Margin calls depress gold
February 15, 2018
From its peak close on Jan. 26 to the close on Feb. 8, the Dow Jones Industrial Average of 30 major U.S. stocks declined 10.4 percent. In the same time frame, the Standard & Poor’s 500 Index fell 10.2 percent and the NASDAQ was down 9.7 percent.
Since the end of 2017 through Feb. 8, 2018, the 10-year U.S. Treasury Debt interest rate rose from 2.40 percent to 2.85 percent, an increase of 18.75 percent! Since the change in the interest rate has a corresponding negative correlation with the value of the underlying debt, that meant that the liquidation value of this debt declined almost 19 percent.
From the end of 2016 to Feb. 8, 2018, the U.S. Dollar Index sank 11.8 percent.
To protect against the times when the values of paper assets are performing poorly, holding physical precious metals has been a traditional safety net or form of “wealth insurance.” In theory, when stock, bond and paper currency values fall, precious metals prices should be on the rise.
Similarly, when people are fearful of rising increases in consumer prices (which some people mistakenly refer to as inflation, which is actually an increase in the money supply), they also tend to seek that safe haven status of gold, silver and perhaps other precious metals. As a consequence, precious metals prices tend to rise.
Not this time.
From Jan. 26 to Feb. 8, the spot price of gold at the New York COMEX close sagged 2.6 percent. Silver fared even worse, off 6.2 prevent. Also, platinum lost 3.9 percent and palladium was down 11.2 percent.
How can this be? What is going on?
The answer is that there are more factors affecting precious metals prices beyond the values of paper assets.
First, in today’s investor environment of relatively low yields on stocks and debt instruments, more investors are leveraging their holdings in order to magnify their results. For example, an investor may place $100,000 of his or her own capital into a paper asset, then borrow an additional $400,000 to acquire a greater quantity. Should the asset appreciate by more than the interest cost on the loan, the investor will realize a greater return on their $100,000 investment than if they had only put in their own funds.
But if the financial markets move against the investors, they will get a margin call. That means they will have to quickly put up more funds to avoid having their position partly or totally closed out.
When the stock prices were falling recently, you can be sure that many investors were hit with margin calls. If they didn’t want their positions closed out, they would have to find a fast source of cash flow.
Guess what? It is almost certain that some investors took advantage of the recent run-up in precious metals prices to cash in some profits and obtain cash flow to cover margin calls by selling off some or all of their holdings. As gold and silver are being liquidated by investors, that would tend to put downward pressure on their prices.
Further, the U.S. government is the largest beneficiary of holding gold and silver prices in check. To the extent it can suppress precious metals prices, that signal will discourage investors from thinking about selling off stocks, bonds and currencies for the safe haven of gold, silver, platinum and palladium. At the same time, it will be holding down the interest costs it pays on more than $20 trillion of debt.
With governments, central banks and sovereign investment funds around the world now owning more than half of all outstanding publicly held stocks in companies, these entities would also have an incentive to cooperate with the U.S. government in clobbering precious metals prices.
So, for the time being, when you put all these factors together, you can have gold and silver prices falling while the value of paper assets declines. But, this is not sustainable over the long term.
Starting last week, we began noticing a significant surge in demand for physical precious metals, stronger than any surge we have seen since 2016. It is entirely possible that now may be the last great bargain buying opportunity to acquire some physical bullion-priced gold and silver coins and bars to your holdings.