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For a long time, many in the gold and silver communities have been say that the prices of the monetary metals are manipulated. Recently, one particular allegation came to prominence because it was asserted by the German regulator BaFin. This allegation is that the members of the London Fixes for gold and silver are using their position to manipulate the price. This would seem to be confirmation of widely held longstanding belief that the markets are rigged, the long-sought smoking gun.
Not so fast.
If you dig through the numerous articles that have been published on this topic, you get a slightly more nuanced picture. The allegation is not that the banks who run the Fix are keeping the price suppressed. The allegation is rather less earth shattering. They are allegedly front-running their clients. Skimming money from client order flow may or may not be illegal in London. I don’t know. It may be unethical, but that’s not my point today.
Skimming is not the same as suppressing the price.
Let’s take a step back. What is the “Fix”? Some suggest that the very name means that there is something crooked, that nefarious forces are rigging the game. That’s just a misunderstanding. The Fix is an institution born in an earlier era, before the Internet and even before the telephone was widely used. The Fix is when the big brokers sit down and find the price at which the largest volume of metal will clear. How do they know how much volume will clear at any given price? They all look at their own order books.
Back in 1897 when it began, the silver Fix certainly made the bid-ask spread narrower. This is to say it made silver more liquid, and, as a result, costs were lower for those who produced or consumed the metal.
Perhaps, today the Fix does not narrow the spread. It may be like High Frequency Trading. HFT claims to narrow the spread, but I recently wrote an article discussing how HFT may be nothing more than profiteering on regulations that distort the market beyond recognition.
However, I doubt this is true for the silver Fix.
Those who want to buy shares of Apple have to do it on the NASDAQ. NASDAQ has to comply with all of the regulations, including Regulation National Market System. The regulators have the exchange, and all traders of all shares listed on the exchange, by the throat.
No such chokehold exists in silver. Therefore, if silver miners, bullion dealers, or other firms are choosing to do business with the banks that run the Fix, there must be an advantage to them. If the members of the Fix are providing an advantage, then they are adding value and thereby earning the profit they make.
In any case, it’s history. The silver Fix will be ended in August, after 117 years.
The silver community is excited. Many believe that the Fix is part of the apparatus that is suppressing the silver price. Without suppression, the price will shoot up to $100 or $250 or whatever number. Dismantling this very visible operation of the silver suppression cartel is a step on the road towards $100.
Maybe.
I write about the silver price and silver market conditions every week, so I don’t want to get distracted with that discussion here. Instead, I want to make another prediction.
If the silver Fix is adding liquidity to the market, as I believe, then when it disappears the bid-ask spread will widen. The silver price will become more volatile, as will the silver basis.
Higher volatility is a boon to one group of people. Traders, especially the ones who are nimble to change positions quickly, and clever enough to understand the shifts that drive the price moves, stand to make a fortune. For everyone else, volatility is all downside.
There is little on this earth more frustrating to make a decision to buy, and then in the time until your order is executed, the price goes up 5%. So you have to pay 5% more. The one thing that’s even more frustrating is watching the price drop by 6% the next day.
Do you have investments in any silver mining companies? To them, wider bid-ask spreads mean greater frictional costs. It will cut into their profit margins.
When you go to your local coin shop, you will pay more when you buy and you will get less when you sell.
As in a mechanical system, if friction increases then motion decreases. Some parts may seize up altogether.
In recent years, pressure from regulators and litigation has pushed a number of companies out of the commodities business. The latest victim of this trend is the silver Fix. It’s ironic that some of the people who push for this say they want free markets.
It is not a free market when the government pushes company after company out of business, picking winners and (mostly) losers. It is not a free market when everyone can benefit from the provision of a service, but it becomes impossible to provide, so people are forced to incur higher costs or do without products.
It’s one or another flavor of socialism.
Socialists insist that government can deliver better outcomes than the free market. Not once have this ever turned out to be true. What government interference causes is a collapse in coordination between people in the economy.
The bid-ask spread is an obstacle to doing business. The narrower the spread, the more people can satisfy their need to buy or sell. The wider it is, the more people are blocked by the higher cost.
The end of the silver Fix may or may not push up the price of silver. Either way, it will have unintended consequences.
Here is what BaFin’s Elke Koenig actually said (my translation, but check it out if you doubt me)
“A further theme has maintained our attention over the end of the year – allegations of manipulation in relation to important reference rates. At present we are focusing on Libor, Euribor etc. but we will later turn our attention to allegations in respect of reference prices for foreign exchange and precious metals if there is evidence of impropriety. These allegations 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. The central reference prices appeared inviolable, and yet now the suspicion has arisen that they may have been manipulated. Regulators around the world are busy reviewing past activity – which is a far from trivial task and will inevitably take some time. Concurrent investigations are taking place at the European and Global level in order for regulators to get a firm grip on the facts. [Key wording: she did not say “on the situation”]. There is certainly a significant deficit in respect of transparency and effective governance. However, we have taken the first steps, and further steps are being prepared. For example, in Brussels (the EU) an amendment is being drafted to the Market Abuse Regulations, which will make manipulation of benchmarks a punishable offence. In September last year the European Commission tabled a draft regulation in respect of Reference Rates. This draft is similar to all previous attempts at reform – it goes in the right direction, but it does not go far enough
The draft paper addresses a central point: in the future benchmark rates should wherever possible be based on actual transactions. Expert estimates will still be permitted, but only where they are attributable and verifiable. That would certainly represent progress. However, the Commission’s proposal emphasised self-regulation. The prices on which benchmark rates are based should in the future be comprehensively documented, and should be subsequently audited by an independent but nonetheless private-sector oversight body.
Who will be responsible for ensuring that these private-sector oversight bodies really are independent? And can such arrangements really ensure that the processes for setting rates are conducted with integrity? I have my doubts. The money markets, foreign exchange and precious metals markets are decentralised, and most trading takes OTC rather than on Exchanges or via Exchange Trading Platforms. Private oversight bodies are therefore able to oversee only a small proportion of what is going on in the market
We must therefore go one step further: Market Transparency and Oversight are only possible if the innumerable data (price) feeds in the respective markets can be centralised. Insofar as possible, business in these markets should be conducted on transparent platforms /exchanges which are directly or indirectly overseen by Government agencies. If this is possible with OTC Derivatives (i.e. EMIR and Dodd Frank) it should also be possible in the corresponding Spot markets
The allegations of manipulation have brought a previously spotless area of business into disrepute – an area which, however, like no other requires trust and confidence. Comprehensive regulations and effective controls will help to restore this trust. However, rules and laws alone – call it ‘Compliance’ if you will – doesn’t cut the mustard. Not everything that is strictly legal is necessarily legitimate. I do not subscribe to rigidly enforced moral codes of conduct, but we surely need to return to certain ethical values which seem to have gone out of fashion in some sectors of the financial services industry during the boom time. An honourable businessman can be guided towards responsibility not just to his firm, but also to the wider society. The businessman’s image may be tarnished, but he surely has better role models than Gordon Gecko. Senior Management and the Board of Directors are accountable. Instead of the motto “Profit at any Price”, our guiding principles must be long-term goals and responsible business. We can anticipate a change in this direction
http://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Meldung/2014/meldung_140116_neujahrsrede_koenig_en.html
THIS IS VERY DIFFERENT FROM SAYING THAT MANIPULATION IN THE PREVIOUS METALS MARKETS IS WORSE THAN (THAT UNCOVERED IN) LIBOR
revised links http://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Meldung/2014/meldung_140116_neujahrsrede_koenig_en.html & http://www.bafin.de/SharedDocs/Reden/DE/re_140116_neujahrspresseempfang_p.html?nn=2819248
and apologies for the typo – I meant “precious metals” rather than previous
my point is simply this; whilst I have more than a little sympathy with the notion that the London bullion markets are (at the very least) opaque and inefficient as price discovery mechanisms, there has (so far) been no evidence of manipulation published or noted by any Regulator, and no matter how desperately some people would wish it were otherwise, to deliberately misquote BaFin simply to achieve a sensational headline is in itself both devious and manipulative. With this in mind, whenever you see some allegedly esteemed Commentator parroting this nonsense about what Elke Koenig is supposed to have said, remind yourself that you are listening to a Muppet at best, or t worst a Snake Oil- selling charlatan, and ask yourself why it is necessary for them to mislead you in this way if their underlying argument about systematic manipulation is so compelling
Keith,
could you explain more why do you believe the silver Fix is adding liquidity to the market?
Andrew: Thanks for positing that. It looks like a regulator saying–quel surprise!–that all sales of precious metals need to move to a centralized market, under regulatory supervision.
brpaul: I base that on the fact that clients don’t have to choose to use a member of the Fix. The fact that they are making that choice proves that the Fix members are adding value.
Will there not be a “market maker” for the silver market in the future, to ensure spreads stay relatively narrow? Is the Fix the only entity fulfilling this function?
bgoldman: good question.
Probably (who knows what regulations are coming, that may make the business impossible).
But it will be the next marginal market maker, and likely offer wider spreads.