On the morning of September 12 1919, just 10 months after the end of the first world war, bankers at NM Rothschild & Sons in London sat down to calculate a fair price for gold. They had been asked to do this by the Bank of England, which wanted to restore the city’s status as an international finance centre.
Sir Brien Cokayne, the BoE’s governor, envisaged “an open market for gold in which not only every seller would know that he would receive the highest price the world could pay but also every buyer would know that he would get his gold as cheaply as the world could supply it”.
At 11am that day, Rothschild set a reserve price at £4.92 or $20.67 an ounce. The four other bullion banks invited to bid wanted all the precious metal on offer and the price was increased by 2 pence to reflect the demand. The “London gold fixing” was born.
Nearly 95 years on, the fix remains the global gold benchmark, used by miners, central banks, jewellers and the financial industry to trade gold bars, value stocks and price derivative contracts. The original five bullion dealers have been replaced by five banks: HSBC, Deutsche Bank, Scotiabank, Barclays and Société Générale. But the process and traditions are little changed; had Rothschild not sold its fixing seat in 2004 the members might still be meeting in its oak-panelled boardroom with small Union Jack flags on their desks, rather than via conference call.
To supporters of the gold fixing, its longevity is a mark of its efficiency and utility. To a growing group of critics, however, the benchmark is opaque, old fashioned and vulnerable to market abuse.
Pressure to reform is coming from several directions.
Since uncovering evidence of alleged abuse by bankers of the Libor and forex benchmarks, regulators have been scrutinising other big financial benchmarks for signs of weakness. The German watchdog BaFin has requested documents from Deutsche Bank, which has put its seat up for sale, as part of a precious metals market review. Academics have questioned the fix’s fairness and suggested possible collusion. Smelling blood, US lawyers launched at least three class action suits in March alleging rigging. From being an asset of considerable prestige, a fixing seat may be turning into a liability.
“Most people in the industry would like to keep the fix because it works,” says Natalie Dempster, head of public policy at the World Gold Council, which represents the industry. “But reform is needed. What was acceptable five years ago in terms of transparency is not acceptable today.”
Unlike other commodities, from copper to coffee, gold does not trade on an exchange in London. People wishing to buy and sell bullion wholesale rely on a 24-hour over-the-counter market serviced by fixing members and investment banks such as Goldman Sachs, JPMorgan and UBS.
The main futures contracts are traded in New York and Shanghai. The gold fixing takes it cue from and influences these markets.
Every day at 10.30am and 3pm London time, the five banks join a secure conference call. The chairman – the job rotates among the banks annually – suggests an initial price, close to the market price. Each bank confers by telephone with its clients – other financial institutions and gold producers and consumers – and then declares if it is a buyer, seller or has no interest. If there are only sellers, the price is lowered, and vice versa.
When there is two-way interest, members say how many 400-ounce (12.4kg) gold bars – each worth about $531,600 at current prices of $1,329 a troy ounce – they wish to trade. The chairman moves the price, and the banks adjust their orders, until the difference between buying and selling requests is less than 50 bars, at which point the price is fixed. The call usually takes less than 15 minutes.
The process is a world apart from other benchmarks. Libor, for example, is independently calculated using lending rates submitted by international banks, while foreign currency benchmarks are based on electronic trades within a 60-second window. Advocates of the gold fixing say it provides a snapshot of the entire interested market in equilibrium. “It has an unfortunate name but is a genuine benchmark, backed by physical bullion traded,” says Rhona O’Connell, head of metals research at Thomson Reuters GFMS.
The fix is not especially lucrative for the banks, which typically charge clients a premium of 5 to 10 US cents an ounce above the benchmark price. What membership offers is a potential edge in winning business from large clients, such as central banks, since it demonstrates a commitment to the market.
But are there other financial advantages for all gold fixing participants, including the member banks and their clients, who receive a live commentary by phone or secure internet chat? In a paper published in the Journal of Futures Markets last year, Andrew Caminschi and Richard Heaney, lecturers at the University of Western Australia, looked at the impact of the London afternoon fix on the biggest gold futures contract and exchange-traded fund between 2007 and 2012.
They found that during the first four minutes after the start of the fix, trading volumes in futures and ETF contracts spiked by more than 50 per cent, with volatility up 40 per cent. This implied that information from the call was being acted on before the fix price was published, usually a few minutes later. The direction of these trades was “significantly predictive” of the ultimate price direction of the fix, in some cases exceeding 90 per cent, the paper said.
The authors estimated that an “informed trader” had an advantage over other market participants of 0.1 per cent, in terms of returns, “which far exceeds trading costs and can be deemed economic”. The paper, “Fixing a leaky fixing”, does not accuse anyone of acting improperly but says the findings might give regulators and ordinary investors cause for concern.
“If you have five stock brokers getting together in the middle of the day to hold a private auction of shares that were being traded all the while, and the result of that auction had a strong influence on the share prices, I think there would be some scrutiny of that process,” Mr Caminschi says.
Bankers counter that the information does not “leak” during the fix. Instead, it is designed to flow swiftly through the wholesale industry to assess real supply and demand, as well as to encourage trading and thus increase commissions.
Even so, nobody denies that arbitrage opportunities exist or that there is heavy trading in other gold markets during the fix. Numerous derivative products are tied to the benchmark, such as options to trade gold if a certain price is achieved. So financial institutions – from banks to hedge funds – may have an incentive to drive prices higher or lower in the lead up to the fixing, or during the auction.
“Everybody in the market understands that it is big boys’ games,” according to a former precious metals trader at an investment bank. “But I never felt there was any abuse. Would a fundamentally flawed product have existed for so long if there was?”
The lack of public information about the gold fixing leaves it open to criticism. No transcripts of the conference calls exist, nor are there details about prices and volumes. Rosa Abrantes-Metz, an adjunct professor at New York University Stern School of Business, who has advised regulators on financial benchmarks and worked as a paid expert witness to class-action lawyers, has been one of the most vocal critics of the fix.
She lists numerous weaknesses of the benchmark, from the lack of oversight to the fact that it involves “five competitors exchanging information on prices while also doing proprietary trading”. Mrs Abrantes-Metz says to support her suspicions of collusion she is working on a research paper, but it has not been finalised and is not ready to be made public.
Bloomberg, however, quoted from a draft of the study in a February story, where Mrs Abrantes-Metz writes that “data are consistent with price artificiality” and that “it is likely that co-operation between participants may be occurring”. Since then, that article has been cited in the three US class- action lawsuits filed against the fixing members.
The five banks all strongly deny wrongdoing but none wanted to comment for this article. “It’s a case of ‘when did you stop beating your wife?’” says a banker. “There’s nothing to be gained by speaking out.”
The London Bullion Market Association, the trade body whose members include the market-making banks, also had no comment. Such silence is bad for the industry, says Adrian Ash, of BullionVault, a London retail broker, adding that the “perception of the fix is broken”.
Industry veterans dismiss talk of rigging. Philip Klapwijk, managing director of Precious Metals Insights, a Hong-Kong-based consultancy, is sceptical of the collusion allegations. “With Libor, you had interests pushing in the same direction. But here you have different banks, some with too much gold, some with too little gold. I very much doubt that there’s a consistent identity of interest,” he says.
Apart from BaFin, the German regulator, which has offered little detail of its precious metals market “examination”, no other watchdog has barked. The US Commodity Futures Trading Commission and the Financial Conduct Authority, which oversees the UK markets, have not announced investigations into how gold prices are set.
The five banks are conducting their own review of the fix to ensure compliance with guidelines set last year by the International Organization of Securities Commissions. But this is not enough, says Brian Lucey, a professor of finance at Trinity College, Dublin, and an expert on the economics of gold. Although he thinks that the idea of prolonged rigging of the market “is getting into tinfoil-hat territory”, there needs to be an analysis of how the market reacts during the auction.
“In this context, you want to be Caesar’s wife – above suspicion,” Mr Lucey says.
So will the fix last until its 100th anniversary, in five years?
Several people interviewed in the financial sector believed it was expendable, and that a better benchmark could be built using electronic trading data. Companies that use the fix daily to trade gold for clients, such as Japan’s Sumitomo, say that would be a mistake. “I am a strong believer in the fixing because it allows everyone to transact at a single benchmark price,” says Bob Takai, president at Sumitomo’s research group.
But he agrees more transparency is desirable. Mrs Dempster, of the World Gold Council, suggests improvements, such as introducing electronic capturing of the auction process, real-time data dissemination and external oversight. If the banks do not react quickly enough, regulators may.
“One way or another reform is coming,” she says.
Shifting membership: In the east, the allure grows stronger
Two attributes have defined the London gold fixing over the decades. First, the prestige conferred by a place on the body that sets the gold price could prove irresistible to those on the outside – such as billionaire banker Edmond Safra, who in 1993 purchased Mase Westpac, the bullion bank, mainly for its seat on the five-member fixing. Second, the gold auction has always been the preserve of western financial institutions.
The sale of Deutsche Bank’s seat suggests that neither characteristic holds any longer. The German bank announced it was quitting the fixing in January. Unlike in the late 1990s and early 2000s, when Scotiabank, Credit Suisse, Société Générale and Barclays swiftly snapped up seats, there appears to be little interest from North American and European institutions. For them, the controversy surrounding financial benchmarks has dulled the fixing’s lustre.
But this is not necessarily true for banks elsewhere. The frontrunner to buy Deutsche’s seat, according to people with knowledge of the matter, is the UK-based markets arm of South Africa’s Standard Bank. And it is no coincidence that this very division is at present being sold to Industrial and Commercial Bank of China for $765m. State-owned ICBC is the world’s biggest bank by assets and has millions of customers in its retail bullion business. Its ambitions to raise further its precious-metals profile are well known in the industry.
If it does buy Deutsche’s seat – and the other fixing banks are understood to have consented to the move – it would match the recent trend in the physical gold market. After gold’s 12-year bull run ended in 2012, western investors have been dumping gold-backed exchange traded funds.
Much of the bullion that has come on to the market has been flowing east, to India and especially to China. Last year China became the largest gold-consuming country, with demand reaching 1,190 tonnes – a fivefold rise since 2003 – according to Thomson Reuters GFMS. Chinese buyers, unlike their western counterparts, often purchase jewellery for investment rather than adornment. Coins and small gold bars are popular, too.