Scandal unfolds: How prices are set in $20 trillion gold mkt

By Bloomberg | 27 Nov, 2013, 10.41AM IST 

LONDON: Every business day in London, five banks meet to set the price of gold in a ritual that dates back to 1919. Now, dealers and economists say knowledge gleaned on those calls could give some traders an unfair advantage when buying and selling the precious metal.

The UK Financial Conduct Authority is scrutinising how prices are set in the $20 trillion gold market, according to a person with knowledge of the review who asked not to be identified because the matter isn't public. The London fix, the benchmark rate used by mining companies, jewelers and central banks to buy, sell and value the metal, is published twice daily after a telephone call involving Barclays, Deutsche Bank, Bank of Nova Scotia, HSBC Holdings and Societe Generale.

The process, during which gold is bought and sold, can take from a few minutes to more than an hour. The participants also can trade the metal and its derivatives on the spot market and exchanges during the calls. Just after the fixing begins, trading erupts in gold derivatives, according to research published in September. Four traders interviewed by Bloomberg News said that's because dealers and their clients are using information from the talks to bet on the outcome.

"Traders involved in this price-determining process have knowledge which, even for a short time, is superior to other people's knowledge," said Thorsten Polleit, chief economist at Frankfurt-based precious-metals broker Degussa Goldhandel GmbH and a former economist at Barclays. "That is the great flaw of the London gold-fixing."

The UK capital is the biggest center for gold trading in the world, according to the LondonBullion Market Association, which said more than $33 billion changed hands there each day in 2012, exceeding the $29 billion of futures traded on Comex, the New York commodities exchange, data compiled by Bloomberg show. Financial instruments including cash-settled swaps and options are priced off the London fix, according to the LBMA website.

In private meetings this year, the US Commodity Futures Trading Commission, which regulates derivatives, discussed reviewing how gold prices are set, according to a person with knowledge of the talks. The FCA review is preliminary and not a formal investigation, another person said. The people wouldn't say what's being looked at or if regulators suspect wrongdoing.

Participants on the London call can tell whether the price of gold is rising or falling within a minute or so, based on whether there are a large number of net buyers or sellers after the first round, according to gold traders, academics and investors interviewed by Bloomberg News. It's this feature that could allow dealers and others in receipt of the information to bet on the direction of the market with a high degree of certainty minutes before the fix is made public, they said.

"Information trickles down from the five banks, through to their clients and finally to the broader market," Andrew Caminschi, a lecturer at the University of Western Australia in Perth and co-author of a September 2 paper on trading spikes around the London gold fix published online in the Journal of Futures Markets, said by phone. "In a world where trading advantage is measured in milliseconds, that has some value." Pat McFadden, an opposition Labour lawmaker who sits on Parliament's Treasury Select Committee, said British regulators need to probe any possible abuses by dealers.

"The gold market is hugely influential, and there needs to be public trust in the gold price," McFadden said in an interview. "Question marks have been raised about the benchmark price of gold, and it's important that regulators investigate."