Ross Norman: Why a gold benchmark is still needed and why London fix is best

Section:

By Ross Norman, CEO
Sharps Pixley Bullion Brokers, London
http://www.sharpspixley.com/
Tuesday, October 18, 2016

My thoughts on GATA Secretary/Treasurer Chris Powell's most recent reply to me, which can be found here:

http://www.gata.org/node/16845

1) Benchmarks. Actually, besides gold, there are many other fixings in commodities and they are more important than they might appear.

For example approximately 85 percent of global base metals trades are conducted through the London Metal Exchange and they have benchmarks except that they are called "rings" as opposed to "fixings." Essentially they are a five-minute, heavy-duty bout of trading that concludes with a price that becomes the benchmark or "settlement price" for the day in copper, aluminium, nickel, etc. Indeed the oil sector, the shipping sector, the agriculture sector, and the chemical sector all also have benchmark pricing too. It's just that they all have different names and different methodologies.

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So why use a benchmark? Well, thousands of companies will refer in their contracts to "the gold price" and it needs to be defined. Many will not actually trade on a particular fix but the financial transaction they are a party to will be linked to it. Hence they need to know that the price is fair and reflects reality.

Take a mining company or a jewellery company. One will sell and the other might buy through a contract with a counterparty at the average of the PM fix for the month plus, say, $1. But they may not be active on each and every fix. Their contracts will refer to "the gold price," but you have to ask: Which one?

The spot price is no good as they are merely subjective adverts by individual banks (adverts displaying their buying and selling interest and not a "traded at" price) and thus massively open to manipulation -- or a closing price that again can be gamed by market participants. (But this is quite similar to the fixings in base metals.)

People have looked at volume-weighted averages and other procedures but most are fallible or can be corrupted. The gold fix in our opinion is exceptionally difficult to game -- and if you were so minded, then there are far easier ways to do so such as simply front-running a trade in the spot market. Who would ever know?

In short, the real market (that's to say producers and consumers) needs a fair, reliable, and representative price against which to honor its contracts and commitments. I happen to think that the gold market has done a pretty good job in evolving and devising the best foolproof way of deriving an objective price for those who may not actually be trading that particular day but will be affected by the outcome.

Any other prices are simply subjective and therefore invalid or not representative.

2) Deutsche Bank and the other banks. I think they are a red herring. It is tempting to imagine that banks hold a central role in determining price outcomes when in fact they are just a conduit and merely reflect what is going on around them. They are far more clueless than you think. If the Basle III banking regulatory framework goes ahead as anticipated, then most will become history anyway by 2018 as far as commodities trading goes.

It is proposed that holdings in gold will be valued at a mere 15 percent for capital adequacy purposes and the costs of funding or holding positions will skyrocket, which will drive most banks out of the market if regulation and compliance have not already done so by then. They are all already in significant retreat, and for a good many houses bullion is now simply tacked onto the side of foreign-exchange trading and managed by a currency trader who knows little about the market -- and cares even less.

In short, the banks are a much-diminished influence and getting less significant, with a few exceptions.

Few people will shed a tear as the commodities traders at the banks retreat, but do ask yourself what you think might replace them, like unregulated entities, and how well they will treat you. Be careful what you wish for.

The news that Deutsche Bank has "settled" by paying a $38 million fine confirms my point. They "settled" without admitting guilt or being found guilty; they just wanted out. This is why the fine is so small.

Now it may still transpire at some point that there have been some minor irregularities around the London gold fix and, again, it's not for me to defend the people and institutions. I am defending only the London fix as the best solution there is, and if you wanted to cheat, it's the worst place to do so.

3) Central banks. I think it is a popular myth to blame the investment banks and commodity traders for all evils. They are actually just guys who play within the framework set by the regulators. No malice aforethought. As said, they are losing relevance.

However, there is an invisible hand at play and it sets the rules of the game and often attempts to pre-determine its outcome -- that is the official sector. Once benign custodians of the reserve assets of countries, official sectors here are the architects of the economy and masters of its narrative. I fear that we are moving toward a centrally planned and managed economy of the sort once mocked in the former Soviet Union.

If GATA's gripe was with these institutions rather than the conduit through which they trade, I think your efforts would resonate with many more market observers and participants.

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