September 11th, 2011
by Ghamal de la Guardia, Global Economic Intersection Associate
The recent margin hike in gold futures contracts has many traders crying foul over its timing. I thought it would be useful to take a look at how precious metals futures prices are affected by a change in margin requirements in order to see what if any correlation can be observed.
First let’s look at gold. The following is a plot of prices for Comex gold futures contracts (GC) and initial margin requirements at the CME since 2009, which is all the data that’s available from the CME website. Follow up:
There have been nine major changes in initial margin requirements for the gold futures contract (GC) at the CME since 2009. Of the nine, four have been decreases and five have been increases. A decrease in margins has generally led to higher prices in gold, even though the relationship is not perfect and may turn out to be not so much causation but coincidence as gold is currently in a bull market anyway.
Of the five increases, three have been followed by a range bound market and two by rallies, although the rallies have been a bit less pronounced than the ones following a margin decrease. Only the increase of December 15 2009 resulted in lower prices in the immediate days following it, and it was only a slight dip. This implies that gold prices are not significantly affected by speculation in the U.S. futures markets. That is not the case with silver as we will see shortly.
This is the same plot of price and initial margin requirements at the CME since 2009, this time for the Comex silver futures contracts (SI).
As you can see there have been a greater number of major changes in initial margin requirements for the silver contract than for the gold contract, which reflects the much greater volatility in the price of the silver contract. I will concentrate only on two major increases which I believe are the most important.
The first one was a pair of increases in late 2010 which were followed by a sudden four day drop of more than 8% in price, from $27.40 to $25.06. Prices soon recovered but volatility remained elevated. Shortly after the start of 2011 prices took off! Prices kept increasing at a very high rate despite a series of conservative small increases in margin requirements implemented by the CME. The next major increase in hikes was the now-infamous set of hikes in late April and early May which caused an implosion in the price of silver. Let’s take a closer look at that time frame. The following is the same plot as above but only from February to August 2011.
As you can see the pace at which silver prices approached the $50 level seemed to have raised alarms at the CME and starting on April 26 they blitzed the silver contract with a series of five quick-succession very large margin increases. The exact start and end date for this set of increases is highlighted with two vertical dashed lines. The hikes should have been expected. The CME has a responsibility to protect itself, their clients and the integrity of the clearing process. The march of silver futures prices was a liability that could soon get out of hand. What is striking is the response of the silver price to the margin increases, especially when compared to what has so far been the case for gold. Margin increases in the gold contract have barely moved the price of the underlying. You can see for yourself what’s possible with silver. It's clear that any aggressive hike in margins by the CME due to price volatility is much more likely to seriously affect the price of silver than gold.
Even though silver has traded in a range after the last burn-out and margin hikes may take a breather, due to the uncertainty hanging over financial markets and the volatility this creates, it's very likely there will be more margin hikes going forward in both gold and silver. Silver is the more volatile of the two and the most sensitive to both speculator fever and decisions made at the CME.
Editor’s note: This analysis was prompted by a comment made by a reader known as Options Girl on Seeking Alpha.