Since the Barclays trader was found guilty of manipulating gold prices and Barclays fined $44 million, the entire "Fixing" process has come under the spotlight. The bankster involved is thought to reflect one or maybe other 'rogue' traders, not a condemnation of the whole process of the "Gold Fix" by the banking fraternity.

Nevertheless, many are saying it is archaic and should be done away with. The danger with this attitude is that the need for the "Fixing" is critical to the bulk of gold that it traded globally. Accordingly there are three proposals, at the moment, to be discussed in a Forum arranged by the World Gold Council. It is appropriate that the WGC hosts such an event as they are funded by gold producers across the world and will favour not just a buyer's position but the seller's.

The need for a "Fix"

What do we mean by this? By now you are all aware that twice a day the five London Bullion Banks link up by phone and bring all their clients together to weigh up a price that reflects demand and supply within 50 bars of gold. Then the price of gold is "Fixed" at that price and all deals discussed at the session are done at that price. Please note that when we say the bank's clients, we are talking of clients who cover the range of participants

Let's be clear on what this process really is. It is not an average price during a day, it is not a random price set at certain times, it is a price where the greatest volume of gold is traded in one 'place' at one time, twice a day. It is favoured because it is the most representative price of gold's demand and supply at two points in the day. It is where the greatest volume of gold is traded on that day. And that is the point that must be emphasized. It is most representative of the bulk of gold traded twice a day.

After the Fix, the gold price may move strongly in another direction, but this will be on smaller volumes or involve far fewer players, not representative of the total market. If gold trading were restricted to just these two processes in London, then it would be a true reflection of demand and supply. But this could never happen in view of the diverse nature of the gold market. But because it is the closest price to a balance of demand and supply traded on a daily basis, it is taken as such and therefore pertinent to setting contracts outside of the market. Any other mechanism that does not reflect, at least in main part, demand and supply on a daily basis would fall short of the market requirements for price setting. As we have seen it may occasionally be manipulated by a bankster or two, but it remains the closest to a true reflection of demand and supply. Any alternative system must bring the same elements to a replacement price setting process.

In London's afternoon at 1500 hrs the second "Fixing" takes place at around the time that the U.S. markets open, thus reflecting a more global consensus of demand & supply. Why is this process necessary in the first place you may well ask?

Gold Volume & Liquidity & Contracts outside the market

Some commentators have said that the Fixings reflect 90% of the world's physical demand and supply at any time. We are sceptical about this number because much of the world's gold traded uses the "p.m. Fix" as a reference price to be used in contracts where gold is supplied at a particular set of dates. This gold is then delivered to the client at those prices. These contracted amounts don't pass through the London Bullion market or "Fix". Nevertheless, there is a need for a daily price that reflects the value of most gold traded on any particular business day. This need is thought to cover the bulk of the world's gold traded, certainly at wholesale levels. Without it such contracts would find it difficult to find a truly reflective price of demand and supply on that day.

What the "Fixing" does reflect is perhaps 90% of the physical dealings in gold, not on a contracted basis.

To what extent the Fixings allow large clients to trade physical in the short-term is not quantified, but certainly there is ample opportunity to do so with no intention of delivering to others. This does add swings to the gold price but cannot at the end of the day detract from real supply and demand outside of these professional traders. In other words such trading will not defeat the underlying trends of the gold price. Contained within the volumes seen at the Fix such swings are prevented from being disruptive in the longer term.

Some may say that COMEX sees a far greater volume of gold contracted, but we beg to differ. Only up to 5% of deals done on COMEX are done with physical delivery intended. Even there the buyer and seller must notify the exchange that they have this intent beforehand. London remains the hub of global gold trading. COMEX is essentially a financial derivative market not a gold market. Even such derivative trading has a muted affect on the gold price. The positions taken their are in support of physical positions either through hedging or backing up a long or short position in the physical market [as we saw April 2013]

"Snapshot" pricing in place of the "Fix"

With the above criteria in mind we look at two proposed alternatives.

Some have put forward the concept of a 'snapshot' price at different times of the day with these times changing frequently. This would ignore the key virtue of the gold "Fix" and that is to reflect the bulk of global demand/supply two times daily. We have seen the way speculators try to manipulate the gold price by picking the quiet times of the day to swamp the gold price in the hopes that holders will be panicked into selling because of the change in price when they do this.

So the ability to bring the bulk of gold buying and selling professionals and their deals together at one particular price twice daily served far more than picking a representative daily price. It reflects the twice daily times of the maximum volumes of gold traded that day. If the "Fix" failed to bring such high volumes of deals together at those times then it would be no better than an unrepresentative 'snapshot' of gold prices. "Snapshot" prices would also be open to far more corruption than the "Fix". The difficulty would then be, "who would take the snapshot and would he be beyond manipulation?"

Change is coming

A change is taking place in most global financial markets that is being noticed but not yet appreciated. It is based on the transfer of wealth and power from west to east. As we have quoted before, in the past 80% of global cash flow accrued to the developed world. Between 2016 and 2020 this will have changed to 35% to the developed world and 65% to the emerging world. We are already at 40% to the emerging world.

In the gold market we have seen Asia dominate demand for a few years now. In 2013, we have seen China overtake India as the largest source of that demand with much more growth on the way. With that in mind it makes sense for China to become the hub of the gold world in the future. And so it should, in that Middle Eastern, Indian and Chinese demand makes up 74% of true gold demand.

So for the gold "Fixes" to be truly representative of the prices of the bulk of trades done that day we should have three or four "Fixes" [morning and afternoon] in Asia and London. Before this happens, the gold market would need to see gold producers or their agents delivering gold direct to Asian markets like the Shanghai Gold Exchange and not through London.

Indeed, Shanghai has jumped in importance in the last year as Swiss exports to the region reportedly reached 2,711 tonnes in 2013. China has moved a long way towards being able to accommodate a "Fix" through the offering of a Yuan contract system and opening its market to international banks. It would only require direct delivery of gold from gold producers world-wide to ensure that control moved from the banking system to buyers and sellers at the "Fixes". For sure China is headed towards its own representative system in time unless it agrees to the reforms to be discussed, with them in miond.

The joy of Shanghai, to date, is that it is primarily a physical market with the bulk of trading leading to the delivery of gold to clients. With the proportion of speculative trading far less than in the West we see Shanghai reflecting true demand and supply much better.

With the 'Fixing' Forum coming up, it would be good if such an expansion of the system could be developed inclusive of Shanghai too. While the Forum is discussing a London system, it needs to recognize that it is part of a 24-hour market. To avoid future contentions and inadequate representations of the gold price reference point, these evolutions of the gold market should be built in to any reformed system. This would result in an improvement on the current London based system as well as make it less vulnerable to distortion and manipulation, globally.

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