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The Bullion Report

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July 6, 2011 in 'The Bullion Report'

Dodd-Frank and the Stir Over Metals TradingDodd-Frank and the Stir Over Metals Trading

Nothing can get the precious metals community buzzing quite like the idea of the government adding controls to the bullion trade. A numbers of articles have been circulated in the past two weeks concerning the possibility that the Dodd-Frank Reform Act aims to do just that. Is the financial legislation set to outlaw the retail sale of gold and silver, or is this just an example of an overreaction to one company’s notice? If there is a ban, what does that mean for the price of precious metals? 

Most of the hullabaloo seemed to stem from an original email sent to clients from Forex.com. The email details changes to products available to trade for US residents. According to reprints of the email on several websites, the text states, “As a result of the Dodd-Frank Act enacted by US Congress, a new regulation prohibiting US residents from trading over the counter precious metals, including gold and silver, will go into effect on Friday, July 15, 2011….In conjunction with this new regulation, FOREX.com must discontinue metals trading for US residents on Friday, July 15, 2011 at the close of trading at 5pm ET. As a result, all open metals positions must be closed by July 15, 2011 at 5pm ET.” It goes on to tell traders to “wind down” their trading activity. ZeroHedge.com was among the first sites to focus on the email, and the potential ramifications of a law like that.

The actual details for fresh regulations do not appear to be as blatant as the text of the email would suggest, but the effect is the main cause for concern. First let’s dispense with the definitions. The Dodd-Frank Wall Street Reform and Consumer Protection Act is about 848 pages of sweeping regulatory overhaul for the financial industries. Summaries of the act highlight that it is the largest reform for the industry since the Great Depression. It was aimed at closing some loopholes (seen as gaps in regulations) and adding oversight where Congress felt it was necessary.  The whole point of this act is to try to prevent the kind of financial missteps that lead to meltdown. The mortgage and ensuing credit crisis were the catalyst for it, and virtually no area of the financial services industry is left untouched by the act.

When the president’s pen went to paper in July of 2010, there were already several bloggers and news outlets pointing out the potential for OTC products to be eliminated. This wasn’t limited to the OTC trade of gold and silver. Various forms of foreign exchange investment were also included in the queries over potential ban. The language that spurs such discussions comes in 742a for Retail Commodity Transactions where, “prohibits any person [which again includes companies]from entering into, or offering to enter into, a transaction in any commodity with a person that is not an eligible contract participant or an eligible commercial entity, on a leveraged or margined basis.” The rule does not apply to anything that, “results in actual delivery within 28 days or such other longer period as the Commission may determine by rule or regulation based upon the typical commercial practice in cash or spot markets for the commodity involved; or ‘‘(bb) creates an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery, respectively, in connection with the line of business of the seller and buyer; or ‘‘(IV) an agreement, contract, or transaction that is listed on a national securities exchange…...”

I am not a lawyer so I don’t aim to interpret this language, but other sources have suggested that in plain terms this text is really just meant to make it easier for the CFTC to flex its oversight muscle. There is no reason to think that either Congress or the CFTC are on a path to banning bullion buying or ownership. This section obviously changes the way that OTC markets operate and how the CFTC can set rules for these spot transactions. The last part explicitly excludes transactions that result in a delivery, or acknowledgement of allocation, within 28 days or futures contracts traded on any number of designated exchanges.

Summary

The language of the act will obviously have an impact on some retail investors in gold and silver and other precious metals. It is not outside the realm of possibility that other places might cut their offerings the way that Forex.com did. The trick is that it shouldn’t hold a bigger impact for the price of precious metals. There won’t be some massive exodus from gold or silver on the heels of this becoming law on July 15. OTC markets count for only fractions of the whole scope of precious metal trade. Closing out any speculative long positions in these markets is a matter of interest for those clients and companies, not for bullion bugs in the bigger picture.

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Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results.