Why Higher Gold Margins Do Not Matter to Gold Prices (CME, GLD, IAU, GDX, GDXJ)

Less than two months ago, CME Group Inc. (NYSE: CME) lowered margins on its 100-ounce Comex gold contracts in what the company said was part of its “normal review of market volatility to ensure adequate collateral coverage.” The margin requirement was cut by 10% for both new and maintenance contracts.

Today, Comex raised its margin requirements by slightly more than 22% on the same contracts for the same reason. Before the margin drop in June, a non-commercial (speculative) contract cost $6,751. The margin fell to $6,075, and has jumped today to $7,425. At $1,800/ounce, a hundred ounces of gold is worth $180,000. The new margin represents just 4% of the value a 100-ounce contract. Does anyone really believe that the higher margin is going to put the brakes on the rampaging gold market?

Gold has fallen from an opening price of $1,795 to around $1,760 this morning, a drop of about 1%. That is more equity market-driven and Euro-news driven than anything to do with margin rates.  The SPDR Gold Trust (NYSE: GLD) fell about -2% in the first hour of trading, as did the iShares Gold Trust (NYSE: IAU). The Market Vectors Gold Miners ETF (NYSE: GDX) is off about -1.2% and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) is actually up about 0.5%. None of these declines will be anything but temporary because even the slightly better news on US unemployment claims doesn’t change the fact the global economy is getting weaker.

Demands for austerity only make the economic issues worse because austerity will only increase unemployment. Fewer people working only reduces demands for goods and services, and it is lack of spending that is weakening the economy. This set of events just increases the appetite for gold.

Another issue that has driven gold to new highs virtually every day recently is its value as a safe haven from the volatility in the equities and commodities markets which was exacerbated by the downgrade of US debt. Whatever one thinks about the move by S&P to lower the US debt rating, the fact is that if US debt is no longer ‘AAA’-rated, does any other sovereign debt deserve the coveted ‘AAA’? France or Germany? With all the concern over Greece’s problems, the issues in Spain and Italy could make the Greek issue look small. No Eurozone country can escape the shadow cast by the weakness of several of its member nations, and to think so is fantasy.

The broad hint dropped by the Federal Reserve that the fed funds rate would remain at zero until 2013 is also pushing gold prices higher. If 10-year US Treasuries will yield less than 2.5%, why not invest in gold which will almost certainly do better than that and will also act as a hedge against future inflation?

Until US and European policy makers face up to the fact that there is still an enormous amount of toxic debt on bank balance sheets and then act to do something about that debt, gold prices have nowhere to go but up. Not in a straight line, of course, because every pronouncement from Ben Bernanke or Jean-Claude Trichet will add new volatility.

Simon Johnson, former chief economist at the IMF, argues that the core issue for solving the sovereign debt crisis is bank capital. The fear of bank failures is epidemic and until it is clear which banks are toast and why, sovereign debt issues will continue to push up prices for gold.

Terry Hanlon of Dillon Gage Metals noted, “In January 1980, gold was $850 a troy ounce, and when that price is adjusted for inflation that is $2,400 in today’s dollars. So $2,000 an ounce is not unreasonable.”

Strategists at J.P. Morgan have given an extreme call, noting that gold could go parabolic and we could see $2,500 gold by year-end.  That would not be pretty.

Tom Winmill of The Midas Fund updated his gold targets with us this week.  Winmill noted in an email, “We raised our target high for the year to $1,750 with a year end price of $1,700; next year we are now looking for a year end price of $1,900.”

David Rosenberg, chief economist at Gluskin Sheff, has said, “Expect Gold to go much, much higher as well — just to get back to prior highs in inflation-adjusted terms would mean a test of $2,300; and normalizing by world money supply points to $3,000 an ounce.”

If any of the regulatory bodies want to truly attack gold prices, they better reconsider making a cheap trading margin more than “just a bit less cheap.”  A 22% rise on the surface sounds like a lot, but realistically this is nowhere close to anything that will drive the excessive speculators out of the markets.  A 100% rise in the trading margin requirements might not even deter many of the speculators.  If gold is really going to $2,000 or $2,500 an ounce, then coming up with an extra $1,000 to bet on gold is just not going to discourage speculators. This is such a headline-driven market in gold and even stocks that one day is not going to definitively mark the end of the end.

Once today’s rise in the Comex gold margins is absorbed and fed into the appropriate algorithms, that small increase in the cost of playing won’t be enough to stop the price from being bid higher.  As long as governments continue to punt on bank restructuring and recapitalization, gold has no direction other than up.

Paul Ausick and Jon Ogg