Summary
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The Justice Department and CFTC looking.
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A question of jurisdiction.
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It is all about nickels and dimes.
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The new profit centers and a bigger issue.
I have been trading precious metals since 1981. For many years, I had a bird's eye view of these markets by virtue of managing a global precious metals trading business for major dealer. While I left the dealer community fifteen years ago, I understand and observe developments in the bullion markets on a daily basis. Over the course of my career, there has been a rising tide of voices stating the dealer community manipulates these markets. There is some degree of truth in these voices. There have been many regulatory changes over past years. When I ran the precious metals trading business in the late 80s and 90s for various divisions of Salomon Inc., the Commodity Futures Trading Commission (CFTC) regulated the futures markets. However, there was loose regulation, if any, in the over-the-counter markets. There was manipulation -- I witnessed it firsthand. However, that manipulation never affected long-term price trends. While the manipulation may have been unethical and immoral, it did not violate any laws. Today, new laws and regulations have changed the trading landscape. The announcement of an investigation into the precious metals markets will result in fines and maybe even some punishments. Individual traders may have to account for their actions. The regulatory environment has changed. However, there has been a disconnect. A culture of institutionalized greed sewn into the fabric of the banking and trading industry that causes these abuses remains in place. Institutions pay traders for performance, they make more money for themselves when they make more money for their firms. This is the root of the problem in terms of the investigation. It is a very difficult issue to address. Meanwhile, the regulators were sniffing around the bullion markets and that sniffing has turned into a formal investigation.
The Justice Department and CFTC looking
Last week the conspiracy crowd in precious metals had an ah-ha moment. The United States Justice Department and CFTC announced a formal investigation of these markets. The investigation centers on trading activity at the banks that trade gold, silver, platinum and palladium. According to the Wall Street Journal, the banks under the microscope are HSBC, Bank of Nova Scotia, Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, J.P. Morgan, Societe Generale, Standard Bank and UBS. The investigation is at "preliminary stages." The usual suspects are subjects of the probe. This is not the first investigatory probe -- last year more transparent and fair benchmark pricing mechanisms replaced traditional precious metal fixings. Details of the specifics of the current investigation are scant. However, if they look closely enough they are likely to find that banks and dealers used their order books to enhance profits.
A question of jurisdiction
The regulators in the United States are conducting the investigation. There will be cooperation from regulators in the United Kingdom. However, precious metals markets are global. Trading centers today include New York, London, Zurich, Hong Kong, Singapore, Tokyo and Shanghai as well as other locations. The precious metals markets operate around the clock, the markets are open from early Monday morning in Australia until the close of business on Friday in the United States. They operate on a 24-hour basis.
Precious metals markets are important global centers of commerce. Producers of precious metals use the markets to finance, hedge and sell their output. Consumers use the markets to secure their requirements. Traders, speculators, arbitrageurs and investors use the markets to trade. Precious metals have a dual role in the global economy. They have all of the characteristics of currency; historically they are all means of exchange -- hard assets. They also are industrial metals used for a variety of purposes and consumed by many industries due to their physical properties. As hard money, financial institutions traditionally trade precious metals. Many of these banking firms count central banks around the world as clients. The central banks borrow, lend, buy and sell gold, as the yellow metal is an important part of government's foreign exchange reserves. Regulators must tread carefully in terms of these markets and the dealers who facilitate trade and liquidity. If they create an environment that is too restrictive, financial institutions may decide that trading in precious metals is not worth the regulatory price. This could cause the dealer business to move from the regulated banks to those who are out of the reach of both regulators and tax collectors. In an article I wrote for Seeking Alpha in September 2014 called The New Commodity Kings: How the Commodity Markets Changed This Year, I cautioned on the unintended results of a regulatory environment that is overly restrictive. The current investigation by U.S. regulators will eventually come down to questions of present jurisdictional authority as well as future regulatory reach.
It is all about nickels and dimes
It is highly likely that the investigation will uncover misdeeds. These misdeeds are likely to have occurred in the less liquid precious metal markets. Therefore, expect price manipulation to be particularly evident in platinum and palladium markets, while silver and gold manipulation will be present but less ugly. Those violations will create an environment of mistrust.
When it comes to platinum group metals, the markets tend to be thin. Therefore, price volatility is higher, daily trading ranges tend to be wider. This presents the opportunity for traders to move the price of these metals by buying or selling large quantities. It is likely that the investigation will find that aggressive dealers purposely triggered stop orders for their own economic benefit. It is also likely that dealers who stood to gain an economic profit triggered customer orders in all precious metals by triggering those customer purchase or sale orders. While this activity is ethically questionable, the profits amount to nickels and dimes. It is highly unlikely that dealer activity caused medium or long-term price changes in the price of any of these metals. That is of course, unless government agencies themselves are involved in the manipulation -- if that is the case then all bets are off.
There is another motivation for the current investigation. In the United States, the aura of bad feelings between Main Street and Wall Street continues to compel regulators to investigate and act. The political reason is to respond to and act on bad behavior -- that is their job. In the wake of the financial meltdown in 2008 and bailouts that followed, civil penalties have been the regulatory and Justice Department response to bad behavior. Criminal prosecution has been a rare exception. In terms of the current probe into precious metals trading, expect more of the same.
The new profit centers and a bigger issue
The new regulatory environment in the United States has turned regulatory agencies like the CFTC and SEC into huge profit centers for the U.S. government. Both agencies have collected enormous sums in fines and settlements over the past few years. Many times, even the commencement of a probe will result in a financial settlement where an institution ponies up hundreds of millions if not billions of dollars in fines in order to make the problem go away. I suspect that the current investigation of precious metals markets will lead to the same result. I would not be surprised if the banks were negotiating huge fines to settle the matter right now.
Gold, silver, platinum and palladium markets are important global markets. Pricing in these commodities are all dollar-based. Those responsible for bad behavior will pay. It is likely that the bad behavior will continue. Until the root problem, a compensation system that rewards aggressive behavior, is addressed, the investigation and usual cure is meaningless.
Regulators and prosecutors walk on thin ice in terms of these markets. If they push too hard, these markets will find friendly environments in which to operate. At the end of the day, this investigation is about nickels and dimes. The real problem is institutionalized greed. Therefore, the current investigation makes for great reading and press, but it is meaningless. The conspiracy crowd will continue to be frustrated.
Gold, silver, platinum and palladium prices go higher when there are more buyers than sellers. Prices go lower when there are more sellers than buyers. Institutions may influence prices on a very short-term and limited basis, and that is wrong. However, they do not have the ability to change price trends over long periods. This new scandal in the precious metals market is nothing more than an old story.
Additional disclosure: The author always keep precious metals in his portfolio, the amount depends on market conditions.