Don't think that today's drop in gold and silver is a sign that the market is about to turn

09/12/2011 6:29 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

There comes a time in every financial market rout when traders begin selling the stuff that they bought as hedges against falling prices. We hit that point today with gold and silver.

Gold for December delivery closed down $46.20 an ounce, or 2.5%. Silver for December delivery closed down 3.4%.

Why did these safe havens take such a beating on a day when the U.S. stock market indexes managed to finish ahead? The Standard & Poor’s 500 Stock Index was, after all, up 0.7% today.

Margin calls.

Investors have been getting them every day as stock prices sink, lowering the value of the shares they’ve used as collateral on the margin loans that they used to buy those stocks. When that happens, margin clerks all around the global financial system begin placing calls asking for more cash to back these loans. No cash? Then after a very short decent period, the clerks sell your shares.

In the early days of a rout, investors can easily meet those margins calls from cash on hand. As the rout goes on, they might be pressed for cash and have to sell some shares to raise the amounts they need. At some point, the shares they have to sell are down so far that either 1) selling won’t raise the amounts needed, or 2) that looking at their stocks, traders decide that selling now will waste a chance to get even.

And so traders who get a margin call start to look around for assets that haven’t tumbled too far in value and that might be closer to a top than a bottom.

Right now that’s gold and silver.

So don’t think for a moment that today’s drop in gold and silver is a sign that traders think this market is ready for a turn or that risk has fallen.

What we’re seeing is traders trying to preserve their portfolios by selling one of the few things they own that hasn’t crashed in price. Whether that’s wise—selling gold so that you can go on holding bank stocks, say—will depend on how much further this market has to fall.

 

 

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