On August 11, 2011, the Chicago Mercantile Exchange (CME) raised the margins on gold futures by 22%, effectively reducing the demand for gold. CME group is the world's largest gold futures market which takes measures to reduce certain risks associated with volatility. The organization can have an effect on the price of gold by making it harder or easier to trade futures contracts. This was not an isolated decision; Shanghai Gold exchange also raised its requirements to 11% from 10% earlier this week. (If you are a hedger or a speculator, gold and silver futures contracts offer a world of profit-making opportunities. Check out Trading Gold And Silver Futures Contracts.)
A margin is basically a set of funding requirement which must be met in order to receive a type of loan for trading. The trader can use this loan to purchase more of a security. These requirements are made up of the initial margin which is the amount of money that a trader needs to contribute to open a position. This was raised 22% from $6,075 to $7,425 on COMEX 100 Gold Futures. There is also the maintenance margin which is the lowest value the position can reach before the participant either needs to deposit more money or sell their position (known as a margin call).
This was raised from $4,500 to $5,500. These requirements are typically different based on the institution, and the type of security. These futures margin amounts are set by CME Clearing and changes are announced 24 hours in advance, so this was announced on August 10, 2011 and implemented August 11, 2011. The price of gold dropped 1.5% on the news.
How is This Regulation Going to Affect Traders and the Price of Gold?
In the short term, this increase in margin will reduce demand and ease the upward trend of the precious metal. The volatility should decrease as well because less traders will speculate on the price of gold. The change will not be drastic, but the intention is to increase predictability with lower swings in price.
In the long term, other factors contribute to the price of gold such as demand for industrial use, or in electronics. Also if individuals feel there might be an increase in inflation they might move to gold as a hedge to the loss in buying power of their currency.
Some traders use gold as an alternative to exposure to the stock market if they feel the markets are due for a tumble. With the new credit rating drop in the U.S., and other poor economic reports coming out such as smaller than expected rises in the retail sales numbers, gold might be used as an alternative "safe haven" for investors. In the long run, gold's price is hardly affected by these margin increases or decreases. (There is a strong correlation between gold's value and the strength of currencies trading on foreign exchanges. See How Gold Affects Currencies.
Who Sets This Margin Price?
The CME Clearing house is integrated with CME Group and acts as the counter party between sellers and buyers. They are the central futures clearing mechanism for the Chicago Mercantile Exchange. They normally act as a neutral participant and attempt to set margins so market participants such as traders have enough money contributed to cover most movements. Higher movements (known as high volatility) mean margin requirements need to be increased. This is what they have recently done.
Gold is seeing new highs in recent months, which could be due to many factors such as fear in the U.S. market, and global economic difficulties continue. These increased margins are one measure that the GME Clearing uses to decrease risks associated with high volatility and essentially lending money to traders. It does affect short term gold prices, but long term gold is based more on fundamental external factors.