Understanding the London Gold Fix
Jan Skoyles takes a quick look at the London Gold Fix and outlines the latest developments in the growing financial scandal.
In existence since 1919, the London Gold Fix is a process that results in a gold price that is used to buy, sell and value the yellow metal. Those who use the Fix claim it helps them to hedge risk and it helps them to see a clear picture of the market, twice a day.
The twice daily Fix discussions now take place over the phone, rather than a wood-panelled room, however is this just small change against a backdrop of traditions in this process.
Currently managed by five banks, Barclays, Deutsche Bank, Bank of Nova Scotia, HSBC Holdings and Societe Generale, the Fix occurs twice a day; 10 am and 3pm, London time.
The price is set according to the both the banks’ and banks’ client orders. According to Bloomberg, traders were concerned that the five fixing banks had an unfair advantage in terms of foresight as to where the gold price would head to, thus benefitting them in the futures market.
How does this gold fixing price compare to the spot price regularly referenced on COMEX? Our research last year found that both the London and COMEX volumes shifted in terms of market majority suggesting neither price carries more weighting than the other. However, the COMEX price is set on the principal of supply and demand, compared to London which is based on supply, demand and traders’ thoughts.
Many argue that the London Gold Fix is an opaque process. Readers will recall in our past research our comments that the London Gold Market in its entirety is an extremely difficult one to try to understand. Whilst the LBMA has nothing to do with the Fix, the whole market is steeped in tradition and anachronistic processes.
Can the gold Fix really be that opaque?
However, not everyone believes the Fix is opaque. Some argue that the setting of the price involves all market participants, all those who are demanding and supplying the market. All participants can affect their order at any point, making it transparent.
Others believe that the opacity means the difference between the spot and the Fix price can not be so easily traded on.
Research in September showed trading in gold derivatives literally explodes as fixing begins, implying information going on in the talks is being used by certain market participants. “Not only are the trades quite accurate in predicting the fixing direction, the more money that is made by way of a larger price change, the more accurate the trade becomes,’ stated the Caminschi and Heaney, authors of the research.
Even if the talks go on for just a few minutes, these traders have insider, superior knowledge to other speculators. It therefore is not an optimal way to allow price-determination to play out.
The involvement of just five of the world’s most powerful banks, influenced by their own order books, knowing they can come back in just a few hours and amend the price accordingly does not sit well in my understanding of market economics.
Is this gold price manipulation? The word ‘Fix’ is perhaps a clue to the answer of that question. But at the moment no investigation or regulator has concluded as such. However, it has caught the attentions of regulators in London, Bonn and New York.
It seems Elke Koenig, head of Germany’s financial regulator Bafin, may already be convinced of the ongoing manipulation in the metals markets and the implications this has on the trustworthiness of the market. A few days ago it was reported by both Bloomberg and Zerohedge she said that the manipulation of metals, as well as currency rates, “is worse than the Libor-rigging scandal,” however further investigations show that in fact she implied that these latest allegations (in the metals markets) “carry particular weight, because, unlike Libor and Euribor, these reference prices are typically based on actual transactions in liquid makrets and not on Bank estimates… It is understandable that this theme causes such waves in public opinion; the financial services industry is dependent upon widespread trust, both that it has the capacity to conduct business and that it conducts that business honestly. ” (thank you to Zhanglan, in the comments below).
It shouldn’t stretch anyone’s mind too much that the prices of precious metals might be manipulated. After all look at the scandals the financial world has faced in recent years, namely Libor, currency trading and ISDAfix.
When Ned Naylor-Leyland appeared on CNBC in July 2012 and suggested that gold was manipulated to the same extent seen as LIBOR, it made headlines in the financial world. The term ‘Gold Fix’ and its real meaning had clearly only sat uncomfortably with a small number of people.
A history of gold price manipulation
For many, many years academics to economists to gold investors have declared the system by which the gold price is set to be manipulated.
It may come to some’s relief then that Bafin has interviewed Deutsche Bank employees regarding the potential manipulation of gold prices and the FCA are also apparently looking into the issue. Rumours are also circulating that the CFTC have privately discussed the Fix.
Re. the CFTC, nothing came of the silver price manipulation investigation and so some gold and silver investors may not have their hopes up over this latest foray into manipulation investigating.
Something has obviously rubbed off somewhere and made regulators in the three aforementioned cities feel somewhat uneasy. And not only the enforcers, the participants too.
Perhaps concerned about being associated with yet another financial scandal Deutsche Bank announced earlier this month that they are planning to withdraw from the panels that set both the gold and silver Fix. They attribute this decision to the scaling back of their commodities business, however the timing appears somewhat suspect.
Also, in response to the sniffing around by the regulators the five owners of the London Gold Market Fixing have begun consultation on how the process can be improved and perhaps more transparent. This is all an effort to make improvements before the EU legislation regarding financial benchmarks comes into play.
Anyone else want to play at this table?
So there is now a seat at the table, literally for sale. Deutsche Bank, as explained above are looking to put their seat onto the market, but will anyone want it? Too many banks have been stung too many times over manipulation scandals.
Not only is there a clear moral issue in the bigger picture but we are discussing a market that is rapidly being opened up and exposed thanks to the growing involvement of Eastern buyers, namely China. Given their open speeches about the US’s manipulation of the gold price, one can’t but help wonder how much longer they will stand by an allow London to carry on an obsolete and opaque process in an increasingly modern market?
Even if regulators find little evidence of manipulation, the benchmark is still outdated and wide-open to abuse, particularly due to the closed-curtain nature of the actual Fix meetings.
It’s time the London Gold Market joined the 21st century. Sunlight is the best disinfect for rotten market mechanisms. We look forward to seeing London’s gold market evolving for the benefit of all market participants, not just the most powerful few.
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