a distinct starting point, the rule of thumb on commodities was "buy the dip" (or BTFD as they say on Zerohedge - and you can figure out the F all by yourself).  This is definitely a dip.  I've already heard of local coin shops saying they will not sell their silver coins at less than a $38 or $39 spot price today, not believing for an instant the price is going to stay down. 


  1. What does that mean, "hiked their margins"?

  2. Kerry - big dollar traders in all markets (that I know of) trade on margin. For example, say you want to buy $1000 worth of something; you may only have to spend 50% of that, or $500, to buy that $1000 deal - 50% margin. Essentially, you're borrowing the $500 difference. Before you take delivery of the asset, you have to pay that $500 difference in real money, so margin traders frequently sell the thing to generate the difference and never actually take delivery. Obviously, they have to sell it at a more than a $500 profit per (in this example) to make money. If they sell it for a $525 profit, say, they pay the margin back and keep the $25 profit. If they sell it at $475, they lose $25. In volume sales, a lot of money is made (or lost!) this way. For that $1000 asset, if you only have $1000 you can control one share if you buy it without margin, or two shares if you buy it on 50% margin. You double your profit - or loss - for the same money out of pocket.

    There's risk involved here for both parties, but more for the buyer. The company you borrowed that $500 form is not going to let you get away without paying them first. If you can't pay them, they keep the asset. In this case, they'd get it half price - you paid half the price and they paid the other half (the half they loaned you). It's lucrative enough to keep entire markets in business.

    Now margin deals have dates, so if the price of the asset goes down, buyers can lose money. It can be riskier, but the amount of potential profit goes up with the amount of the asset they can control for the same amount of investment.

    In the case of gold and silver this week, I don't know what the margins were at first, but the amount of money the traders risk increases because they have to put out more cash to control the same number of ounces of metal. When margin requirements go up, buyers always sell off some amount of gold so that the amount of money they risk losing stays the same.

    Hope that makes sense!