August 25, 2011

Gold Zigzags as CME Raises Trading Margins

Metal gives back 10% over three days, then rises sharply

Gold took a roller-coaster ride this week, climbing to record highs before falling back more than $200 an ounce before soaring to records once more.

The wild ride started on Tuesday with gold falling and then taking a nosedive from Tuesday's record high of $1,911.46 per ounce after the CME Group hiked the margins required for trading in the precious metal

Trading on Thursday morning in Asia and Europe saw gold give back 10% of its heady gains from earlier in the week, with spot gold dropping over $200 at one point from its Tuesday high to reach a low of $1,702.44. But after having lost the most since March of 2008 in morning trading, it reversed course to gain everything it had lost and then some.

Bloomberg had reported that a 100-ounce futures contract traded in New York fell by $10,400 on Wednesday, more than the existing margin requirement of $7,425. That led  CME to raise margins. The new margin requirements are to take effect Thursday afternoon after close of trading.

The minimum cash deposit CME is putting in place for borrowing from brokers to trade gold futures will be a 27% increase, to $9,450 per 100-ounce contract in the speculative Tier 1 category. The maintenance margin will also increase, going from $5,500 to $7,000. The Shanghai Gold Exchange said on Aug. 23 it will raise margins from settlement Thursday as well.

While at first the new margin requirement seemed daunting, when gold resumed its upward climb it was clear that investors were not finished with the metal as a safe haven, regardless of cost—particularly since global equity markets fell. The MSCI World Index of equities lost as much as 1.3% in the wake of the extension by Italian, Spanish and French regulators of temporary bans on short selling they had put in place earlier in the month.

There may still be more action to come, however, regarding margins. Economist Dennis Gartman's Thursday Gartman Letter was cited in the report saying, “In our opinion the margin is not nearly high enough yet. Proper margining would seem to be closer to $15,000 per contract, for given the volatility that exists presently the exchange needs to protect itself and its clients from the possibility that a large speculator or two or three cannot put the exchange into jeopardy.”

The fall in gold prices may have been “a correction that we have to have,” according to Justin Smirk, senior economist at Westpac Institutional Bank, a unit of Australia’s Westpac Banking Corp., who was quoted in the report. However, he added, “Near term, there’s still a lot of reason for gold to outperform other commodities, because we don’t think that problems are being resolved.”

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