The first of all is to explain that the beginning of the falls was a political catalyst. I am referring to Donald Trump’s announcement about the possible appointment of Kevin Warsh as future chairman of the US Federal Reserve.
Although this seems to have nothing to do with gold and silver, the truth is that it does. One of the tailwinds for them to rise so much in recent times is the dollar credibilitywith everything that is associated with it. If there is more debt, less credibility. If more dollars are issued, less credibility. The more lax monetary policies, the less credibility. And of course, monetary policy is part of the Fed and it turns out that Warsh has a reputation for not being fond of printing banknotes and to stimulate the economy artificially.
That triggered the expectation of relatively lower interest rates and from one Fed less willing to open bar. And what happens when rates rise (or fall less than expected) and the dollar strengthens (or weakens less than expected)? That gold and silver lose attractiveness. It’s that simple.
But of course, This would mean a small dropnot the catastrophe that we saw in a few hours. Well, this occurred because some small falls —and this happens and will happen increasingly with many assets—can represent a drag effect for the leveraged products.
Here comes the most important part of the article. And no, you don’t need to be an economist to understand it. The first thing is to explain what is a leveraged positionto understand the margin calls.
Imagine that you want to invest in gold, but you only have €1,000. To earn more, you decide ask for service money to the broker and you buy €5,000 in gold. That’s leverage, invest with borrowed money.
Your broker lets you do it, but with the condition that you have to leave a warranty to cover the risk of you losing money. In this case, those €1,000 are your initial guarantee, what is known as margin (margin).
It is a sign of trust. It’s like saying that if this goes wrong, at least I have something of yours. And if gold goes down a little, nothing happens. But If it goes down a lot, your investment starts to be worth less. of what you borrowed. and that’s when your warranty no longer covers losses. And the broker calls you (call) and tells you that where before €1,000 was enough, now you need to put in another €200€500, or €1,000 additional, depending on the latent losses you have. AND but you put those additional guarantees, they close your positionbecause the broker does not want to lose money because of you.
That’s a margin call. A call (nowadays it is automatic) that requires put more money or force sell.
Well then, many people have leveraged positions with gold and silver. When the fall began, hundreds of thousands of margin calls They were activated at the same time. And, since many could not cover the new guarantees, the brokers sold those positions, thus produces a massive sale of gold and silverwhich causes its price to plummet suddenly. And, in turn, that forced sale caused more price drops… which in turn generated further margin calls in other investors. As a consequence, a downward spiral occurs.
to this let’s add the sale of indexed assets as a consequence of weighting due to price decline and the derivatives. Here is a technical note that I want to explain. If you see that the price of gold has risen a lot, some investors may bet that it will fall selling options call (i.e. giving others the right to buy gold at a certain price in the future). But sell an option call is risky (as we have seen, because if gold continues to rise, you have to deliver that gold at a lower price than the current oneand that can generate a big loss). To protect yourself, you buy gold futures; Thus, if the price rises, you gain with the future what you lose with the option. But what happens if gold starts to fall? what those calls what did you sell lose valuebecause it no longer makes sense to exercise them. Then, since the risk has disappeared, you no longer need the coverage. What are you doing? You sell the futures you had bought to cover you. And when you sell them, you add downward pressure to the price of goldwhich can generate a domino effect of falls.
Although this is a little more confusing, it was also another addition to the fall of gold and silver.
Of course, All this does not mean that gold and silver are useless.. In fact, the session of declines did not end so defeatist and it still makes perfect sense to be structurally in these metals. But it does show that markets get carried away by noise in the short termwhich is a blessing because it opens very interesting purchasing windows.
The lesson I want to learn About this event it has been to remember 3 ideas that I share with you in case they help you.
1. Do not invest in an asset because it is going upbut to understand the reason for that rise. The behaviors of herd They usually end badly.
2. Do not play with borrowed money. Let others do it, not me. Leverage is a thing for a few. And most of us are not in those. It can multiply profits, and losses too. Your hair falls out from stress.
3. Maintain perspectives. Gold is not dead, and neither is silver. The fundamentals of both metals remain the same.