Bulls Beware the Margin Lever
Over the past couple of weeks, I have focused on the activity at the Comex for the upcoming delivery months. While the data still supports a very bullish near-term posture as shown below, aggressive longs should consider when and how margin rates could be used to rein in prices.
I have a new theory developing: The fundamentals for gold and silver are extremely strong right now (war + inflation + dovish Fed). It will be hard to tamp down the price without taking on huge amounts of risk. What if the big players are positioning to let the price run? They can then better set themselves up in the future to rein prices when longs get overextended.
I know there are lots of theories about price smashing and manipulation. I think some of these theories have merit with data to support them; however, one look at a 20-year gold chart shows a complete failure of price suppression if that is the goal. Instead, what if the manipulation is used to control the micro-movements up and down in an overall long-term trend.
What does this mean for the near term? Here is a summary of the data:
- Deliveries in March have been incredibly strong, setting a minor month record
- April gold could see another huge delivery volume
- Spreads between April and June are widening which increases the cost to roll the contract. This could encourage more longs to take delivery instead of rolling
- May and June’s open interest is historically high for this stage in a minor contract
- Gold margin rates have only moved up some despite prices returning to record highs
- Margin rates are 40% lower than they were in 2020 despite massive geopolitical uncertainty
The theory: big players are expecting high delivery volume in April and May. Traders could be using Trade at Settlement contracts to actually widen spreads encouraging even higher delivery in April (i.e., they are buying June and selling April instead of what they normally do). This will be supportive of prices. The soon-to-be-published stock report shows a major inventory increase in gold within Comex vaults. This further supports this idea as this metal can be used against delivery requests.
From a futures standpoint, they are now well-positioned in May and June contracts to ride a wave higher. Higher prices will pull in more speculative money. At this point, big players can liquidate their longs into strength. The Comex can then increase margin rates. An increase with more spec money involved will force liquidate freshly entered positions causing prices to drop significantly (similar to what occurred on March 9 causing prices to fall from $2060 to $1988). Big players buyback once the dust settles.
Please note this is a working theory and is by no means strong enough to trade against. The future is forever uncertain. We may have already seen a near-term top in gold. Alternatively, we could quickly blow through $2,050 resistance with no major pullbacks. Furthermore, “letting the price run” does not mean prices will go straight up from here. They may just be less inclined to restrain prices in the weeks ahead. The technical analysis this weekend will show gold in need of consolidation.
Regardless, long-term bullish investors should consider a buy-and-hold approach of physical metal. This analysis is simply used to hypothesize on market positioning against price movements.
Let’s dive into the data…
March gold is crushing the last 5 minor months, and showing strength similar to 2020. It has actually surpassed the previous minor month record delivery in November 2020.
Figure: 1 Recent like-month delivery volume
Much of this is being driven by mid-month contracts opening for immediate delivery. As previously mentioned, this volume is being driven by the BofA house account.
Figure: 2 Cumulative Net New Contracts
Gold: Next Delivery Month
April gold has fallen back to the middle of the pack, but the early surge is still interesting. The rapid decrease was seen around the same time as the increase in margin rates (see below). The latest day shows a mild slowing, but the roll is still in full effect.
Figure: 3 Open Interest Countdown
The spread between the contracts continues to widen despite a minor pullback yesterday. It is still rather small at $5 or 30bps, but the increase is significant relative to history. This makes it more expensive for contracts to roll from April to June.
Figure: 4 Roll Cost
At first, I was confused about the reason for this divergence. After reading the Craig Hemke analysis of Trade at Settlement (TAS), I realized what might be going on. Hemke states that in past months, TAS is used to push prices lower into month-end through buying the near month and selling the far month. Longs are then liquidated first to drive prices lower. Based on his analysis and the data, I think there is definitely a case to be made. Furthermore, this tactic can be used to keep spreads incredibly tight.
However, this month I am suggesting they are doing the opposite. After blowing through resistance, there is strength in the gold market. Why risk fighting the strength instead of riding the wave? The plot below shows TAS trades. Unfortunately, we cannot see the direction of the trades (long or short), but you can see the months being traded. Given the increase in spreads aligns with the increase in TAS trades, you could presume they were pushing spreads wider rather than together.
Figure: 5 Trades at Settlement
The other suspicious activity is the lack of margin increase. Margin rates have increased some to combat higher prices, but they are well below the peak set in 2020. While both longs and shorts are subject to margin requirements, the Swap Shorts are generally better capitalized than Speculative Longs. This means that an increase in margin force liquidates longs who are running on a thinner margin.
Figure: 6 Gold Margin Dollar Rate
The chart below shows how margin rates can be used to control prices. As margin increases as a percentage of price, open interest falls. We know that higher open interest supports prices, so margin increases will weigh on gold prices. Considering the current geopolitical environment, why would margin not be higher? Higher rates can happen quickly. In 2020, margin went from $5,000 to $9,050 within two months.
Figure: 7 Gold Margin Percentage Rate
Big players may not want margin rates to go up and instead want to see the price run some. May open interest is well above the recent historical average for minor months and still drifting upwards. Who is taking these positions?
Figure: 8 Open Interest Countdown
The same is true for June. It’s hard to see exactly, but this June is more than 90k contracts higher than it was leading up to June 2021 and 70k contracts higher than June 2020! June 2020 was at peak Covid uncertainty and is currently the highest delivery month on record (55k contracts). This was also right before the gold market took off. Today open interest is 32% higher even though the gold price is $400 higher. Please note that December shows higher OI because of the major month gap between August and December.
Figure: 9 Open Interest Countdown
Lower margin rates keep speculative money flowing in and supports prices. Looking at open interest in May and June shows historically high positioning. If the Comex raised margin rates right now it could crush these positions. However, if my assumption about the TAS data is correct, June is almost certainly the big players. It’s hard to believe May is also not dominated by big players (BofA House?). These investors want the price to keep running and need low margin for that to happen.
We have had a big pullback from last week’s price, but gold is still well above where it was a month ago. It can’t move too fast or people won’t jump on the train. Perhaps margin rates were raised some last week to slow the price increase. The increase was done on March 9, the exact day gold dropped from $2060 to $1988! This cools prices some but not too much. It slows the train down to let more speculative money flow in.
The current silver month is a major month and the action is similar to gold. We are seeing one of the strongest months since 2020.
Figure: 10 Recent like-month delivery volume
Net new contracts have started to level off but still blow away the previous major months. It was up over 44 contracts from yesterday.
Figure: 11 Cumulative Net New Contracts
Silver: Next Delivery Month
After the current month, the data in gold and silver do not lineup. The April contract is a minor month in silver. Currently, it is way below trend.
Figure: 12 Open Interest Countdown
Jumping ahead to May also shows the data trending lower. This is surprising given the current environment.
Figure: 13 Open Interest Countdown
Silver May briefly entered backwardation against the July contract. This was surprising but has since corrected itself.
Figure: 14 Roll Cost
Looking at silver TAS trades shows that the May to July hedging is still a few weeks off.
Figure: 15 Trades at Settlement
Another curious (non) development is that margin rates have not budged at all. Despite a pretty large run-up in price, margin rates are completely unchanged since Jan 6.
Figure: 16 Silver Margin Dollar Rate
Looking historically shows that margin as a % of price is the lowest it has been since Feb 2020. When is the Comex planning to raise margin? Why are they willing to let the price run right now?
Figure: 17 Silver Margin Percentage Rate
Lots to digest. Long story short, gold looks to have major activity while silver seems to be lagging aside from the current month. Gold looks to have momentum behind it despite the recent pullback. Open interest shows positioning for more gains in the months ahead. That being said, keep a close watch on margin. It’s very odd margin has not been increased so far. It could be the big players are working together to let prices run, but they could also end the party any time they want.
Long-term investors should ignore the noise and embrace the strong fundamental backdrop. In the short term, the next few months look to have some excitement in store. Perhaps silver will join the party before it ends.
Data Source: https://www.cmegroup.com/
Data Updated: Nightly around 11 PM Eastern
Last Updated: Mar 17, 2022