Who’s Really Moving Margin Rates?

06/27/2011 8:00 am EST

Focus: COMMODITIES

John Person

Founder and President, John Person, Inc.

Throughout history, increased margin requirements have led to lower commodity prices, says John Person, but how is the decision ultimately made to raise margin, and do entities outside the commodity exchanges—like the government, perhaps—have a hand in it as well?

We're talking about chaos in the commodities pits with John Person. John, as we're speaking, there has been a lot of volatility, excitement, and news in the commodities pits, and one thing that's happened is that the exchanges have started raising margin requirements. 

They did it five times with silver; they did it with oil; they're doing it with gasoline as well. What are they trying to accomplish?

Well, at the Chicago Mercantile Exchange (CME), they use a formula and a system known as “span margin,” and it's done by volatility and pace of price change. When we start to see an acceleration of price movement, they're going to increase the margin requirement, which means it's the good faith deposit.

They don't want people to be undercapitalized while trading a highly leveraged product. When we start to see that they raise margin requirements, it's actually a great indicator to scan, and you can go directly to the CME Web site and look for changes in margin requirements, and look for that, because when we see increases in margin requirements, almost throughout history, you generally see corrections in prices. 

It's like raising interest rates, isn't it?

Yeah, it's like if your interest rates are going up, it may be a temporary shock to the economy and the stock market, and therefore, most people will say, “Gee, when interest rates and the Fed start to tighten it, that's the sign that we may see a correction in equities.”

In the old days, that is. I think that right now, with where the Exchange is, they're taking a proactive stance in trying to make sure that people are adequately funded when they're trading in a speculative market such as the futures.

Now, I have a question, maybe as a conspiracy theorist would say. I did a column a few weeks ago about the amount of speculation in the oil markets and I got some E-mails back from people who said “Well, they should just raise the margin requirements and we'll have gas down to $3 a gallon.” 

I always wonder whether the government or the Commodity Futures Trading Commission (CFTC) or someone sort of whispers into the ears of the exchanges, and says “Hey, you know, if you guys raise requirements, I wouldn't have all this heat about gas prices.” 

Well, I think that the function of commodities is to allow a central marketplace to discover price, and so we have three—to make a good market or fair market, you need three entities: Speculators; hedgers, those that are using the commodity markets to pass risk off or to lock in a profitable (price)…

The commercial hedgers, the airlines, people like that.

Correct. And finally, an end user or a producer; someone who wants to either lock in a profit or reduce their risk in a cash position.

We need the hedgers, and we also have speculators and locals and hedge funds that are there to also help provide liquidity into the marketplace, and so those three groups.

But when a market gets too lopsided and we start to see increases in price swings, the exchange needs to step in and raise the amount of money, or good faith deposit, that one needs to put down to trade the market. 

Have you ever seen any instances in which there were rumors or apparently facts that the government or the CFTC or anybody was getting involved and telling people “Hey, come on, we gotta raise the margin requirements here?”

You know, I just don't get those E-mails. (Laughter.)

I'm not on that E-mail list. No.

The exchange sets the margin, and they have a margin committee, and so therefore, they will sit and discuss to say “We're seeing a move in the markets. We need to increase the margin requirements,” and so the exchanges are setting the margins.

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