Gold. Collateral Damage

Bruce Johnson

In reference to the bottom dropping out of the "greater fool" market known as precious metals, let us consider the behind the scenes ramifications of Gold's sudden plummet.

Yes, Gold is used as collateral.  It was considered a bullet proof good faith backing for market risks.  A speculator or trader could even use Gold to back up his purchases of  more Gold. Some exchanges even allow the posting of Gold to serve as margin, or good faith money.

So what happens when Gold drops?  If Gold is placed to back other Gold purchases, the drop in the market creates a domino effect.  The Gold owned in the position loses value, and the Gold placed as good faith money also loses value.  So there is less "good faith" margin or collateral behind the falling value of the commodity owned.  A liquidity problem develops for the financial guarantor of the customer.

Back in the ancient history of commodity trading (1930s),  there was an extremely bullish Wheat scenario.  It became vogue to buy Wheat futures, and sell Wheat put options.  As the market became top heavy and rolled over, the Wheat futures lost money, and the Put options gained value.  A double dip of sorts for the owners of Wheat.  The owners of Wheat were having their position in a falling market increased as prices declined. Debacle.  Option trading on commodities would take several decades to reemerge.

As Gold drops, the collateral behind many trades vanishes.  The margin or good faith money that backs the financial risk of trades actually could, in certain circumstances, create cascading financial conditions for those who accepted Gold and Silver as solid backing for financial risk. 

There are those who shook their heads when exchanges accepted Gold as margin.

They are shaking their heads again. 

 

Bruce Johnson

 

In reference to the bottom dropping out of the "greater fool" market known as precious metals, let us consider the behind the scenes ramifications of Gold's sudden plummet.

Yes, Gold is used as collateral.  It was considered a bullet proof good faith backing for market risks.  A speculator or trader could even use Gold to back up his purchases of  more Gold. Some exchanges even allow the posting of Gold to serve as margin, or good faith money.

So what happens when Gold drops?  If Gold is placed to back other Gold purchases, the drop in the market creates a domino effect.  The Gold owned in the position loses value, and the Gold placed as good faith money also loses value.  So there is less "good faith" margin or collateral behind the falling value of the commodity owned.  A liquidity problem develops for the financial guarantor of the customer.

Back in the ancient history of commodity trading (1930s),  there was an extremely bullish Wheat scenario.  It became vogue to buy Wheat futures, and sell Wheat put options.  As the market became top heavy and rolled over, the Wheat futures lost money, and the Put options gained value.  A double dip of sorts for the owners of Wheat.  The owners of Wheat were having their position in a falling market increased as prices declined. Debacle.  Option trading on commodities would take several decades to reemerge.

As Gold drops, the collateral behind many trades vanishes.  The margin or good faith money that backs the financial risk of trades actually could, in certain circumstances, create cascading financial conditions for those who accepted Gold and Silver as solid backing for financial risk. 

There are those who shook their heads when exchanges accepted Gold as margin.

They are shaking their heads again. 

 

Bruce Johnson