Of Corn and Silver: Evaluating Margin Raises

As corn surges higher and higher on the back of last week’s USDA report which showed low inventory levels, the CME has raised margins 16% to ensure that participants in this rally are able to handle the rapid movements.

Some people see margin raises as an attempt to curb speculation and lower prices, but that isn’t why the CME raises margins in our view. The CME has to do a balancing act with margins, keeping them low enough to attract investors who don’t want to tie up all their capital in betting on commodity moves, but high enough that the CME has a buffer against a large move wiping customers who bought/sold their contracts  (the CME guarantees all trades in its contracts, after all). Theoretically, this should slow the ascent of corn’s prices, as it requires more capital upfront from investors, but that may not be the case. In fact, that hasn’t been the case lately for margin raises in commodities.

Take for example November 2010, when the CME raised margins in Silver. While it slowed silver’s surge momentarily, the ascent continued within a week and silver closed today up over 53% higher than its post-margin raise slump.

Now take a look at corn since the margin hike. Despite this increase, corn surged even higher today, up 3.13% at the bell, setting new highs for 2011.  What is going on here? Are commodities just in such demand that nothing can slow them down?

Likely not… what is really happening is that despite the big headline number (16% increase in margin), Corn margins really only went from $2,025 to $2,363 – for the ability to control $38,000 worth of Corn. [$7.60 per bushel * 5000 bushels per contract = $38,000] When looked at in that light,  the leverage factor built into the commodity merely went from 18.7 to one, to 16 to one, which is hardly crippling for those looking to speculate on prices moving higher.

Viewed another way, you can see the ‘leverage factor’ in the current May Corn contract barely budging at the far right of the chart after the supposedly large 16% margin increase.

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