Don’t PANIC

Posted: November 10, 2010 in Current Events, Gold, Precious Metals, Silver

Don’t panic about today’s correction in precious metals.  Jim Rickards wrote a good post on the price action in metals.  Corrections are normal and healthy in bull markets.

By James G. Rickards

 November 9 (King World News) There’s been a lot of buzz about today’s price action in gold and silver.  Beginning with the Monday push upwards based on the Zoellick op-ed in the Financial Times, the market surged upward through most of the day today and then hit a serious air pocket with gold falling 2% and silver falling almost 5% in a short period of time late in the trading day.

 On a technical basis, there’s nothing surprising about that; we’ve seen similar moves before and I expect to see them again.  The overall trend has been upward with higher highs and higher lows.  The market seems to find a strong bid at progressively higher levels even after sharp corrections.  Nothing too disturbing there and nothing to indicate that primary trends are not still intact.

 What was noteworthy was the catalyst for the pullback, specifically an increase in margin requirements for silver futures contracts.  There was no comparable change in gold futures margin but as often happens in markets there was instantaneous contagion from silver to gold notwithstanding the different circumstances.  Again, no surprise that the markets correlate to a great extent even when the news only affects one market or the other.

 This is a pointed reminder to the readers and listeners of King World News and something we have discussed before.  Most markets consist of two parties, the buyer and the seller.  But in futures markets there’s a third party in every trade which is the exchange and more specifically the rule making bodies and margin setting panels on each exchange.  They act not in the best interests of buyers or sellers but in the best interests of the exchange itself and its statutory duty to maintain orderly markets.  Of course, the word “orderly” can be in the eye of the beholder.  What may be an “orderly” price spike to a long may be a “disorderly” rout to a short.  Either way, the exchange has the last word.  They have many tools at their disposal.  They can increase initial margin (what you put up when you open a contract) increase the frequency of variation margin (make you post intra-day instead of end of day) and require “trading for liquidation only” which means longs can go short and shorts can go long but no one can expand a position or increase the open interest.  Finally, an exchange can suspend physical delivery and allow offsets and rolls only.  All of these rules have been invoked many times and will be again.

 Invariably the parties disadvantaged by these moves complain that the exchange is “changing the rules in the middle of the game”.  That’s a naive and pointless perspective.  The fact is that the ability to change the rule is itself a rule.  The exchange is not changing the rules, they are just utilizing an alternate set of rules that are already in place.  Traders should stop complaining and read the rule book.  It’s all there.

 What is more intriguing is what motivates the exchange officials to use these rules? Is it truly a disorderly market (the usual reason) or is it part of a larger coordinated effort involving Federal regulators and policymakers to do whatever it takes to push up prices of risky assets such as housing, stocks and junk bonds and push down prices of safe-harbor assets such as gold and silver?

 The point is, when buyers and sellers transact in futures markets, they’re never alone.  Exchange monitors are always looking over your shoulder.   Never ignore the power of the exchanges and regulators and always remember they will use this power when it suits them, not you. 

 Follow Jim Rickards on Twitter at twitter.com/JamesGRickards

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