Twice every weekday, members of five major banks convene on a conference call to set the gold price.
This routine encourages trading spikes on the $20 trillion global gold market both during and after the call is made, and some have questioned its fairness, according to a Bloomberg investigation.
It dates back nearly a century to 1919, when a consortium of five banks led by N.M. Rothschild & Sons first met to fix the price the gold and to establish London as the world’s main marketplace for gold following WWI – as told by the website of London Gold Market Fixing Ltd, the association itself.
Today, it consist of five banks: HSBC, Barclays, Deutsche Bank, Societe Generale, and the Bank of Nova Scotia.
It’s an entirely private process, performed without government oversight – but the Bank of England (as well as jewellers and other gold traders) set their gold price by it, according to Bullion Vault, a gold trading company.
How Does It Work?
When the conference call starts – there’s one at 10:30 a.m, and another at 3 p.m. – the appointed chairman names a price for an ounce of gold, which is usually close to the current market spot price.
The other firms then declare how much they would be willing to buy and sell at that price, based on orders from their clients and on what the firm itself wants to trade, Bloomberg reports.
If the balance is zero, the trades are made. However, if the amount of buys are higher than sales, the chairman will raise the price, and the bidding begins again. If sales are higher, the price will be lowered. This continues until the buy and sell orders are within 50 bars, or about 1,300 lbs of each other.
All these sales are then made at the same price.
However, the bankers are free to communicate and trade while they are on the conference call, enabling them to, for example, place fresh buy orders if the price seems to be going down.
This allows them to estimate whether the price will go up or down, and place orders accordingly.
For instance, if a banker can see that the gold fix will make the price go up, he can order a trader outside of the meeting to place an order to buy gold at the current price in the future (a futures contract), profiting from the spread.
Bankers can even pause proceedings at any time by saying “flag,” a throwback to when the gold fixers would meet N.M. Rothschild’s headquarters and raising a small Union Jack would signify a pause in negotiations.
Ahead Of The Curve
Through trades that are made while the meeting is ongoing, information also leaks to the market before the final fixed price is published after the call.
The price is only fixed for the trades made by the five banks; it doesn’t dictate the price of gold on the market. However, the movement of the price, whether up or down, is a good indicator of whether market demand is high or low.
For the five banks involved, there seem to be clear benefits to being privy to this information.
According to Bloomberg, research has shown that trading volume surged almost 50% higher during the gold fix call, and the success rate of futures trades rose to almost 80% within the first five minutes of the call.
On days when the gold price moved more than $3 per ounce, the success rate rose to nine out of 10.
In other words, during the call, the amount of sales skyrocket – and banks privy to gold fix info are making a profit from it.
Fixing The Gold Price Is An Opaque Process
Defenders of the process say that it’s a good way for the banks’ clients to sell large amounts of gold anonymously without having to use the futures market, which requires a registration.
It’s also designed to be hard to game, and the information spreads quickly enough to the market that it’s difficult to exploit, a member of a fixing bank told Bloomberg.
However, the secretive process creates a large incentive for the participating banks to manipulate the gold price based on their trading positions, critics interviewed by Bloomberg say.