Thursday, August 11, 2011

Gold Margin Raised

Last night the CME Group raised the maintenance margin requirements on gold futures contracts.  For readers who are not familiar with futures here is how it currently works:  Gold contracts trade in paper form and represent a contract to purchase the metal at a specific future date.  The contracts can be settled in cash and while many novices assume they represent actual physical gold, they do not.  These are strictly paper instruments.  

Only a fraction of the total contract value is required to place a futures trade making the instrument highly leveraged.  The CME Group, in this case, controls the amount of leverage available on each commodity.  Once the trade is placed an amount of cash per contract must be held in the account. This is called the Maintenance Margin Requirement.  If the value of the contract decreases, more cash must be posted in order to keep up with this requirement.  Also, the CME can raise the amount required at any time.  So, when margin requirements are raised it makes trading more expensive and when lowered, less expensive.  This can be used as a tool to persuade price.

As of last week $4,500 in cash was required on each gold contract.  This is effectively 32:1 leverage.  Gold rose over $150/oz and they raised the cash maintenance requirement by 22% to $5,500.  The leverage ratio remains virtually unchanged at 32:1.

This move has not really changed much in the gold market.  Selling today can likely be attributed to traders adjusting to the new margin requirement.  Some contracts must be sold to get back into agreement with the exchange.

This is a good time to mention that US Treasuries can still be leveraged 40:1 on the exchange!

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