Gold ix is being sold to absorb the oil price shock – but no amount of tinkering with margin requirements can solve the physical shortfall.
The moment has come when we all wonder. Oil has crossed $100 per barrel and markets are under serious pressure. When I wrote the initial reaction to the Iran war last week, the markets were clearly still pricing it in “Nothing to see here” Situation
I wrote that with the global governance system in disarray and institutional checks conspicuously lacking, markets may now be the only force capable of imposing sanctions. Think of the markets as Congress having to approve the continuation of the war – except this Congress can’t be bought so easily.
US officials, of course, are still downplaying the carnage (in the 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, but US Energy Secretary Chris Wright said the recent rise in oil prices reflected temporary. “Fear Premium” And prices are predicted to bounce back within a few weeks.
Maybe he’s right, but the whole thing is starting to feel like Ceausescu’s final speech in Palace Square. Sometimes history moves very fast and the language of ‘temporary fear premiums’ can seem awfully silly.
Brent oil prices touched $119 a barrel on Sunday night before falling slightly after reports that G7 finance ministers would discuss releasing petroleum reserves. Reports suggest that 300 million barrels could be released. This is a big release by historical standards but hardly enough to cover the persistent shortfall. Keep in mind that the world uses about 100 million barrels every day.
Crude oil prices are now up nearly 50% since the US and Israel launched their attacks. JP Morgan was roundly ridiculed for predicting that oil would hit $130 a barrel, but that looks more conservative if things are moving as they are.
Meanwhile, many people are confused that all this confusion did not lead to a rise in the price of gold. In fact, gold was down just over 1% as of around 10:00 GMT on Monday. This has led to predictions that a wave of inflation caused by rising 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’re used to seeing central bank rate policy as having the gravitas of a big star, but in the midst of a full-blown crisis and tremendous uncertainty about what will happen next, does anyone believe that bets on future interest rate cuts will actually drive price movements? Gold’s move smells awfully like forced liquidation behavior. When the margin calls start coming in (and they certainly are), traders sell what they can, but they don’t prioritize. Gold is one of the most liquid assets out there, which means it’s often unloaded when losses have to be covered elsewhere.
Meanwhile, here’s an interesting take. The Chicago Mercantile Exchange (CME), the world’s largest commodities marketplace, has reportedly lowered its margin requirements on oil and oil products to gold and silver. When you trade futures, you don’t 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 $100k worth of oil futures; You might need to post $10k in margin, for example. This allows you to control $10k plus $100k of oil. When margin requirements tighten, traders must put up more money to hold the same position. As a result, speculators often reduce positions. This may result in cooling volatility or speculation.
Increasing margin requirements on oil increases the cost of speculating on oil futures. Similarly, shorting 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 specific macro outcome. These are often mechanical exchange decisions related to risk management models and volatility.
But some analysts see a fascinating deeper mechanism at work that, even if somewhat overstated, illuminates an important concept. For example, Luke Gromen said: “Looks like they’re trying to leave gold as a release valve for the coming oil inflation. If so, this would be smart IMO, because if gold goes to $7,000, nothing will happen…but if oil goes to $130, all hell will break loose globally.”
Grohmen’s point is that if oil speculation explodes, prices can rise rapidly and cause real economic damage: gasoline prices rise, shipping costs rise, food prices rise, inflation accelerates. But what happens if gold rises to $7,000 an ounce? There really isn’t much immediate real-world impact. Sure, jewelry gets expensive, gold investors get rich and central banks have a lot of gold profits. But everyday life doesn’t change much.
It’s unlikely that the people running CME are tapping themselves on the shoulder about tinkering with margin requirements in some sort of conspiracy. Think of it more as a matter of alignment of incentives. Exchanges like the CME are not neutral in the sense of being indifferent to market stability. They are part of the system and depend on that system.
When markets are under geopolitical stress, capital needs somewhere to go. If fear-driven capital movements are taking place, it is better for that capital to dive into gold than into oil because the macro effects are much less severe. In this sense, gold acts as a pressure valve for geopolitical fears.
How risk management models, volatility indicators, and human understanding of dangerous real-world volatility come together in CME is beyond my pay grade, but it makes sense for institutional mechanisms to tend toward system stability.
Right now, gold is being sold to absorb the oil shock – a condition of affairs necessitated by the market’s extremes these days. From a system-wide perspective, however, gold must absorb an oil shock through a different mechanism: money must plow gold as an escape valve, with the idea that markets can absorb higher gold prices more easily than a chaotic oil shock.
The problem, of course, is that we can get a messy oil shock anyway. No amount of tinkering with margin requirements can solve the physical shortfall.
Ultimately, the global economy cannot withstand a sustained period of high energy prices without plunging into recession – or worse. And the money printed to counter that recession (what else do they do besides print money?) is a veritable inflationary bomb.
