Is there a Decade of London PM Gold Fixing Manipulation?

Last Friday, on February 28, Bloomberg reported about a study co-authored by NY University Stern School of Business Professor Rosa Abrantes-Metz and Albert Metz, a managing director at the rating agency Moody’s Investors Service. In their not yet published draft research paper, the two authors claim that “The structure of the benchmark is certainly conducive to collusion and manipulation, and the empirical data are consistent with price artificiality” and that “It is likely that co-operation between participants may be occurring.” We come to the conclusion that their findings could be well explained and are not a valid proof for manipulation of the PM London gold fixing.

The authors of the study refer to unusual price activity around 3 p.m. in London when the afternoon fixing of the gold price is taking place. They have not observed these trading patterns during the morning fixing. Furthermore, large price moves during the afternoon fixing were overwhelmingly to the downside. Screening intraday data from 2001 to 2013 they found those patterns from 2004 until the end of the data sample. In a telephone interview, Mrs. Abrantes-Metz said “There’s no obvious explanation as to why the patterns began in 2004, why they were more prevalent in the afternoon fixing, and why price moves tended to be downwards”. Thus, the two authors concluded in their research paper that unexplained moves may indicate illegal behavior by the five banks of the gold fixing working actively together to manipulate the benchmark.

Mainstream academic theory is that financial markets, and gold could be included in this group, were efficient. Anomalies were only temporary and as soon as the market had discovered them, they were exploited and disappear. Nevertheless, many academic studies also found that anomalies in stock markets persist even many years after their discovery. One of those anomalies is the year-end effect that stocks, which already performed well during the year tend to rally further towards the year-end. The reason behind this move is that institutional investors who had been not invested or underinvested in those equities buy the stock for reasons of window dressing for showing in the reports that they had also held the top performers in their portfolios. This behavior is absolutely legal and is not regarded as market manipulation. This leads to our first objection against the conclusion of Abrantes-Metz and Metz. Detecting anomalies in price behavior might be an indication for illegal behavior but it is by no means evidence that prices had been manipulated.

Furthermore, that Professor Abrantes-Metz could not explain the unusual price patterns is more an indication for a lack of familiarity with the gold market than an indication for price manipulation.

In a comment, Ross Norman, the CEO of Sharps Pixley, provided already a good explanation why the unusual price behavior had been detected only for the pm fixing but not for the one in the morning. The afternoon fixing covers trading in both financial centers, London and New York and thus provides commercial participants in the gold market a higher liquidity and thus, the chance to get a better price. In addition, many producers are located in North America and the afternoon fixing is more convenient for their time zone. While gold at the Comex division of the CME trades electronically also during the London morning hours, the liquidity is higher at the futures exchange during the afternoon fixing. This is another reason for commercial participants to prefer buying or selling of gold at the p.m. fixing.

However, one might argue that with higher liquidity the occurrence of price spikes should be reduced and not increased. What might sound compelling at first quickly turns out as a flawed argument by closer inspection for several reasons:

First, if a larger order has to be executed the price impact would be greater in a less liquid market situation. Thus, a buyer or seller still obtains the better price if it is executed in the afternoon fixing despite moving the price considerably from the level prevailing shortly before 3 p.m. in London.

Second, the development of the price of gold could be explained by prices of some financial instruments and other commodities. In our quantitative fair value model, the weekly or monthly price development of gold is well explained by the S&P 500 index, the US dollar index and crude oil. Also GARCH-X models show that these factors have an impact on the daily return and volatility of gold. Thus, we are not surprised that intraday spikes in the gold price occur during the afternoon gold fixing.

When the afternoon fixing starts in London, then it is 10 a.m. in New York (except for a couple of days as shifts to daylight saving time and back take place at different dates in spring and fall). Some of the market moving US economic data is released at this time. If this economic data deviates from the consensus forecast then the stock and forex market react strongly. Sometimes also data releases confirming the consensus can trigger stronger price moves in the stock and/or forex market. Thus, it should not be surprising that also participants at the gold fixing react on those moves if a new price is called at the fixing and bids and offers could be adjusted.

Also the behavior of institutional investors in the US stock market could provide an explanation for the price spikes at the London afternoon fixing. Trading at the NYSE starts at 9:30 a.m. in New York. However, some studies have found out that institutional investors just enter the stock market at around 10 a.m. – exactly at around the time the fixing in London starts. Often the US stock market reverses direction around this time. Furthermore, a popular strategy among intraday traders is to trade breakouts of the trading range during the first 30 minutes. Price reversals and increased volatility of the US stock market then could also have an impact on the price of gold during the fixing period.

Abrantes-Metz and Metz also point out that the spikes are more to the downside than to the upside. As Bloomberg wrote “on days when the authors identified large price moves during the fix, they were downwards at least two-thirds of the time in six different years between 2004 and 2013. In 2010, large moves during the fix were negative 92 percent of the time”. But also this is not really surprising if one just considers who participates in the London fixing on the commercial side. During the period under investigation, many central banks had been sellers of gold. For this group, the fixing is one mean to sell larger quantities and to obtain an “official price” for the audits. But also mining companies sell their production in larger quantities at the fixing as hedging and financing operations are often tied to the fixing price. The typical buyers like jewelries or ETFs are less reliant on an objective price set during the fixing and could also be active in unreported spot market transactions.

Another argument often used in articles and blog contributions is the movement of the gold price during the period of the fixing. But again, this is not an indication of price manipulation but reflects more a lack of understanding. In a few articles, we even found statements that the LBMA would be an exchange. However, this is not true. The London Bullion Market Association is just an industry association and not an exchange. It is also not responsible for the gold and silver fixing.

This misunderstanding might result that some exchanges hold auctions at certain times and call the price of this auction the fixing price. However, the London gold fixing is not an auction. At an auction, the participants submit the quantities, which they buy or sell at a certain price. These bids and offers have to be submitted at a certain time and then the price is determined that leads to the highest quantities traded. Usually all orders are settled at the same price. This procedure is for example applied at the Xetra trading platform of Deutsche Boerse. There, prices of the closing auction deviate often considerably from the last price of the official trading session and in some cases are even outside of the trading range of the day. Nevertheless, the German watchdog BaFin, who critized fiercely the London gold fixing, has not yet the slightest suspicion or even started any investigations that this practice might be a manipulation.

The London gold fixing is a process of price finding. The chairman is calling a price close to the actual spot quotations when the fixing starts. Then the five member banks submit the quantities they would buy and sell based on the orders of their clients or for their own accounts. For fixing the price of gold, the difference between supply and demand has to be less than 50 bars – around 620kg. This is usually not immediately the case. In the case of excess demand a higher price is called and a lower price is called if supply exceeds demand. The five banks involved in the fixing then contact their clients with the new price called and collect again bids and offers, which are then submitted to the chairman. This process of adjustment to find the fixing price takes some time. Usually, the gold price is fixed within 10 minutes, but could also last up to one hour depending on the market situation. This procedure had also been applied by official exchanges. For example, the Frankfurt Stock Exchange used this procedure for the official fixing of the Deutsch Mark exchange rates until the introduction of the euro.

However, markets are not standing still during this process. Especially, trading in the gold future continuous and prices are disseminated within milliseconds. But this information is also available to the clients of the five banks conducting the fixing. Also banks active in spot gold trading display indicative bid and ask prices. Thus, when a new price is called, the clients of the banks are also well informed about the current market situation and can adjust the quantities they want to buy or sell at the new price called accordingly. Usually, the banks don’t know the exact quantities their clients want to buy or sell in total when a new price is called.

If one defines market manipulation as an attempt to move the price to a certain level, the five banks would have to agree on this price before the fixing starts. For pushing prices artificially lower, this would also require that they were willing to sell an unknown quantity of gold, which would expose them to significant price risk. At best, they might know the total quantity supplied and demand at the first price called. That gold is not fixed at the first call and that prices move and more calls of a new price are made is not an indication of price manipulation. Just the opposite, it is an indication of no wrong doing by the fixing group!

All in all, we come to the conclusion that the findings of Professor Abrantes-Metz and Metz could be well explained and are not a valid proof of manipulations at the PM London gold fixing. Normally, a flawed academic research paper is not a problem. However, Professor Abrantes-Metz advises the European Union on financial benchmarks. But if such a flawed research paper leads to accusations against the five Banks of the London gold fixing and the EU imposing considerable fines, then it is a scandal.