Commodities | Oct 05 2011
By Greg Peel
At the close of trade last Friday, the CME Group announced it was raising the margins required for trading in gold, silver and copper futures contracts on Comex. This effectively means that players in the market must now put a greater amount in the kitty per contract before being allowed to play, and existing position holders must also up their antes. The increases were not unsubstantial, with margins for gold increased 21%, silver 16% and copper 18%.
Increases in CME margin requirements are nothing new and occur regularly. Basically it's the exchange's way of saying can we all just settle down a bit please. Futures are leveraged contracts on initiation which then attract margin calls as often as daily if positions are running against traders. If a trader is unable to meet a margin call, the exchange must make good on that trade anyway, making the exchange every position-holder's counterparty. Whenever there is a surge in futures price volatility, by default there is an increase in the risk of unpaid margins.
In order to hedge this increased risk, the exchange requires increased collateral, just as a bank might require a greater deposit on a mortgage in volatile economic times. It is no surprise that increased margins are usually a source of immediate price weakness as some speculators are forced to reduce positions to be able to comply. However, given exchanges increase margins in times of volatility, the impact of margin increases can still be lost in the wash.
The prices of all of gold, silver and more recently copper have plunged rather spectacularly in recent sessions, prompting the margin increase. It is worth noting, however, that exchanges will reduce margin requirements just as regularly as they increase them if volatility dries up.
The Comex futures exchange in New York and the London Metals Exchange see the bulk of the world's physical and paper metals trades. A single day's trading in Comex gold, for example, can exceed the volume of all the gold in known physical existence. Speculation rules these metals, and therefore it is incumbent upon market regulators to ensure the system does not break down. Were the counterparty to these trades, being the exchange, unable to make good on speculative positions then the global financial system would collapse.
It is with this in mind that New York and London are looking nervously to Kunming City in China's Yunnan province – the gateway to all of South East Asia. It is here that the Pan-Asia Gold Exchange is scheduled to be opened in June 2012 as part of Beijing's most recent Five-Year Plan. That FYP, say the cynics, is Beijing's plan for dominance in global financial markets and the global economy.
Once opened, the Pan Asia will allow private Chinese citizens to speculate in gold for the first time by buying physical gold or gold futures contracts. Currently the Chinese are limited to buying gold jewellery, thus making China already a significant “consumer” of the world's annual gold supply. China is the world's largest supplier of mined gold.
It is a well known fact China loves its gold as a sign of wealth and success – as a source of “face”. It is also well known that the Chinese are ardent gamblers. When the exchange opens, Chinese citizens will be able to open an account with a broker or bank and start trading. Customers of the Agricultural Bank of China (numbering 320m) will be able to directly access their renminbi deposits for example, Forbes magazine notes.
Unlike other Chinese financial exchanges, the Pan Asia will be open to foreigners, allowing anyone to speculate in renminbi-denominated gold contracts.
The first thought here is: omigod, the gold price is going to go through the roof. While the price of gold has surged this century with a lot of help from monetary inflation (money printing) meeting dwindling global gold supply, one of the most influential drivers of gold price strength along the way has been the introduction of gold ETFs (exchange traded funds) which have made gold speculation more accessible to small players who otherwise eschew risky futures markets. A whole new cohort of gold investor has been opened up as a result, and whereas 75% of annual global gold production once found its way into jewellery production, that figure has fallen now to around 50% with ETF holdings making up the difference.
Now unleash 1.2 billion Chinese on the speculative gold market.
Then comes the second thought: who will regulate this market? Has Beijing moved further enough along the financial market learning curve now to appreciate the inherent dangers created by speculation in one of the world's most dominant financial assets? Will we, from Day One, see the Pan Asia exchange ready to increase margin requirements in the face of increased price volatility, for example?
Should we be very afraid?
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