Gold Margin Hike
Research for Online Investors

by John Dalt

8/11/11

The CME Group raised margin requirements 22.2% for gold contracts on the Commodity Mercantile Exchange (COMEX) to take effect beginning today.  This has caused the gold market to sell off, as traders must close contracts if they cannot meet the new maintenance margin requirements.  Will this be a repeat of the actions taken by COMEX against the silver market in May?

Silver hit its high on April 28 when the COMEX announced an increase for margin requirements.  Over the next two weeks, COMEX increased margin requirements a total of five times.  SLV closed on 4/28 at $47.26 and dropped to the low of $31.97 by 5/12.  This low matched the price back to the end of February.  Since 5/12 SLV has been a choppy trade but has stair stepped higher.

I don’t trade on the commodities market, but will attempt to explain the workings of the margin requirements, so we can understand why an increase can affect the spot price of gold.  Gold is traded in 100 ounce contracts.  At $1800 dollars per ounce, that makes one contract worth $180,000 dollars.

Yesterday it cost $6076 to buy one contract on the COMEX.  The margin requirement was $4500.

If you wanted to bet on the price of gold you could buy a contract for $6075.  If the price went up $10 dollars per ounce, your account would be worth an additional $1000 (100 ounces x $10=$1000).  You can see how quickly money can be made trading gold when it goes up $20 or $30 dollars per day!

If gold goes down $20 per ounce, that would result in a loss in the value of your contract of $2000 dollars ($20 x 100 ounces = $2,000).  The $2000 (paper) loss is deducted from your initial payment of $6075 leaving a balance of $4075.  Last night you would have had to meet a margin call of $425 to bring your “maintenance” balance back to $4500.

Today that same contract costs $7,425 to initiate.   Today the margin requirement is $5500 dollars ON ALL OPEN contracts.  As we are ready to go to press, gold is off $50 per ounce.  This would equal $5,000 loss per contract.  Your old contract from yesterday will receive a margin call of $4425

Contract initiation: 6075
Loss:                   – 5000
Balance:                 1075

New maintenance balance requirement:
                            5500
Balance:             1075
Margin Call:      $4425

This would bring your maintenance balance up to $5500, the new maintenance balance requirement.

CME gauged the volatility of the gold market and determined there was too much risk of a sell off that would erase trader’s cash and leave the exchange with a loss before they could close out contracts.

It is easy to think this is some plot to destroy the gold market, as your editor suspected when the CME raised the margin requirements five times for silver in May.  But, think about this; when gold was trading for $800 per ounce the maintenance balance represented 5.6% of the value of a contract.  The new maintenance balance of $5500 only represents 3.2% of a gold contract when gold is valued at $1700 an ounce.

This does not give the CME very much protection in the event of wild swings during the trading day.  With the price of gold falling and margin calls being made, we can expect more selling in the gold market and the probability of more increases in the margin requirements.

If we look at the CME’s actions last spring concerning silver, they took the price of purchasing a silver contract from $11,745 to $21,600 and the maintenance balance from $8,700 to $16,000 in two weeks.  A silver contract is for 5,000 ounces of the white metal.  At $40 per ounce the nominal value per contract is $200,000.  The present maintenance amount of $16,000 represents 8% of the value of the contract.

Many thanks to our commodities trading friend for help with this article.  He wishes to remain anonymous due to his work in the business, but has been of great help to us as a resource concerning the precious metals market.

Our premium subscribers are long silver in various forms.  We may experience a “sympathy” short term pull back if CME raises the margin requirements on gold.  Gold pulled back 6.5% in the first week of May when silver was under pressure from margin increases.

Silver and gold are not the only coin; virtue too passes current all over the world.—Euripides

The desire for gold is not for gold.  It is the means of freedom and benefit.---Ralph Waldo Emerson

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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