London gold fix still does the job

Improvements can be made to enhance the accountability and governance of the process

PUBLISHED : Monday, 14 July, 2014, 10:05am
UPDATED : Monday, 14 July, 2014, 11:52pm

The Chinese expression "real gold is not afraid of the melting pot" suggests that if you have genuine quality, then you will not fear adversity.

Well, in that sense, the London gold fix, an institution with a history going back nearly 120 years, is facing its own test as regulators question whether the process is "fit for purpose".

The gold fix is in essence a benchmark price that is derived twice a day from actual trades all concentrated into a short space of time to determine an objective price for gold.

The fix affords the participants far more protection than more traditional auctions

Of course, prices are also being set in trading outside the London fix, but these prices are subjective as they are posted by individual banks.

The London gold fix, therefore, has two advantages: it is derived from many market participants and it provides a venue for large deals to be done.

The process is rather like an auction. The fixing chairman suggests a price to the four other fixing members, who in turn pass the information on to their clients, who pass it on to their clients, and so on, through a fixing commentary conference call.

There can be several hundred clients effectively receiving the information, and they are invited to submit their buying and selling orders, which are passed up the chain to the fixing participants. The price is then adjusted higher and lower to find an equilibrium price where the optimal number of trades can be offset.

Rather like in an auction, the hammer effectively comes down, and a new benchmark is set that can underpin thousands of contracts for the buying and selling of gold around the world.

Actually the fix affords the participants far more protection than more traditional auctions in that you can change your order and even cancel it at any point until the last moment.

The question is whether traders seeing the order flows have information they can usefully use. This is a polite way of saying "can they manipulate the market?"

On the basis that client orders can and are being changed as prices adjust higher then lower, then the answer has to be "no".

There is sometimes a desire to remove all potential risk, which, while laudable, sometimes just cannot be attained.

Given that those that use the process are institutional investors, major miners and central banks - all with treasury teams with expertise in gold - one has to wonder when caveat emptor ("let the buyer beware") comes into play - these are not widows and orphans who are using the fix!

And at the end of the day, these participants have signalled quite clearly that the process is fit for purpose.

As a user of the London gold fix (we buy physical bars to supply investors), we remain satisfied that the fix is optimal in deriving a fair price for gold.

Two improvements could, however, be incorporated. Firstly, regulators should be able to reconstruct a specific fix (seeing all order flows) so that, if necessary, they can hold participants to account. Secondly, there should be a separation of responsibility between the managing of the fix from participation in it - this is called good governance.

Yes, true gold does not fear the furnace. Another gold test is the touchstone, which was developed 5,500 years ago and gives you a good indication of the purity of the gold.

Combine this with a little trust, and you have it covered - it is a shame that last commodity seems to be in such short supply.

Ross Norman is the chief executive of bullion broker Sharps Pixley