A Word About Precious Metals Margins
There has been a bit of misinformation and faux outrage about the CME margin requirements for Gold, Silver, and other precious metals, as well as Copper.
I do not think people understand what this means, and why the CME is doing this.
To begin with, commodities are purchased with futures contracts, which offer enormous leverage to speculators. As of this Monday, the minimum cash deposit for trading gold futures will be $11,475 per 100-ounce contract — at $1700 per ounce, that is a $170,000 position. The leverage is nearly 15 to 1. Stocks and bonds, for comparison, trade at 2 to 1 maximum leverage using firm margin. At 15-1, a less than 7% move against you wipes out your capital entirely.
Put it in other terms, if you have $100,000 to speculate with, you can purchase $200,000 worth of stock, or using the same $100k, you can buy $1,481,481.48 in gold futures.
Back in Q1 2009, when Gold was $1000 per ounce, you only needed $5,807.70 to buy 100 ozs of gold in futures (worth $100,000); That’s a little more than 17 to 1 leverage. At those levels, a less than 6% move against you wipes out your capital.
Hence, as Gold has been purchased by more speculators who are highly leveraged, the exchange is trying to ensure that these gold traders have sufficient posted cash as a margin of safety in case of any significant move against them.
Given the vertical spike in Gold prices the past few months, this is merely prudent risk management. Call it managing margin and counter-party risk — something we haven’t seen in other non exchange traded items like CDS or CDOs. Had they been exchange traded with margin rules, perhaps the 2008 collapse would not have been as significant as it was.
~~~
The recent history of CME margin changes for Comex 100 Gold Futures is after the jump.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> Following are the percentage changes in the Comex 100 Gold Futures <0#GC:> initial and maintenance margins since 2009 (in U.S. dollars per contract) EFFECTIVE DATE MARGINS FOR INITIAL MAINTENANCE PCTCHANGE Sep 26, 2011 Spec...Tier 1 11,475.00 8,500.00 +21.4 Aug 25, 2011 Spec...Tier 1 9,450.00 7,000.00 +27.3 Aug 11, 2011 Spec...Tier 1 7,425.00 5,500.00 +22.2 Jun 20, 2011 Spec...Tier 1 6,075.00 4,500.00 -10.0 Jan 21, 2011 Spec...Tier 1 6,751.35 5,001.00 +11.1 Nov 16, 2010 Spec...Tier 1 6,075.00 4,500.00 +05.9 Apr 30, 2010 Spec...Tier 1 5,738.85 4,251.00 -14.9 Mar 02, 2010 Spec...Tier 1 6,747.30 4,998.00 -- Feb 12, 2010 Spec... 6,747.30 4,998.00 +24.9 Dec 15, 2009 Spec... 5,402.70 4,002.00 +20.1 Aug 21, 2009 Spec... 4,499.55 3,333.00 -16.7 Jan 22, 2009 Spec... 5,398.65 3,999.00 -07.0 Jan 08, 2009 Spec... 5,807.70 4,302.00 -- (Reporting by Soma Das in Bangalore; Editing by Bob Burgdorfer) Source: Reuters
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September 24th, 2011 at 7:11 am
What’s wrong with this margin hike sequence is that the Comex got so far behind the curve.
As of August 11th, just before initial margin was raised from $6,075, it represented only 3.4 percent of contract value — almost 30-to-1 leverage.
For brokers, it’s the difference between initial and maintenance margin that’s significant. At the early August levels, a gold move of $15.75 would trigger an intraday margin call. With gold often moving $20 and $30 a day, those margins were simply ridiculous — arguably failing to ensure the security of counterparties, unless brokers were very quick to force-liquidate their margin-called customers.
Even as we continue to dissect the regulatory nonfeasance of the mortgage bubble era, to this day the authorities continue to fail. Why did the CFTC stand by and suck their thumb while Comex set such absurdly low margins earlier this year?
Two words: ‘regulatory capture.’
September 24th, 2011 at 7:15 am
p.s. BR — your readers somewhat expected a Friday night retrospective on the late, great R.E.M.
http://www.ydr.com/living/ci_18963895
Is music too painful in a bear market?
September 24th, 2011 at 7:20 am
They raised the margin requirement after the close but Gold falls 6% during the day even more on silver, is it possible someone was trading on inside knowledge ?
September 24th, 2011 at 7:24 am
Allowing higher leverage for gold than for stocks make no sense. They are both very volatile assets and it is bad idea to allow much of any leverage on either. I sure hope that none of the consumer commodities are allowed any leverage at all, that would be a crime against society.
September 24th, 2011 at 7:51 am
Its how commodity futures are traded
September 24th, 2011 at 8:05 am
Barry – silver’s one day move yesterday was MORE than the previous margin requirement for silver. that should put to rest any debate that these margin hikes were unwarranted: it proves the opposite: margin requirements, on silver at least, were, undeniably, too low.
~~~
BR: The CME is behind the curve
September 24th, 2011 at 9:11 am
and since we do our best to pickup destitute people ..
all will be well in Socialist Crony Captialism world .. go play .. churn
.. just remember where you got rich and pay it forward :-)
September 24th, 2011 at 9:19 am
The margin action in silver these past few months, resulting repeatedly in much lower prices, should prove to the public that gasoline could be $1.60 a gallon if only the exchanges raised margins on oil and gas futures, eight times in the next month, until that price was achieved.
Also, who exactly makes these margin decisions that wipe out positions? As a CME shareholder, I know that no independent person or agency decides. Just insiders who leak to the chosen few.
September 24th, 2011 at 9:25 am
Thanks for the explanation, Barry.
As someone who spends most of my time in non-financial arenas, this kind of timely and clear post, along with the routinely perceptive and balanced insights, is why I consider TBP my no. 1 blog for economic & financial insights.
September 24th, 2011 at 9:31 am
Barry, you are just spreading the propaganda of the fiat-money-printing central banks who don’t want anyone to be able to hold REAL money. I know this because I read Zero Hedge :)
September 24th, 2011 at 9:37 am
Buying futures is gambling (actually, anything bought solely in anticipation of selling it at a profit is gambling), leveraged, or not. Leverage — especially at radical ratios — only makes it worse, as the more radical the ratio, the more enticement to get in and the greater the distortion in actual price/value.
Anybody remember the housing bubble, or is ancient history too difficult to remember and/or not applicable to sophisticated modern people?
September 24th, 2011 at 9:44 am
What is interesting is that my broker – Interactive Brokers – had the new margins in effect at the start of trading on Friday. Might have been even earlier but I only checked Friday morning. When I first saw the new margins on the IB website, I shrugged it off thinking IB is just being fiscally prudent and covering it’s own just in case.
CME announced the new margins at the end of the day. When I saw the announcement, it scared the hell out of me. I can’t understand how IB can front run CME like this, so openly. Is there no regulation? Surely someone somewhere must ask how did IB know?
September 24th, 2011 at 9:45 am
hwwesq:
Your comment is true, to a point. Gasoline is a consumable and a necessity (in 100 short years we have entirely restructured our society around it) — it isn’t purchased in anticipation of a profit being made. The market can and will charge what the market will bear, at the pump.
Anybody remember the Easter Islanders, or is the ancient history of far-off places too difficult to remember and/or not applicable to sophisticated modern people?
September 24th, 2011 at 9:54 am
OT:
“China cancels dog meat festival after tens of thousands complain online”
Just a coincidence, but I recently had the best . . .
. . . awwww, nevermind.
Time to watch the grandkids (y’all can thank them that this doesn’t go on all day).
Read more: http://www.mcclatchydc.com/2011/09/23/125076/china-cancels-dog-meat-festival.html#ixzz1YsUIRXSR
September 24th, 2011 at 9:57 am
If that is how they trade commodities futures then it is no surprise that the gamblers have flocked into it. An easy stimulus would be to demand at least 25% down on any futures related to consumer prices (with 2 % being a non-refundable tax). Let the gamblers stay in gold where they only harm each others not the country.
September 24th, 2011 at 10:08 am
Petey Wheatstraw Says:
September 24th, 2011 at 9:37 am
Buying futures is gambling (actually, anything bought solely in anticipation of selling it at a profit is gambling), leveraged, or not. Leverage — especially at radical ratios — only makes it worse, as the more radical the ratio, the more enticement to get in and the greater the distortion in actual price/value.
reply:
————
No, it’s a necessity to commodity pricing. Futures started about 100 years ago when farmers and merchants had difficulty in matching supply with demand. Being able to sell a crop a few months before harvest when the price was good made the food supply more stable. If everyone sold at harvest time, then prices would be low in the Fall and high in the Spring unless farmers built storage facilities and hoped for the best. Likewise, merchants couldn’t buy or sell crops with price certainty, thus they couldn’t price their products with price certainty. This is called hedging.
Speculators are required to make hedging work. They provide liquidity in the markets for hedgers. Making contracts affordable allows speculators in and out with ease and low economic barriers to entry. Initial margin and maintenance margin requirements make sure contracts have financial backing. Speculators and hedgers need each other. In all cases, for every buyer there is a seller, although the exchange is always really in the middle of every trade in order to guarantee it. It’s not a large market, as compares to equities or asset classes when just looking at speculators and hedgers doing things old school.
The problem today is not with the CME system. Far from it. It’s with financial innovation and how consumables become asset classes that attract oceans of cash that invest long only. For everyone with common sense who easily sees this asset class system distorts prices upward, a thousand financial innovators will swear with experts that they have no distorting impact in the pricing of consumables. The fix is forcing position limits on financial innovators so they can only apply innovation to a miniscule fraction of current investments. The CFTC is supposed to announce position limits for this situation in early Oct. They will likely fuck it up and only move deck chairs on the Titanic, if that much.
September 24th, 2011 at 10:10 am
@hwwesq;
I agree that it is both dangerous and outrageous if these margin requirements are set by the exchanges themselves. Their only interest is personal profit and obvious abuses of insider knowledge is a huge risk. The setting of these margins have tremendous effect on society, we cannot allow private profiteers to control that. Wasn’t any lessons learned from the 2008 crash about misalignment of private incentives and societal good?
September 24th, 2011 at 10:15 am
People need to understand that almost EVERYTHING is extremely overvalued due to leverage. While equities are less levered, they are nevertheless very much overvalued on a perpetual basis because of leverage. Leverage increases volatility as does naked shorting, derivatives etc.
We need to go OLD SCHOOL. INVEST. Get a stock certificate. Hold your stock for many years. N more lowering of interest rates every time the market sneezes. No more buying $100,000 of oil with $10,000.
STOP THE MADNESS. These enormous ups and downs are not driving nor helping the economy. THEY ARE DESTROYING IT like 75 foot waves would destroy the largest ocean liner given enough time.
End all this crp and give the economy back to the economy!
September 24th, 2011 at 10:26 am
dead hobo offers a good rebuttal to the claim that futures are just gambling. Two addenda:
1. It isn’t only speculators that take the other side from hedgers. An unleveraged position in diversified commodities (or simply in gold, if you want to boil it down to one) is an asset class which is relatively uncorrelated to stocks and bonds. Such a strategy has nothing to do with speculation. It is supported by the rigorous math of increasing risk-adjusted return through asset class diversification. Those who shun commodities because of obsolete prejudices will endure higher risk and lower returns on their narrowly and traditionally defined ‘investments.’
2. Although it’s the predominant approach, commodity investing doesn’t have to be long-only. An investable example is S&P’s Diversified Trend Indicator, developed by Victor Sperandeo. It takes both long and short trend-following positions, and delivers the uncorrelated returns which are increasingly sought in portfolio diversification.
http://www.standardandpoors.com/indices/sp-diversified-trends-indicator-dti/en/us/?indexId=sp-diversified-trends-indicator-dti
September 24th, 2011 at 10:26 am
dead hobo:
regardless of the origin of futures, if the future price of a commodity is set in the here and now, the chance that someone will pay too much or too little for something in the future (based on the LAW of supply and demand), is assured, and there will be winners and losers based purely on speculation (thus, the gamble).
Should we fix prices of commodities in order to stabilize them?
Only if we want to have a command economy.
Future price stability can be controlled by reserves of the commodity (notable that we used to have strategic grain reserves. Then again, grain is a renewable resource).
September 24th, 2011 at 10:36 am
machinehead Says:
September 24th, 2011 at 10:26 am
dead hobo offers a good rebuttal to the claim that futures are just gambling. Two addenda:
1. It isn’t only speculators that take the other side from hedgers. An unleveraged position in diversified commodities (or simply in gold, if you want to boil it down to one) is an asset class which is relatively uncorrelated to stocks and bonds. Such a strategy has nothing to do with speculation. It is supported by the rigorous math of increasing risk-adjusted return through asset class diversification. Those who shun commodities because of obsolete prejudices will endure higher risk and lower returns on their narrowly and traditionally defined ‘investments.’
2. Although it’s the predominant approach, commodity investing doesn’t have to be long-only. An investable example is S&P’s Diversified Trend Indicator, developed by Victor Sperandeo. It takes both long and short trend-following positions, and delivers the uncorrelated returns which are increasingly sought in portfolio diversification.
reply:
———-
Excellent example of flibbity-flab. I have no idea what you just said as it relates to old school commodity hedging and speculation. I don’t want rice or coffee or soybean meal or oil in a balanced portfolio that S&P considers an asset class. That just puts middle men into the mix and raises the price without adding value. Innovators don’t want to trade old school because it cuts into profits for them.
September 24th, 2011 at 10:37 am
NEVER BUY IN CASH WHAT OTHERS ARE BUYING IN CREDIT. You are overpaying!
That means YOU Mr. 401k holder.
September 24th, 2011 at 10:41 am
… somebody’s gonna hafta ‘splain it to me how this amount of leverage — for anyone, on anything — serves the public interest.
September 24th, 2011 at 10:45 am
search: “a command economy” .. and bunch a links later .. this Sept11th was .. umm interesting:
http://en.wikipedia.org/wiki/Cybersyn
September 24th, 2011 at 10:49 am
Constant it doesn’t! It serves the financial community the same way the housing bubble served the home builders and NAR.
We have about 40 percent to 70 percent excess credit meaning everything is about 60 to 70 percent overvalued. Everything!
September 24th, 2011 at 10:49 am
constantnormal Says:
September 24th, 2011 at 10:41 am
… somebody’s gonna hafta ‘splain it to me how this amount of leverage — for anyone, on anything — serves the public interest.
reply:
—————
If you read a book on elementary futures trading and how it originated and how margin requirements actually work, you will see it makes perfect sense and is not the same kind of leverage that banks use when they put OPM in a debt ponzi scheme. Although the word ‘leverage’ is used in both systems, it means two entirely different things. Exchanges will close out an account if margin dissipates. Private contracts have no margin requirements in the same sense and they don’t originate on exchanges. The latter is wild west while the former is pure economics applied brilliantly.
September 24th, 2011 at 10:52 am
Quimby:
Is your last comment sarcasm?
Why would anyone buy a dinner (or anything else), on a credit card and automatically increase their cost by X% over inflation? (Assuming there will be inflation. Otherwise, deflation could render you a debt slave over the cost of a dinner)?
September 24th, 2011 at 10:58 am
Petey Wheatstraw Says:
September 24th, 2011 at 10:52 am
Quimby:
Is your last comment sarcasm?
reply:
————
No, he’s just an idiot with issues.
September 24th, 2011 at 11:00 am
Oh and you’re wrong about futures trading. At the end of the day when all is said and done, people are still buying many multiples of what they can “afford” on a cash basis.
September 24th, 2011 at 11:01 am
dh:
there’s always hope for a cure.
September 24th, 2011 at 11:02 am
@dougc – what do you mean “…is it possible someone was trading on inside knowledge ?” – come on! Everybody who *needed* to know obviously was made aware of the fact before the news hit the wires. They knew, and you and i – well, we didn’t. This was not the sort of “leak” or “scoop” that is provided to CNBC! And I bet you 1 gold contract that SEC won’t lift a finger to investigate this.
You see, while NYT trumpets SEC’s anti-insider-trading crusades in a 6-page article http://www.nytimes.com/2011/09/25/magazine/in-the-insider-trading-war-market-beaters-beware.html , the NYT itself says that “The dollar amounts involved in such cases tend to be small, which has led critics to question whether the S.E.C. shouldn’t be spending more of its resources on larger offenses like mortgage fraud”
According to the SEC, if you work on the assembly line and see groups of “suites” snooping around, you suspect a takeover (not told by an executive – simply put 2 and 2 together all on your own!) and buy you own company’s shares – you will go to jail. But if you’re “big enough” to cause 17% drop of silver and 6% drop in gold, just minutes before critically important (if not “fundamentally” than at least psychologically important) data was released – I guess that you’re “above the law”, too “systemically important”….. as a future employer of SEC bureaucrats and as a provider of cash to certain politicians’ campaign funds!
September 24th, 2011 at 11:08 am
Petey…you go video tape him performing the act!
September 24th, 2011 at 11:23 am
@ dead hobo
I agree that futures in commodities markets can also serve a good purpose. However, at current time it has become another gambling parlor on Wall Street. Demanding that the person who want to hedge against price fluctuations, by purchasing futures, puts a certain % down and pay a small tax for the hedging would help drive the gamblers out of that market. Just squeeze the down payments and the tax until you have chased a sufficient number of them out to have a functioning market. It may be possible to obtain the same goal with appropriate position limits. I am not sure which way would be most likely to be botched by regulators.
September 24th, 2011 at 11:23 am
>> Petey Wheatstraw @ September 24th, 2011 at 10:52 am
>> Why would anyone buy a dinner (or anything else), on a credit card
That’s not the kind of “credit” he’s talking about. Using a credit card (and paying it off the next month) is like paying cash.
Mayor Quimby’s talking about longer-duration credit. The kind where people expect (or “hope”) to be able to pay the debt off some vaguely defined time in the future but often can’t. E.g., “buy this house with an ARM now, but (a) when your finances improve you can refinance or (b) if housing prices keep rising you can sell the house and pay off your mortgage.” E.g., “it’s okay to quit your job and attend law school full-time with a student loan, because — according to law schools’ own surveys — their graduates make a ton of money.”
>> dead hobo Says:
C’mon, hobo. Don’t pile on.
September 24th, 2011 at 11:39 am
I also disagree with the proposition that commodity futures raise commodity prices (long term). I can only offer armchair, fact-free reasoning. But, maybe you’ll still find it persuasive. Here goes:
Yes, maybe financiers can push long-dated contracts up (or down) in price. (You *can* take a short position, people!) But, who puts a bid under the front-month contract? Only people willing to take delivery. If you’re purely a speculator and you hold on to your contract until it approaches the delivery date, you HAVE to sell to someone willing to take delivery. What that tells me is: the front-month contract price will hardly be supported by anyone who doesn’t plan to use (or stockpile*) the goods. And if I were a commercial user, I’d build storage facilities and start buying more front-month contracts and store the goods for later use. Ultimately, I believe I could mostly bypass any ill effects of commodity market speculation.
September 24th, 2011 at 11:44 am
…So, if we do find evidence that speculators are somehow contributing to price rises, then I say commercial users are to blame for not stockpiling a little more. (Let’s encourage a little more supply chain resiliency, people!)
September 24th, 2011 at 12:00 pm
wunsacon Says:
September 24th, 2011 at 11:39 am
If you’re purely a speculator and you hold on to your contract until it approaches the delivery date, you HAVE to sell to someone willing to take delivery.
reply:
——–
No, that IS NOT the way it works. To get out of a contract you simply buy or sell an offset position. If you have a contract to go long X, to get out you simply short for X in the same period. If you are short X you get out by going long X in the same period. The exchange settles you account daily using the margin you have on deposit. Few contract result in delivery and some held to term may only result in net settlement. You are trading contracts with the exchange, not a buyer or seller.
Commodities are priced via longs and shorts negotiating if doing things old school.
I suspect financial innovators arbitrage with derivatives used for asset class management and the price of the ETF help set prices for commodities today. If oceans of money flood into the ETF for oil and the price of the ETF rises then the price of oil will also rise to match the ETF. Shorts don’t care because they get paid more if they are actual sellers. Hence, commodity prices are biased upwards.
September 24th, 2011 at 12:52 pm
DeadHobo, you misread my comment.
>>>> If you’re purely a speculator and you hold on to your contract until it approaches the delivery date, you HAVE to sell to someone willing to take delivery.
>> No, that IS NOT the way it works. To get out of a contract you simply buy or sell an offset position.
Nevertheless, if you hold on to your contract as it approaches the delivery date, then the percentage of buyers wanting to take physical delivery increases. Seconds before the contract strike date, “delivery takers” are the only bidders.
If speculators push up long-dated futures in a particular market, I would expect the market to be in contango. But, then, all other factors being equal, they’ll lose money for any length of time they hold.
September 24th, 2011 at 12:56 pm
wunsacon;
Would anybody who needs physical delivery actually dare to wait purchasing the contract until the last minute? The idea as i understand it is that the business needing the physical delivery is able to purchase it long time ahead to have a known price.
September 24th, 2011 at 1:13 pm
>> No, that IS NOT the way it works. To get out of a contract you simply buy or sell an offset position.
To be even clearer, yes, I know that. I trade commodities occasionally. Please re-read my comment knowing that I have a clue.
September 24th, 2011 at 1:18 pm
As far as I can tell the larger problem with futures has less to do with how the market operates and more to do with the models or assumptions used to analyze that market. i.e., the margin requirements seem more consistent with an assumption of normalcy although DH’s useful discussion illustrates why this would probably be less a problem for a commodities trader than might be the case otherwise.
As far as I can tell though, typical price moves of many commodities as well as a number of derivatives and structured instruments are not consistent with a normal probability distribution even though that is what virtually every analytic model out there assumes; e.g., a move of three standard deviations might be expected once a year, not weekly or daily, and a move of more than nine SD would be expected maybe once in a million years give or take a few millennia.
Mandelbrot (and his student Taleb) looked at markets such as cotton and, IIRC, tracked price moves of as much as sixteen SD in a single year. This is consistent with a power function*, not a normal distribution, and the black swan theory essentially projects this into a fat-tail model in which very big moves are significantly probable at any time.
Boiled down to its essential trope, the black swan argument is that risk in financial markets is much, much greater than most people realize.
I’d just say that merely emphasizes the need for good money management, specific exit/entry points and discipline; that’s the right thing to do when uncertainty is high (risk cannot be accurately assessed).
*actually speaking in terms of SD is rather misleading when discussing power distributions because both standard deviation and correlation are defined in terms of variance but variance can be infinite for power distributions, certainly the stable ones at least.
September 24th, 2011 at 1:21 pm
DeDude, if commercials think speculators are screwing them over, then I say:
(a) They should commit some extra capital to warehouses and buying some extra inventory at spot prices for use in later years.
(b) They’re only in this weak position because their financial engineer MBA’s told them to run with lean balance sheets and not hold any extra inventory (dismissing my advice in “a” above).
Also, speaking for myself, I only buy long-dated commodity futures because the Fed (via printing and ridiculous leverage ratios) and the government (by lowering taxes on the wealthy while spending more and more on war) has been punishing anyone who dares save.
September 24th, 2011 at 1:49 pm
Wunsacon;
If the commercials did that we would have an added cost that would be passed on to the consumers (so the speculators would drive prices up indirectly). The good (or increased productivity) that these exchanges can provide is that both the farmer and the bread factory can plan 1-2 years ahead and settle the production of wheat to the demand for wheat, reducing the costly storage of wheat (which ultimately is inefficient and add to end product prices). A certain amount of risk money is needed to lubricate that system, but an excess of speculators drives prices up way beyond what they would be based on supply/demand.
If the “hot” money is convinced that wheat prices will increase 20% from what the actual supply/demand trade would settle it at, then they can drive the futures price up 20%. The business that needs the commodity may not have the luxury of waiting for the final settlement of prices back to true supply/demand market levels, but will have to buy at that inflated price. However, for the speculators (who neither need or want the product) the worst case scenario is just another trade gone bad (not a closed factory), so they can afford to wait to the last minute.
I don’t hold you personally responsible for a bad system, nor do I expect you to refrain from making money in that system. I am not one of those morons who say that if you think taxes are too low, then hand your money over to the government. The individual can only be expected to stay within the limits of the system, not to sacrifice themselves so that there can be even more loot for the rest. What I do expect is for government to regulate these types of activities such that they are to the benefit, not the detriment, of society.
September 24th, 2011 at 1:49 pm
It’s mind-blowing to see many long-time posters on here that have very little or no clue on how trading works. There are several dozen excellent books that will enable you to get a solid foundation on how all financial products are traded but it doesn’t seem like many are actually interested in spending the time outside of reading (and posting) on blogs.
As for the current topic, I didn’t see one post about SPX futures. The ES emini overnight margin is $4000, and the nominal value for 1 contract currently is $56,800. Therefore that’s a leverage of 14.2 to move the SPX. For BR to just say 2-1 leverage for stocks ignores all the major and minor players that trade the eminis and that stock leverage really is similar to gold. How come when stocks make a huge upswing they don’t raise margin requirements on ES? How many would cry if they raised margins and then stocks made a dive right after they like do with precious metals? Think how much lower would the stock market be if they really made stock ownership leverage 2-1.
They are still issuing FHA mortgages with 3.5% down – that’s 28X leverage. But if they act prudent and require a larger down payment how many would cry (besides the NAR) that would only hurt house prices?
The 5 most prolific posters on this thread should really read more and post less.
~~~
BR: Excellent point about the E-Minis, its a bit if an apple vs orange comparison.
But stocks are how the vast majority of people own and or trade equities, and NYSE/Nasdaq stock margin rules certainly have an enormous impact on total leverage in equity trading.
On the other hand, if you want to trade Gold, the vast majority of it (other than physical bullion) is heavily leveraged.
September 24th, 2011 at 2:57 pm
What is interesting is that my broker – Interactive Brokers – had the new margins in effect at the start of trading on Friday. Might have been even earlier but I only checked Friday morning. When I first saw the new margins on the IB website, I shrugged it off thinking IB is just being fiscally prudent and covering it’s own just in case.
CME announced the new margins at the end of the day. When I saw the announcement, it scared the hell out of me. I can’t understand how IB can front run CME like this, so openly. Is there no regulation? Surely someone somewhere must ask how did IB know?
September 24th, 2011 at 3:54 pm
DeDude, I generally agree and recognize that storage costs would have to be passed along (probably like they used to be, before JIT).
>> However, for the speculators (who neither need or want the product) the worst case scenario is just another trade gone bad (not a closed factory), so they can afford to wait to the last minute.
“Another trade gone bad” is supposed to be a horrible outcome for the speculator. It is a horrible outcome for me unless either (a) I’m a member of a group of speculators that contributes enough campaign money to ensure the taxpayer compensates me for my losses or (b) I work for a corporation and — “IBGYBG” — my bonuses aren’t subject to clawback.
September 24th, 2011 at 4:03 pm
>> If the “hot” money is convinced that wheat prices will increase 20% from what the actual supply/demand trade would settle it at, then they can drive the futures price up 20%.
If prices are 20% higher than the baseline fundamentals support, that implies farmers are making a killing. They’ll gladly sell into the futures market to lock in their gains, plant more than they would’ve otherwise, and come harvest time deliver a glut of product — destroying any longs holding during that period. In other words, high prices are the cure for high prices.
…
Remember Bobby Brady wearing the Tiki Idol to bed, daring the evil spirits? I dare Bernanke to stop printing money and to put an end to the cheap money that small-timers (like me) and big-timers alike use to buy commodities. “High interest rates, come and get me!”
September 24th, 2011 at 4:35 pm
@Madiq – individual brokers will regularly have margin requirements that are above and beyond those of the exchanges – because it’s their a$$ on the line too. Did IB have the EXACT new margin requirements (that came out from the CME friday pm) in effect on Friday morning? That would be odd.
September 24th, 2011 at 5:14 pm
brianinla;
I am not sure if you are saying that other markets are as reckless and in need of regulations as commodities, or if your argument is that if some are allowed high leverage, then all others should also be allowed. Personally I would say that leverage should be allowed to a larger extend when it almost exclusively can hurt the gamblers, whereas it should be strongly contained when it can have severe negative consequences for society.
wunsacon;
I am talking about traders bidding prices up after the farmer has committed (then he gets none of the gain) and before the end user has purchased the commitment (so the end user has to pay the higher price, and will pass it to the consumers).
September 25th, 2011 at 8:07 am
[...] If you think margin hikes caused gold to fall you are not paying attention. (Mish, Big Picture) [...]
September 25th, 2011 at 9:36 am
@brianinla
Thank you. I had pretty much given up on BR or anyone else in this thread to point out the obvious gaming of markets by the regulators/admin.
September 25th, 2011 at 1:41 pm
Futures are a market to set a “future” price. You are not buying the commodity “now,” so you do not need to pay the full price now. If you see a car that you want to buy and put a deposit on the car, should that be banned? Should you be required to put the full price down or wait and hope that nobody buys it before you are able to get the full amount? What about a house?
Some commodities can be invested in, because they are not likely to be consumed, such as gold. Other commodities are consumed, so it is not appropriate to invest in them as a buy and hold purchase. Energy, grains, and softs are not much good unless sold to someone to process them for sale.
Some energy companies pass this along to customers by allowing them to lock in the future price of their energy. For example, in June, you have the option of locking in the future price of winter fuel. The energy company buys futures contracts based on the number of customers choosing this option and based on their typical consumption of energy. This allows the energy company to control their costs with more predictability and to pass on some of the savings to customers. This option (and it is an option) only works in the customers’ favor if the price of fuel is higher and they have locked in a lower price.
2007, 2009, and 2010 were years where the customer and the energy company would have saved money (prices were higher in the Winter, than in the Summer). 2006 and 2008 would have resulted in the customer choosing this option paying more than the customers who did not (prices were higher in the Summer than the Winter). Should customers have to pay full price to choose this option on the future price of energy?
Should customers be prohibited from gambling in this manner on the future price of energy? If they are right, they save money by paying the lower prices they locked in. If they are wrong, they end up paying the higher prices they locked in.
Should only those who will take delivery be able to participate in futures markets? Would that lead to more stable prices? There are research papers that conclude that futures markets produce more stable prices. If that is the case, should we let the unusual cases of speculative excess discourage the use of something, even though that leads to more stable prices the rest of the time?
If futures markets are such a guaranteed profit making scheme, why do most people lose money in futures?
Since a buyer (long position) requires a seller (short position), are both people making money on the same trade?
September 25th, 2011 at 2:36 pm
If you are talking about a market between people who deliver a product and people who will take delivery of that product then leave it alone. Problem is that the wast majority of gamblers in the commodities markets never deliver or take delivery of the product, nor did they ever have any intention of delivering or taking delivery. They are in there to make an gamble (investment) on the direction of prices and in the process they drive up prices. I have no problem with leaving it alone if we made it illegal or put a huge tax penalty on people who bought futures without ever taking delivery of the product.
September 25th, 2011 at 2:45 pm
Yes futures markets do produce more stable prices. But excessive speculation in futures markets increase price volatility and creates bubbles. Right now commodities have become such a popular way to diversify investment portfolios that the commodities futures are traded way to much by people who are not taking delivery of any product. This has created an unacceptable volatility in prices, so it has to be stopped or discouraged.
September 25th, 2011 at 8:12 pm
You are trying to impose your preferred morality for others on futures markets.
How do you define excessive?
Is it the same as speeding on the highway? Anyone who drives slower than me is a jerk and anyone who drives faster than me is a maniac? Who decides what to use as the definition of “excessive”? Potter Stewart?
If delivery is all that matters, do you really thin that people will not find ways to get around the rule, such as using ETFs to take delivery? Unintended consequences of rules can be more dangerous than that which the rules are designed to fix.
September 26th, 2011 at 9:51 am
Yes we do define excessive speed on the highway by a somewhat arbitrary process mostly based on an educated guess of when speed gets so high that it causes unacceptable damage. And some people try to find ways around it or get away with ignoring the rules etc. For that we have enforcement and additional rules. Wall street has long ago proven that it cannot control itself so someone else has to do it. Personally I think we have had enough with those bastards sucking up 30% of the productive economy to conduct a simple task of distributing savings into productive investments that grow the economy. Lets make all financial activities illegal unless they have been specified as legal – and demand that any financial activity is proven to benefit society before it becomes legal.
September 26th, 2011 at 1:11 pm
“Lets make all financial activities illegal unless they have been specified as legal – and demand that any financial activity is proven to benefit society before it becomes legal.”
As if that won’t do more damage to the economy than the damage done by speculators.
You have not provided any evidence that the net effect of speculation is harm, rather than benefit.
Please provide evidence, not polemic.
Contrariwise, I think that regulation, especially financial regulation, should be empirical. Not all of it is bad, but it is so often applied to appease political pressures, rather than because of any understanding of economics, or more importantly, behavioral economics.