HUI continues its strong showing

Mining shares are getting a very strong bid in today's session taking the HUI up sharply through the 600 level, a psychological resistance level. As you can see on the chart, the index is moving ever closer to the top of the recent chart gap created last month when the shares were sold off during a downdraft in both the gold and silver bullion markets. I would expect the perma bears in the shares to try to make an effort to hold the index BELOW this resistance level. If they fail, I believe there will be enough momentum in the sector to mount a move back to the recent all time high.

Downside support is back at the bottom of the gap and is noted.

Note how the miners are continuing to outperform the broader equity markets today as they have done so over the last month.

Also note the much longer term monthly ratio chart I have constructed showing the performance of this sector against the broader US equity market over the last decade+.

Margin Call Process

Many of those who read this site are equity traders and do not live in this exotic world of commodity futures trading as I do and others who read this site. Also, some are relatively new to the world of trading in general and perhaps are reeling at all this talk of  "initial margin requirements", "maintenance margin levels", "margin calls", etc. I therefore thought it might not be a bad idea to provide a very brief explanation of what these things are so they can understand what all the fuss was about this past 24 hours as we sought to understand what was taking place as a result of the original advisory notice put out by the CME Group which was then fortunately clarified later on.

Initial margin requirement is the sum of money necessary to either buy or sell  a single commodity futures contract. For the sake of our illustration, let's say that the DME (Dan's Mercantile Exchange) set the INITIAL margin requirement for a single contract of corn at $1,000. If you want to BUY or SELL one corn futures contract, you need to have at least $1,000 in your trading account or nothing doing amigo.

Now let's say that the DME sets the MAINTENANCE MARGIN level for that corn contract at $750. This is the level at or under which you are going to receive a margin call if your account balance falls to this level or lower. The margin clerk will then notify you that if you wish to continue holding this position open, you are going to have to send enough additional money to bring your account balance back up to the INITIAL MARGIN level; in our case back to $1,000.

At that point, you have one of two options - you can bank wire the sum of $250 or more or you will be forced by your broker to liquidate the corn position by either selling it or buying it back if you were short.

Now let's see how this might work in actual practice. You start out with an account of say, $20,000. In keeping with the DME exchange (I have always wanted to have my own commodity exchange!) you could conceivably BUY or SELL a total of 20 corn contracts as the initial margin is $1,000 for a single contract. That of course would not be wise but believe it or not some traders actually are foolish enough to attempt this.

Let's say you are a bit more prudent and take out a LONG position by buying 15 corn contracts (notice I said, "bit more prudent" - this is still very foolish as I will explain later). That means you have $15,000 in a $20,000 account tied up in initial margin requirements.

You bought your corn at $6.50 a bushel and are feeling good about your prospects. Unfortunately, no sooner than you get your fill price then the RISK OFF trades start and your corn drops $0.10 down to $6.40. Each 1 cent move in corn is $50 so for each contract of corn you own, you now have a paper loss of $500 ( 10 cents * $50). Since you have a total of 15 corn contracts, the paper loss is 15 * $500 or $7,500. That did not take long did it? Welcome to the leveraged world of commodity trading.

Your account balance is now $12,500 ($20,000 initial - paper loss of $7,500). Things begin getting dicey at this point. MAINTENANCE LEVEL at the DME for corn is $750 for a single contract. You have 15 corn contracts. So you need to keep your account balance above $11,250 ($750 * 15 contracts).
You have a cushion of $1250 left ($12,500 - $11,250). If corn drops another 2 cents, the margin clerk pays you a visit. WHY? Because your total account balance has now dropped $1500 further (2 cents * $50 * 15 contracts). It is now at $11,000 when the MAINTENANCE LEVEL is $11,250.

At this point you will receive a "CALL for ADDITIONAL MARGIN" (margin call) to bring the total sum in your account back to the INITIAL MARGIN requirement to hold 15 corn contracts, which as you recall was $15,000.

You will either have to bank wire the money to your account that same day or you will be required to reduce the number of corn contracts you have bought to a level low enough that you are above the maintenance margin levels. You might sell 5 contracts at a loss leaving you a total of 10 corn contracts. Maintenance margin levels for TEN corn contracts would be $7500 (10 contracts * $750). Since your account balance is at $11,000 you would then be okay.

This example is the reason that futures traders should NEVER trade in a size large enough to threaten the integrity of their own trading account. I have told many potential traders that in my opinion, a trader who starts off with $20,000 in trading account should trade NO MORE than TWO corn contracts. Even at that you would want to cut any losses quickly and limit losses to no more than 5% of your total account balance. That means $1,000 on a single trade.

This is also the reason why exhange changes in margins and maintenance margin levels can cause such a huge impact on individual commodity markets when they occur. Traders who are leveraged up to the gills as in the example of our overtrading trader above (15 corn contracts in a $20,000 trading account) are always the first to get hit by these events. Seasoned traders use margin sparingly realzing how dangerous leverage can be when it is working against you.

IMPORTANT UPDATE - CME CLARIFIES CHANGES IN MARGIN REQUIREMENTS

I would like to publicly express my appreciation for my pal JB Slear, a dedicated commodity futures broker who operates Fort Wealth Trading for putting in yeoman's hours, over a weekend I might add, to help track down what is occuring with this CME margin changes.

Here is the official clarification from the CME Group where they state that instead of raising maintenance margin levels to initial margin levels, they are doing the opposite, and instead LOWERING initial margin requirements to maintenance levels.

Also, thanks to "KId Dynamite" for posting his view earlier that this is what they were doing.

DATE: Saturday, November, 5, 2011

NOTICE # : 11-400

SUBJECT: CME Group Clarifies Maintenance Margin Ratios; Exchange to Reduce Initial

Margin Ratio to 1.00

                                   

FOR THE FULL TEXT OF THIS ADVISORY :

http://www.cmegroup.com/tools-information/lookups/advisories/clearing/files/Chadv11-400.pdf

---

CME Group Clarifies Maintenance Margin Ratios; Exchange to Reduce Initial Margin

Ratio to 1.00

CME Group today is clarifying its notice to clearing firms regarding margins.  In light of the issues customers transferring out of MF Global are facing, while still maintaining appropriate risk management protections for the market, CME Clearing is setting the "initial" margin upcharge at zero. This upcharge is normally applied to customer accounts when they are receiving a margin call.

The intent and effect of these changes is to decrease the size of any margin calls resulting from

the bulk transfer of MF Global customers to new clearing members, not to increase them.

Yesterday, CME Group successfully transferred MF Global customer positions to a new clearing member with part, but not all, of their funds, as approved by the bankruptcy trustee and the court. By reducing the initial margin “ratio” to 1.00, we ensure that margin calls that are issued to these transferred MF Global customers will be limited to bringing their accounts into compliance with the lower, “maintenance” margin levels. Maintenance margins are set to provide appropriate risk management coverage. Initial margins are set to provide an additional buffer against future losses in the account.

This is a short term accommodation to maintain market integrity and provide temporary relief to customers whose accounts have been disrupted by this event.

We apologize for any confusion our initial advisory may have created.

Trader Dan on King World News Weekly Metals Wrap

Please click on the following link to listen to my regular weekly radio interview with Eric King on the KWN Weekly Metals Wrap.

http://tinyurl.com/3n3g3uh

 

Further thoughts on the CME maintenance margin hike

In communications with my broker this evening he suggested that this might be a way for the CME to let some of the firms accepting accounts from MF Global off the hook from attempting to make one margin call after another and attempt to complete a huge number of bank wire transactions in such a short period of time.

What struck both of us as extremely odd was the fact that the communique stating that maintenance margin levels were going to be raised to a 1:1 ratio with initial margin requirements was sent later in the evening, AFTER the close of regular business hours with the change in margins being made effective AS OF THE CLOSE OF TRADING NOVEMBER 4, 2011. That means there was no advance notice given as is the usual norm (we generally have a day or two to prepare for the hikes). Actually the notice hit my box TWO HOURS AFTER the close of business on Friday. Anyone whose account is underfunded is on call immediately based on the timing of the raise in the requirement meaning that they go into the opening of trading Sunday evening already all call.

That gives the brokerage firm the RIGHT, but not the obligation or necessity to immediately liquidate all exisiting positions of customers whose accounts are underfunded ( it could be aimed at some of these new transferred accounts which, if accounts are accurate, have received no more than 75% of their original account balances, some having received only 60% of the original balance).

I am not trying to be sensational here; rather I am attempting to work through the implications of all this especially seeing that it is coming in on the heels of a $630 million shortfall with MF Global. Some 15,000 accounts or so have been transferred thus far. I cannot even imagine the efforts involved by brokerage firms attempting to sort through all these new positions on their books because of the transfers and gauge margin requirements against what is left of their remaining account balances. Some of these firms might be thinking it is just easier to liquidate everything that these newly transferred accounts have and then start with a clean slate. A maintenance margin hike to initial margin requirement levels will make it very easy to justify such an approach.

Those who trade commodities sign an agreement stating that the brokerage firm can liquidate existing customer positions in the event of financial hardship. We may be seeing that taking place.

If I can get some more information on this, I will get it posted as soon as I can but we are headed into the weekend so I would think news is going to be very scarce until we get around to market reopenings Sunday evening and into Monday morning. We could be in for a very wild and unsettling round of price volatility starting Sunday evening. This is unprecedented in my own personal trading career so I am not certain what exactly we are going to get as a result of all this.

Maybe we will get lucky and learn that the CME Clearing House issued the communique by accident or something. Boy howdy do I hope that is the case, but I fear it is not.

One last thing - it should be kept in mind that if the markets open strongly to the upside in general on a round of RISK ON trades, it is the SHORTS who are going to be hurt by the margin change. That would force additional short covering. The flip side to all this is that a great number of the transferred MF Global accounts are mainly on the long side of the market and the RISK OFF trades are what come on Sunday evening. Then the longs are in trouble... What a stinking mess caused by these ***&&$$ at MF Global.

CME Group hiking margins across the Board

If I am reading the communique from the exchange correctly, the margin requirements for ALL CME products is being raised by hiking the MAINTENANCE MARGIN requirements to the SAME LEVEL as INITIAL MARGIN requirements, effective as of the opening of trading Sunday evening/Monday morning, November7. The changes were implemented as of the close of trading Friday, November 4th.

If this is correct, and I think I am reading it correctly, this is the first time that I can recall seeing something like this occuring. It will also precipitate some very volatile trading conditions.

I suspect this is tied directly to the fallout from the MF Global debacle. Apparently CME group and its clearinghouse want to make sure there is sufficient liquidity present to cover all its obligations.

This might throw my previous assessment of silver and gold technical action out of the window. Stay tuned as this is going to get even more wild than I previously imagined.

Traders who are not margined up to their teeth and have a sufficient cushion in their accounts, will be okay. Those who are not are going to get hurt on any adverse price action. What I mean by this is simple - if a trader is long and the market sells off, his paper losses or loss of profits will cut into his account balance perhaps bringing the total margin requirements of his active positions below his account balance. He is going to get a margin call that day if not Monday morning or even Sunday evening. Once "called", the money is going to have to be wired that day or the positions will be liquidated.

Quite frankly, seeing this occuring is very unnerving as I wonder if there is more stress out there from the MF Global debacle than meets the eye. The Clearinghouses obviously want to make certain that they are well capitalized.

My guess is that many of the accounts from MF Global that were transferred and have not gotten the ENTIRETY of their former account balances reinstated, are going to be forced into liquidating unless they have adequate capital on hand elsewhere that is easily accessible and very liquid.

HUI pushing into Chart Resistance

The HUI had a strong showing this week as the return of the risk trades drew money into the sector. Along with that, many investors have come to view the sector as generally undervalued based on the good numbers being reported by several miners and the fact some were raising dividends.

The result was a move back into the large gap region formed in September when gold and silver were both taken down quite hard. Last week the index mounted its first push into the gap and managed to hold the level going into the weekend. This week after some initial weakness, it found willing buyers who came in and took it further into the gap closing above the 590 level. The index now has the potential to mount a push towards 600. If it can do that successfully, it should be able to close the gap completely. That would be a major victory for the bulls.

Note that the market found buyers on the last two days of this week when it fell back towards the BOTTOM of the previous gap near the 580 region. That is good technical action.

Let's see what we get next week with the risk trades. If they are back on, the HUI is going to hit 600.

Silver Chart improving but still bearish

Let's start by examining the weekly chart for a bit longer perspective. For starters, silver remains held under the 50 week moving average so strictly speaking it is still bearish. Once it climbs above this level, funds generally become more involved in the market so that will be the first achievement which the bulls will have to pull off to get the speculators more interested in the market. Note that the over the last two weeks, this level has effectively capped any upward progress although the bulls are working on securing a breach of this important technical level.

You might also notice that there are two sets of Fibonacci levels drawn on the chart. The first, in red, uses the peak near $50 and the subsequent spike bottom near the $26 level. The second set, in blue, uses the failed rally attempt culminating near $44.27 and the same spike low to project some potential resistance levels. The market has rallied back to exactly the 38.2% retracement level of the former and the 50% retracement level of the latter.

You can see that there is a confluence of THREE key resistance levels near the high made by silver this week. Until the bulls can better this level, the stronger-handed bears are not going to run.

What has been happening with silver is that the risk on, or risk-off trades continue to jerk the metal up or down depending on which trade happens to be in vogue on any given day. If we move into next week and market interprets any events in Europe in a negative fashion, silver is going to get sold down along with copper. If the converse is true, silver will move higher alongside of copper.

As has been the axiom of recent weeks, we will know what will happen only AFTER it happens. There is no predicting any of this madness. The bulls are very close to seizing the initiative but close only counts in horse shoes and hand grenades.