Margin Hikes Do Not Deter Longs From Standing For Physical Delivery

I just wanted to take a minute to give another quick correction for those poor souls who are still being fed a steady stream of nonsense about the metals markets, and are still being misled by blatantly incorrect information.  Someone pointed out a recent article which I will not link here, because I don’t want you to be mis-educated, but it contained this claim about the CME’s recent margin hikes in gold (which brought the level of margin required for buyers/sellers of futures contract up to roughly FOUR percent of the contract value):

“When I read this I laughed at the arrogance of the CME. There is only one reason that it wants to stop gold’s parabolic run: It simply doesn’t have enough gold to fulfill the futures contracts that it has already sold.”

The accusation is that the CME raised margin requirements in order to prevent futures contract holders from taking delivery of metal, and thus “saving” the CME from having to deliver said metal.  Let’s take it step by step to illustrate how impossibly wrong this understanding is.  Never mind that the CME doesn’t sell futures contracts – it’s an exchange that acts as a middleman and clears contracts between buyers and sellers – I want to focus on the even more glaring misconception.

When you buy a gold futures contract, you have to post margin – collateral – instead of paying for the full value of the contract.  A CME gold contract is for 100 ounces of gold.  When you buy such a contract, though, you don’t have to pay 100 x $1750/oz = $175,000.    The new, higher margin requirement required by the exchange as a result of last week’s increase is $7425 per contract, which is all you have to initially put down to buy this contract.  The contract provides (significant!) leverage, and the exchange asks for collateral (margin) in return.  Most people eventually end up selling their contracts (or rolling to the next month: selling this contract combined with buying the next month’s contract), instead of actually taking delivery of gold bullion.

However, if you are someone who wants to actually take delivery of the gold, as per the terms of your contract, you will have to pay for the gold in full, of course.    There really shouldn’t be any confusion, then, about the absurdity of the claim that increases in margin requirements are intended to dissuade longs from taking deliver of metal:  If you want to take delivery of the metal, you have to pay for it in full anyway.  Said differently, the margin requirement for anyone wanting to actually take delivery of gold at the CME is already 100% – you have to pay for all of the gold*: no leverage allowed.   Thus, one cannot possibly be dissuaded/prevented from taking delivery by an increase in the margin requirements.  This goes for silver, too, of course.

Class dismissed.

-KD

disclosure: no positions in $GLD, $SLV or related instruments

* you pay for it at the beginning of the delivery month – not when you buy the contract.

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