The Fix For the Silver Fix Might Not Be a Fix At All

by Stuart Burns on May 2, 2014

Style:    Category: Global Trade, Investing Hedging, Metal Prices, Precious Metals, Public Policy

For more than a hundred years, the world price of gold has been set each day in much the same way as it started out in 1897, with its origins in the coffee shops of London; just as the metals, shipping and insurance markets evolved from a relatively small number of traders getting together to agree on daily market prices.

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Today, it is done over the telephone but, broadly speaking, at the start of each fixing, the chairman announces an opening price to the other members. Usually this is five banks which relay the opening to their customers and, based on orders received from them, instruct their representatives to declare themselves buyers or sellers at that price.

Traders in London

Open And Transparent System

The price is adjusted up and down until demand and supply are matched, at which point the price is “fixed.” Fixed is, in current parlance, an unfortunate term as it has connotations of market manipulation when the whole purpose of the process is to arrive at a transparent, freely negotiated and fair current market price. Recent developments have cast doubt on whether this century-old practice will continue. Silver price has been decided in this manner for almost as long.

Reuters reports this week that US investors and traders have filed almost 20 antitrust lawsuits against the five banks involved in the London gold fix, accusing them of colluding to manipulate the bullion price. As a result one of them, Deutsche Bank, resigned from the gold and silver fix tables on Tuesday, just three months after putting its seat up for sale and failing to find a buyer.

How to Fix the Fix

While this reduces the number of participants for gold from five to four – Barclays, HSBC, Bank of Nova Scotia and Societe Generale are left – it leaves the silver fix in an even worse hole. The twice-daily silver fix is agreed between just two banks, HSBC and Bank of Nova Scotia, calling for a review by Britain’s financial watchdog Financial Conduct Authority (FCA)  to ensure the process remains above reproach. How they would do that is anyone’s guess. Even they, the FCA, seem unsure.

“These (benchmarks) are things that exist for the benefit of the market, so the market should be looking for market-based solutions to make sure it is still viable,” said Tracey McDermott, the FCA head of enforcement and financial crime. “But, if there is a risk of dislocation because people are withdrawing and we think that breaches or is a risk to our objectives then we would set that as one of our activities but it is not entirely straightforward.”

Indeed, it is not. In a five-year probe, the US Commodity Futures Trading Commission investigated allegations that some of the world’s biggest bullion banks including JPMorgan Chase & Co. distorted silver futures prices. But Reuters reports that after 7,000 staff hours of investigation, the US commodity regulator found no evidence of wrongdoing and dropped the probe last September.

A New Fix?

The silver price is notoriously volatile, partly because it has both industrial and investor demand dynamics, but more so because it is not a hugely liquid market. Significant buy or sell orders have the effect of markedly moving prices. Deutsche Bank’s decision to pull out of the gold and silver fixes is said to have been influenced by the dozen US private plaintiff lawsuits accusing the five banks in the gold fix committee of manipulating the price of the metal.

So far, no accusations have been made over the silver fix but the bank’s withdrawal can be seen as part of a trend by the major banks to pull out of commodity markets in the last year as regulators increase their scrutiny of banks’ activities and the risks that they judge commodities expose the banks to. The willingness of industrial consumers to turn to the courts when they believe the markets fail to work efficiently is a huge factor in the withdrawal.

Could the Fix Be Worse Than the Problem?

Market manipulation can certainly take place. Plaintiffs have been encouraged by the outcome of the Libor scandal in 2012, in which leading banks were fined and several have reached out of court settlements. Detractors see squeezing billions of dollars of business through a handful of banks that match off orders to arrive at a benchmark price over the phone as anachronistic and opaque, and you can see their point. Agreeing on an alternative, though, could take some considerable time.

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