How Will CME Performance Bond Reductions Affect Precious Metals Prices?

Includes: GLD, HL, IAU, NEM, PHYS
by: Avery Goodman

In a prior article, I outlined a bearish short term scenario for gold, silver and platinum and, since then, prices have come down a bit. But, in the face of this, CME Group suddenly, and seemingly inexplicably, lowered margin requirements. That means short term speculators can pay less to hold the same number of positions, and that has turned the short term spot price outlook less bearish.

I have explained in many prior articles that the "spot" price often goes out of synch with the real world because of perturbations of the futures markets. The interesting thing is that most miners and dealers are willing to accept "spot" even though they should know better. That means that buyers would do well to wait until spot prices are artificially low before buying. The question is, how does one identify the "low" and the "high"?

On May 1, 2011, I warned when the price of silver was close to $50 per ounce, at a time of intense physical silver demand even at the high prices, that a price attack was near. The "Empire" promptly complied. Silver prices collapsed into the high $20s in about a week. Some time later, on May 9th, 2011, I released an article titled Anatomy of Silver Manipulation - How Low Can it Go? explaining how performance bond changes affect asset price levels.

We are in the middle of what may end up as another "macro" event. Greece is in turmoil. Questions about its role in Euroland, and about the euro itself, are being raised. Strikes and street protests are the order of the day. In spite of carrying out government policy on the streets, the police union has aligned itself with its opponents in the abstract. It made an incredible threat to "arrest" IMF and EU officials. Will they arrest anyone? Not likely. But the powerless always tend to be loud and boastful to compensate for the fact that they are really helpless in the face of real power.

In spite of mass violence, and the burning of important buildings in the center of Athens, the Greek Parliament passed legislation demanded by the so-called "Troika". This requires severe cuts to the budget, to government employment, and to minimum wages. Yet, it may not be enough to satisfy foreign leaders who are tired of pouring money down the Greek drainpipe.

The Greeks are looking at years of austerity that they don't want to accept. It remains to be seen whether the bailout will happen and, if it does, it seems unlikely that the new Parliament, to be elected in April, will adhere by the promises of those it replaces. I wrote almost 2 years ago that the ECB was lying about the solvency of European banks. I also specifically addressed the subject of Greece, in another article, published May 2, 2010, and said:

Greece will default. It will not happen this year, or next, if there is a big money giveaway, but it will eventually happen...

Buyers and guarantors of Greek bonds, and of the bonds of similarly profligate nations, will lose all or a part of their investment, one way or the other. Bailing out the nations involved merely means delaying the inevitable, and shifting losses from the banks which are responsible for incurring them, onto the backs of the taxpayers of Germany, France, the other EU states, and the U.S.A. and U.K. (though the IMF). It is NOT a matter of "if" Greece defaults, but merely of "when".

Since then, Greek bond buyers have lost a large part of their investments. None of us know, however, when the overt default will be allowed to happen. That information is top secret stuff. The timing is in question, but not the inevitability. But what was true 2 years ago is still true today. In fact, certain actions that normally presaged big macro events are happening.

In a very recent article, I wrote:

The upcoming probability of a manipulation event, should not be viewed as a time to sell, but as a time to buy. If you sell, in anticipation of buying back cheaper, a number of things could get in your way. Greece might not default on the timetable expected. Furthermore, capricious changes in mood, or even the reading of this article by a person involved in price manipulation, could cause big changes in the sequence of anticipated events. You might lose your metal forever if you play the game too hard.

One seemingly capricious event has occurred. Viewed alone, it may have no meaning. On the other hand, it may be very significant. Few things happen by accident. It is just that most people don't understand why things happen, and ascribe it to all sorts of market mythology. To understand markets, it is usually necessary to "follow the money." The CME Group has significantly lowered margin requirements on commodities, including gold, silver and platinum. Why?

There is no real justification. Commodities and precious metals prices have been very volatile recently. They dropped like a stone at the end of 2011, dramatically recovered in January, and have been hovering in a "range" for only a very short time. The usual CME explanation that "volatility requires higher margins" just doesn't cut it. Volatility has been already been high, and they are lowering margins. Are the powers-that-be now "long" gold? Maybe. But there is another explanation.

Normally, a performance bond decrease causes commodities traded at futures exchanges to rise. That is because speculators buy more positions with the same amount of money. So far, however, prices have not risen greatly as a result of the recent changes. Prices will not rise, in spite of a performance bond reduction so long as enough new short positions are opened to meet demand. But prices always become more unstable, and susceptible to a price attack, when leverage increases.

Over the next few weeks, speculators may increase their positions. That means that short positions may also rise. If a big macro event does occurs, and financial institutions sell assets quickly to raise cash, sudden price weakness can occur even in the midst of a rising or stable market. In the past, we've seen transient flooding of new short positions into the market at such times. These end up triggering stop-loss orders, which then trigger margin calls, which then trigger more stop-loss orders, etc. until the market tumbles. Then, short positions can be profitably closed into a shell-shocked market.

Of course, the exchange risk committee may also have inexplicably lowered performance bonds to stabilize, rather than destabilize prices. Financial institutions are already selling some assets to raise capital to offset the Greek debt writedowns from the "voluntary" default. Also, the Federal Reserve was about to release its minutes, which indicate lack of interest in QE3 for the moment. This was bound to discourage speculators, as the Fed engages in covert QE3 using "swap" lines, and the ECB engages in what will probably be the biggest money printing episode in history, under the guise of "LTROs".

Artificial price stabilization, however, is yet another form of manipulation. In the real world, the required deposit on a future purchase, whether it be a car, house or a commodity doesn't change. The same must be true for existing positions in futures markets if they are to reflect real world supply and demand. Giving a group of conflicted men the power to raise and lower the "good faith" deposit at will, even on contracts that already exist, is a recipe for unfair markets. But, things are what they are, and smart investors need to consider a myriad of factors that should not exist in free markets.

If prices and/or the open interest level rise significantly, watch out below. The ETFs and funds (NYSEARCA:GLD) (NYSEARCA:PHYS) (NYSEARCA:IAU) etc. will follow the price of gold. Most gold stocks, including Newmont Mining (NYSE:NEM), can also be expected to follow with some added volatility. Silver stocks like Hecla Mining (NYSE:HL), Silver Wheaton (SLW) and others will do the same. All stock prices, however, are subject to unforseen business risks, such as the recent closure of a primary mining shaft at Hecla's Lucky Friday mine for safety reasons. A set of unique circumstances will cause southern Africa's platinum miners to do poorly this year, even if platinum bullion prices do well.

I don't believe in short-term trading, except in the spirit of Las Vegas or going to a horse race. I have elucidated the reasons many times in the past, and won't take space to do it again. However, I will say this. Speculating long in precious metal is safer than selling short. Those hoping for a quick buck, who lose the bet in a downdraft, will be saved by the bull market if they wait long enough. The key is to avoid leverage because it results in involuntary liquidation, and victim status. It is preferable to buy on big dips, rather than after a price reoovery period.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.