So what went wrong to Silver prices?

Week 14.2. So what went wrong to Silver prices?

Let me explain a bit on the future market first from what I understand. If I’m wrong tell me ok, cause I’m a future chicken. 

In the future market, there is no good involved initially. Let said a miner who will have some silver to produce every month, however they require some $ to operate. Thus, they will commit to sell their silver in the future for a particular price. Short seller.

A factory which requires silver for their manufacturing process will need to hedge the silver prices in the future in order to ensure that their product cost won’t varies so much. Thus, they will commit to buy silver from the future market at some agree price. Long Buyer.

These form the basis of future market, from what I understand. You can read below

From: http://About.ag

When you buy a long position or sell a short position, it is done on margin. So if you buy a long contract for 5,000 ounces of silver for June, 2010 at $20, the total value of the silver is $100,000. However, you would only be required to put down a small amount (perhaps $5,000). If the price of silver goes up, the money is deposited into your account. If the price of silver goes down, money is removed from your account, and when it gets below a certain amount, you are required to immediately come up with the more money (or else your position is sold). Maintenance margin.

From:

OPTIMAL MARGIN LEVEL IN FUTURES MARKETS:

EXTREME PRICE MOVEMENTS

FRANQOIS M. LONGIN*

Along with price limits and capital requirements, the margin mechanism ensures the integrity of futures markets. The existence of margins decreases the likelihood of customers' default, brokers' bankruptcy and systemic instability of futures markets. Initial deposits and subsequent variation margin payments are designed to guarantee that investors will perform according to the terms of the contract. The risk of default, however, cannot be completely eliminated, because margin deposits cannot fully cover all adverse price changes. 

Default occurs when a trader reneges on the contract obligations. Such a situation arises when there is a large futures price change such that the investor's margin account is wiped out, the investor receives a margin call, but does not meet this margin call. Setting a high margin level thus reduces default risk. On the other hand, if the margin level is set too high, then the futures market will be less attractive for investors. Because maintaining funds on margin deposits amounts to a transaction cost on traders^ an increase in margin requirements can be expected to decrease trading activity and thus brokers' commissions. And. as noted by Miller (1988). "driving major classes of users to seek alternatives to futures exchanges not only reduces the revenues of these exchanges but undermines the liquidity and market depth that is the very reason for their existence." It is in the self-interest of the exchanges to keep margins at appropriate levels: high enough to maintain market integrity yet low enough to maintain market liquidity.

For more information about future market, you can refer to

http://about.ag/futures.htm

http://www.bullionbaron.com/2011/03/cme-hikes-silver-margin-requirements.html

Performance Bond

Taken from: http://www.bullionbaron.com/2011/03/cme-hikes-silver-margin-requirements.html

Date: November 10th, 2010
Spot Price: $27.18
Contract Value: $135,900 (5000 x $27.18)
Margin Requirement: $8,775 (6.5% of full contract value)
Resulting Leverage: 15:1

Date: November 16th, 2010
Spot Price: $25.40
Contract Value: $127,000 (5000 x $25.40)
Margin Requirement: $9,788 (7.7% of full contract value)
Resulting Leverage: 13:1

Date: December 17th, 2010
Spot Price: $29.15
Contract Value: $145,750 (5000 x $29.15)
Margin Requirement: $10,463 (7.2% of full contract value)
Resulting Leverage: 14:1

Date: January 21st, 2011
Spot Price: $27.45
Contract Value: $137,250 (5000 x $27.45)
Margin Requirement: $11,138 (8.1% of full contract value)
Resulting Leverage: 12:1

Date: March 24th, 2011
Spot Price: $37.26
Contract Value: $186,300 (5000 x $37.26)
Margin Requirement: $11,745 (6.3% of full contract value)
Resulting Leverage: 16:1

Date: April 26th, 2011
Spot Price: $45.50*
Contract Value: $227,500 (5000 x $45.50)
Margin Requirement: $12,825 (5.6% of full contract value)
Resulting Leverage: 17:1

Some of the margin hike is missing here.

As of 5^th May 2011, USD18,900 is required to initiate a COMEX 5000oz silver contract. 5000oz silver contract @USD40 will cost about USD200,000. A maintenance margin of USD14,000 is required.

As of 9^th May 2011, USD21,600 is required to initiate a COMEX 5000oz silver contract. 5000oz silver contract @USD35 will cost about USD175,000. A maintenance margin of USD16,000 is required.

EXAMPLE

After spending so much time in the internet, I can’t find the complete margin rise in CME. With the limited data I have, let me illustrated an example.

Let said you pay USD14,000 to initiate the contract on 26^th April 2011.

Let fast forward to 9th May 2011, off course in reality the contract is already sold off long before 9^th May.

Let said the silver price is USD34.50 on 9^th May, it has dropped USD11 per oz.

Thus, you need to top up USD11 x 5000 = USD55000
Plus the need to maintain a maintenance margin of USD16,000 - USD14,000 (initial) = USD2000.
In total you would have to top up, USD57,000 to maintain the contract you have initiated since 26th April 2011.

USD57000 is way much more than USD16,000 you initially paid to secure the 5000 oz silver contract? Thus, better liquidate the contract-lah much earlier if you think the price will go much lower and get a new contract at USD34.50. That’s why this triggered a chain of sell off.

So what went wrong to Silver prices?

The main cause of the drop is caused by CME raising the margin requirement 5 times over a period of 8 days according to zerohedge.com. Due to the raise in margin requirement, long spectators unable to raise enough funds to cover their margin call thus cause a massive sell-out. Apparently there are quite many long spectators. Probably some are bait-in by the previous lucrative 33% extra cash settlement in exchange for physical delivery.

CME still can raise the margin requirement a few more times. Maybe up it is 30% of the contract price. After that, the buyer may as well buy the physical straight away rather than going to the future market. Just buy less-lah. 30% of 5000oz is 1500oz.

Just hang on to your silver. Overtime it will go up to the sky one. Don’t worry.!