With the launch in mid-August of a new system to arrive at the price for silver, precious metals investors are dealing with the first in a series of changes in how the market prices of silver, gold, platinum and palladium are reached.
More change is coming, since the other three metals have yet to go through the process, but what’s happened so far is this: Concerns about price fixing after everything from LIBOR to currency were found to have been manipulated led to accusations about the gold and silver markets, and in January of this year Germany’s financial regulator Bafin said that the manipulation of precious metals prices was worse than that occurring with LIBOR.
Deutsche Bank was interviewed by Bafin on the matter before the end of 2013, and in January the bank announced that it would exit the commodities business and abandon its positions in the processes of fixing gold and silver prices. Since Deutsche Bank was one of only three involved in the 117-year-old process of setting the price of silver—the other two were HSBC and Bank of Nova Scotia—that meant a new method had to be found before Deutsche Bank departed the scene.
In August, that new method launched. An electronic, auction-based mechanism has taken the place of the traditional conference call among the three banks that had determined how silver would be priced since the time of Queen Victoria. Run by CME Group Inc. and Thomson Reuters Corp., the new system uses electronically entered orders proposing a starting price; if buy and sell orders don’t match up, an algorithm will determine the price to be used for the next bidding round. CME had said in a report when the system went live that each round should take 30 seconds or less, and that participants will be able to view bid and offer volumes, as well as total volumes traded once the price is set.
The London Bullion Market Association (LBMA) said on its website that some of the participants in the live trials of the new system would have to wait for accreditation before participating once the system went live. Compliance, credit, legal and IT requirements had to be satisfied first, but the LBMA said it expected the list of refiners and producers, trading houses and banks to grow in weeks to come as requirements are met.
“In the old days, you didn’t have a market that traded all day, 24/7. [Bullion] was thinly traded. It doesn’t take a genius to figure out that if they’re all banks, they’ll bid it down; they buy at a low price and sell at a high price. You can see in the charts that the bid is fixed below actual trading in futures contracts,” said John Blank, chief equity strategist for Zacks.
“It’s wholesale vs. retail. Only in the last few years have gold and silver become hot with the advent of ETFs having brought the retail player into this market,” he said. “ETFs brought in the retail investor, and also smoked out how bidding works... and now they’re getting rid of the old way. Information is not free, and markets pay for information. The bid/ask spread widens for those who have a lot of information; it’s wide if you have a lot, and narrow if you don’t.”
Thomas H. Yorke, a portfolio manager on Covestor, an online investment management company, also focused on the importance of information. “The precious metals fixing process is more archaic and subject to gaming, like leaking of the direction of the fix or simply slamming the close, than the LIBOR market. LIBOR settings were problematic for years during the Japanese banking crisis of the mid-90s as well the questionable settings during the global meltdown of 2008,” he said.
Yorke added, “Any time traders can buy, sell, or leak the direction of the gold fix during the process, they clearly possess inside information and lure of easy profits exists. This information is not available to the general public and clearly doesn't help the integrity of the markets.”
Silver isn’t the only precious metal in for change, since investigations indicated that pricing systems for other precious metals were also veiled in secrecy and open to manipulation. Barclays Plc was fined $44 million after one of its traders was found to have manipulated the gold fix, and lawsuits were filed concerning price fixes on both gold and silver.
So far the silver system is the only new process to have launched, but gold, platinum and palladium are following. While not much is yet known about how they might change, London Gold Market Fixing Ltd. and the LBMA are looking for proposals for a new authority to take over the gold fix, which they hope to have in place by the end of the year. Plans are for the new third-party administrator to be chosen by the end of September.
There’s speculation that if the new silver process is working well, CME and Thomson Reuters might find themselves in charge of gold as well. But whatever comes next will replace the existing system, in place since 1919, that relies on Barclays Plc, HSBC Holdings PLC, Société Générale SA and Bank of Nova Scotia to determine the fix. Deutsche Bank, formerly part of this elite group, has departed from the process.
Many in the industry are lining up on the side of the changes, feeling that investors will benefit. Rick Rule, president and CEO of Sprott U.S. Holdings, Inc., said, “I think that the changes they’re attempting to make in the price fixes with regard to utilizing more input and greater access to more market participants is a good thing. I think that whether or not the existing fixed system lent itself to manipulation, there were a number of players who felt it did, or could, lead to manipulation. If there’s more confidence in markets, that’s a good thing.”
Rule added, “I don’t know in what fashion [the gold fix] will change when completed, but it’s pretty clear that the gold market has more participants represented in the fix from more time zones, more markets, that have to be represented.”
Platinum and palladium fixings, which began in 1989 and are relative newcomers to the process, will change too. The London Platinum & Palladium Fixing Company Ltd. launched an RFP process in early August to choose a new independent consultant to take over the fixes; that should, like the gold fix, be completed by the end of the year.
According to the website for the London Platinum & Palladium Market, the fix has been handled by BASF Metals Ltd., Goldman Sachs Group Inc., HSBC Holdings Plc and Standard Bank Plc, but Jonathan Spall has been selected to chair the change process, and he and his G Cubed Metals Ltd. Consultancy are officially overseeing the fix during the period of change.
The U.K.’s Financial Conduct Authority is among regulators being consulted for the platinum/palladium change, and one consideration in the review of the process is that it align with the financial benchmark guidelines put forth by the International Organization of Securities Commissions (IOSCO). A key part of the IOSCO guidelines is the need for “observable transactions” in the process of determining a benchmark.