Is the gold price rigged?

Hard on the heels of London’s interest rate scandal, controversy now surrounds the way the price of gold is set.

Summary: For more than 100 years, the setting of the daily gold price has been linked to a “fixing” system operated by a London-based committee made up of several major banks. But that arrangement is nearing its use by date following the LIBOR interest rates scandal and the imminent end of the silver fix system.
Key take-out: Moves to reform the gold fix are underway with the World Gold Council, a gold-producer lobby group, convening a meeting in London this week to discuss ways to modernise the setting of a daily gold-price benchmark.
Key beneficiaries: General investors. Category: Commodities.

It’s not surprising that after last year’s genuine scandal over the setting of the important LIBOR (London interbank offered interest rates), attention has spread to other ‘markets’ where prices are set in arcane fashion.

In recent weeks a flurry of headlines on examination of how the price of gold is ‘fixed’ have received immense attention. In Australia ,where investing in gold and gold mining has always been a key part of the investment market, the issue is of wide interest.

So what’s been happening to gold and can we trust the gold price?

In what might one day be seen as the biggest misunderstanding of a simple three-letter word, “fix”, in the case of gold and silver” it means to “set” the price at a particular time of the day so big owners of the metals can trade with confidence.

Unfortunately for the “fixing” system, which dates back almost 100 years, there have been recent attempts to manipulate the gold and silver prices, in much the same way as other markets have been attacked by criminal dealers with interest rates subject to the most notorious rigging by rogue bankers.

It was the manipulation of the LIBOR by banks such as Barclays which triggered concern about other, old, price setting systems which evolved in London long before the development of high-speed communications and widespread derivative trading based on the official “fix”.

In the LIBOR case, an exclusive selection of banks are supposed to submit to a central committee the interest rate they charge other banks for loans (and the rate they pay for loans). It is a system built on the honesty of bankers to tell the truth and to not try and “game” the system.

Barclays was one of the banks to admit that some of its traders did submit false interest rate numbers which might have affected the daily LIBOR setting and which, in turn, might have affected an estimated $US350 trillion in worldwide interest rate related products and derivatives.

After a worldwide outcry of concern about the attempts to rig LIBOR, plans are being made to dump the system in favour of a more transparent interest-rate setting system.

Gold “fixing” is based on a similar London-style honesty process with variations.

Until recently, representatives of five banks would meet (either in person or by an exchange of messages) to discuss developments in the gold market and to declare how many gold bars they wanted to buy or sell on behalf of customers.

Those discussions would include an examination of the price of gold and silver on international commodity and futures markets.

The talks, which started at 10.30am every morning and 3pm every afternoon, would continue until a common price was agreed (much like LIBOR) with a morning and afternoon “fix” being declared at the conclusion of the meeting.

Trust in what the bankers said at those meetings is crucial to the fix being an accurate reflection of the gold market, with rumours circulating for some time that rogue traders were submitting false buy and sell data.

No-one has been charged with trying to manipulate the gold price at the daily fixes, but the breakdown in trust is likely to see the collapse of the system and its replacement by a more open price-setting mechanism.

Deutsche Bank has signalled its concern about the gold fixing process by quitting the five-member “fixing” committee, leaving Barclays, HSBC, Societe Generale and Scotiabank as a four-member committee.

The silver fix has already effectively collapsed because its “fixing” committee has dropped from three to two after Deutsche Bank quit that committee ahead of its decision to withdraw from the gold fix, leaving HSBC and Scotiabank to handle the silver fix.

A two-member committee is viewed as untenable, so the silver fix will officially end next month with a number of bids being submitted to the London Bullion Market Association (LBMA), the body overseeing gold and silver fixes, to take over the job.

Lead contender for the silver pricing job is a joint venture of the big US commodity-trading organisation, CME Group (which owns the Chicago Board of Trade), and the financial information specialist, Thomson Reuters.

For most investors in gold the morning and afternoon London fix is largely irrelevant, with prices from open markets such as those in Chicago, New York, Tokyo and Shanghai setting the price for the metal.

The fix itself acts as a benchmark and is viewed as being a more accurate pricing mechanism for big owners of gold because it is based on physical gold trading (the bars really do change hands, in a vault, at least) rather than buy and sell quotes.

The fix is also seen as a very flexible system, with bank members able to alter the price they are prepared to buy (or sell) gold at during the meeting and after they have been able to judge the mood and intentions of other members of the fixing committee.

Time, high-speed communications, and a few untrustworthy participants have led to doubts being raised about the process of fixing the price of commodities such as gold and silver, and for money in the case of LIBOR.

The same fraud factor can be seen in the current furore over private share dealing in so-called “dark pools” operated by banks and where high-speed “flash” traders have been able to game the system.

Interestingly, common bank names appear in all of the markets being questioned for their openness and honesty.

Moves to reform the silver market are almost complete. Moves to reform the gold fix are underway with the World Gold Council, a gold-producer lobby group, convening a meeting in London this week to discuss ways to modernise the setting of a daily gold-price benchmark.

The WGC said when calling the meeting that a better price-fixing system was “imperative to maintain trust across the industry”, a view echoed by Britain’s Financial Conduct Authority, a government agency.

Not everyone is happy with the gold producers taking the lead in reforming the gold fix. The body in charge of the current process, the LBMA, is said to have been caught off guard by the speed at which the demand for change is unfolding.

No date has been set for a new gold fixing system, but it would be surprising to see the current one survive the rest of the year.

Either way the London gold price system, though imperfect and in need of some reform, is not “fixed”. Moreover, unlike the 2013 scandal in the interest rate market, what happens in London is not crucial to the price of gold. It’s not rigged; it’s just having a hard time, though this week’s trouble with Portuguese banks gave the precious metal its best week in many months.

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