Is the price of gold manipulated?

The Wall Street Journal reported this week that the top U.S. derivatives regulator – the Commodity Futures Trading Commission (CFTC) - has started internal discussions on whether the daily setting of gold and silver prices in London is open to manipulation. The CFTC has not jet formally started an investigation of the matter, but would be examining various aspects of price fixings, including whether they are sufficiently transparent, according to the WSJ.

Induced was the discussion by the LIBOR manipulations scandals in which many British banks were involved. CFTC Commissioner Bart Chilton stated in an interview at the annual Futures Industry Association conference in Boca Raton: "Given the clubby manipulation efforts we saw in Libor benchmarks, I assume other benchmarks - many other benchmarks - are legit areas of inquiry".

What is striking first is that CFTC Commissioner Bart Chilton is again attacking institutions at financial centers outside the US jurisdiction. There have been claims that also the gold price in the US would be manipulated by leading US banks. The name of a major bank, who was also subject of a US Senate hearing last Friday, is often mentioned in this context. We do not believe in those conspiracy theories about manipulations of the gold or silver market. Nevertheless, the CFTC has not investigated those accusations. This makes all the statements from Mr. Chilton more looking like a political blame game in order to gain a competitive advantage for US financial markets. The UK watchdog, which is responsible for the gold and silver fixings in London, is not aware of any manipulation accusations.

The LIBOR rates are set based on reports from banks in London estimating at which interest rate they could obtain unsecured credits in the interbank market. Thus, LIBOR rates could be but are not necessarily based on real transactions. After dropping a number of highest and lowest estimates, the average of the remaining estimates is then published as the LIBOR rate for the corresponding maturity.

The gold and silver fixing in London has a long tradition. As the London Bullion Metals Association (LBMA) rightly pointed out in a statement, the fixing price is based on real transactions. The purpose of a fixing is to concentrate supply and demand coming to the market at a certain time of the day to obtain the best price available. Ideally, at the fixing price, supply and demand are balanced. In practice, this could not allows be reached. In this case, the fixing price should lead to the highest trading volume, which implies that excess supply or demand would be minimized.

The fact that fewer banks are involved in the fixing of the gold and silver price compared to the LIBOR rate estimations is per se not an indication for possible manipulation. Beside the few banks being a member of the fixing committee, many other banks and institutions being active market participants in the foreign exchange markets also quote prices for the precious metals. Gold and silver are traded almost 24 hours per day, of course with some intraday periods being less liquid than others. However, during the time of the fixings, the market is quite active and liquid. Thus, also during the fixing periods, other banks and institutions could trade with members of the fixing committee based on their quotes in the FX markets. In addition, as a possible fixing price is called out, supply and demand could change as the fixing member banks can receive new orders from clients. It is only after several rounds of adjustment when no further improvement could be reached that the price is fixed.

If one defines market manipulation as bringing the fixing price to a certain level, then it is theoretical also possible. However, it would require that one or more banks of the fixing committee are ready to buy or sell gold or silver in unlimited amounts and to take the risk of pricing moving to their disadvantage after the fixing price has been published. Thus, in practice, it is rather unlikely that the fixing price is manipulated in a systematic fashion over a longer period of time as it had been the case in the LIBOR scandal.

Gold futures and options are traded in the US at the CME, which provides access to level 2 quotes (details of the order book about bid and ask size for various possible prices above and below the recent traded price). Furthermore, they provide the opportunity of co-hosting for high frequency trading firms. This system is far more vulnerable for manipulating the price to a certain level. It could be seen how many contracts would have to be bought or sold to push the price to a desired level, for example to trigger a barrier of an OTC derivative. Has anybody heart the CFTC would investigate whether trading at the US futures exchanges could be misused for price manipulation?