Gold is being sold to meet margin calls, but a tweak to margin requirements is being seen by some as a signal for gold to be the pressure valve
By Henry Johnston, a Moscow-based writer who worked in finance for over a decade
https://www.rt.com/op-ed/authors/henry-johnston/
© Getty Images/Oselote
[RT] The
moment we all wondered about has come. Oil has surged past $100 per
barrel and markets are coming under serious strain. When I wrote an initial reaction to the Iran war last week, markets were still clearly pricing a “nothing to see here” scenario.
With
the system of global governance in shambles and institutional checks
conspicuously lacking, I wrote that markets may now be the only force
left capable of imposing constraint. Think of markets as a congress that
has to approve a continuation of war – except this congress can’t be
bought off so easily.
US officials, of course, are still
downplaying the carnage (in markets, that is – the carnage in Iran is a
source of pride). President Donald Trump called the oil spike a small
price to pay for security, while US Energy Secretary Chris Wright said
the recent surge in oil prices reflects a temporary “fear premium” and predicted prices would come back down in a matter of weeks.
Maybe
they’re right, but the whole thing is starting to have a
Ceausescu’s final speech on Palace Square feel. Sometimes history moves
very quickly and the language of ‘temporary fear premiums’ ends up
looking awfully silly.
Brent oil prices reached as high as $119
per barrel on Sunday night before coming back down a bit after it was
reported that G7 finance ministers would discuss releasing petroleum
reserves. Reports suggested there could be a 300 million barrel release.
This would be a large release by historical standards but hardly
sufficient to offset sustained shortages. Also keep in mind that the
world consumes about 100 million barrels every day.
Crude oil
prices are now up by about 50% since the US and Israel launched their
strikes. JP Morgan was roundly mocked for its prediction that oil would
hit $130 a barrel, but if things keep moving as they have been this will
end up looking overly conservative.
Meanwhile, many people have been puzzled that all of this turmoil has
not sent gold prices surging. In fact, gold was down just over 1% as of
around 10:00 GMT on Monday. This is being attributed to the prediction
that the wave of inflation caused by surging energy prices will force
central banks (namely the Fed) to hold off on interest-rate cuts, thus
boosting the dollar and dampening interest in non-yielding gold.
I
know we are in the habit of viewing central bank rate policy as having
the gravitational pull of a large star, but does anybody really believe
that, in the midst of a full-blown crisis and with tremendous
uncertainty about what lies ahead, that bets on future interest-rate
cuts are really driving price movements? The move in gold actually
smells an awful lot liked forced liquidation behavior. When the margin
calls start coming (and they certainly are), traders sell what they can,
not what they would prefer. Gold is one of the most liquid assets out
there, which means it often gets unloaded when losses elsewhere need to
be covered.
Meanwhile, here’s an interesting take. The Chicago
Mercantile Exchange (CME), the world’s largest derivatives marketplace,
has reportedly raised
margin requirements on oil and oil products while lowering them for
gold and silver. When you trade futures, you don’t actually pay the full
value of the contract. Instead, you post margin, which is only a
fraction of the contract value. Let’s say you’re buying oil futures
worth $100k; you may be required to post $10k in margin, for example.
This lets you control $100k of oil with $10k. When margin requirements
are tightened, traders must put up more cash to hold the same position.
Speculators often reduce positions as a result. This can have the result
of cooling volatility or speculation.
Raising margin requirements
on oil increases the cost of speculating on oil futures. Accordingly,
lowering them on gold and silver allows traders to take larger positions
in those assets with the same capital.
Now to be clear, margin
increases are generally an automatic risk response and not an attempt to
steer markets toward a particular macro result. These are generally
fairly mechanical exchange decisions tied to risk management models and
volatility.
But some analysts see a deeper mechanism at work, which, even if
somewhat overstated, illuminates an important concept. Luke Gromen, for
example, said: “This looks like they are trying to let gold be a release valve of the coming oil inflation. If so, this would be smart IMO, because if gold goes to $7,000, nothing happens…but if oil goes to $130, all hell breaks loose globally.”
The point Gromen is making is that if oil
speculation explodes, prices can spike rapidly and cause real economic
damage: gasoline prices surge, shipping costs spike, food prices rise,
inflation accelerates. But what happens if gold rises to, say, $7,000 an
ounce? There’s really not much immediate real-world impact. Sure,
jewelry becomes expensive, gold investors get richer, and central banks
holding a lot of gold benefit. But daily life doesn’t change much.
There’s
not likely some kind of conspiracy whereby the folks running the CME
get a tap on the shoulder about tinkering with margin requirements.
Think of it more as a matter of alignment of incentives. Exchanges such
as the CME are not neutral in the sense of being indifferent to market
stability. They are part of the system and depend on the system.
When
markets are under geopolitical stress, capital needs somewhere to go.
If there are going to be fear-driven capital moves, better for that
capital to plunge into gold than into oil because the macro consequences
are much less severe. In this sense, gold can function as a pressure
valve for geopolitical fear.
How the combination of risk
management models, volatility indicators, and a human understanding of
dangerous real-world instability coalesces at the CME is beyond my pay
scale, but it would make sense for institutional mechanisms to lean
toward system stability as a gnat moves unconsciously toward light.
Right
now, gold is being sold to absorb the oil shock – a state of affairs
necessitated by the severity of the market moves in recent days. From
the point of view of keeping the whole system going, however, gold
should be absorbing the oil shock via a different mechanism: money
should be ploughing into gold as an escape valve with the idea that
markets can absorb higher gold prices much more easily than a disorderly
oil shock.
The problem, of course, is that we might get the
disorderly oil shock anyway. No amount of tinkering with margin
requirements can address physical shortages.
Ultimately,
the global economy simply cannot withstand a sustained period of high
energy prices without plunging into a recession – or worse. And the
money that will be printed to deal with that recession (what else would
they do besides print money?) will be where the real inflation bomb is
smuggled in.