BackMore entities may join gold electronic auction
The new digital price setting platform allows for more market makers, and better price discovery
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After nearly a century, the traditional practice of fixing gold prices through the historic London Gold Fix has been discontinued in favour of the new electronic London Bullion Market Association (LBMA) gold price, as of 20 March 2015.
Buyers, sellers and investors referred to the London Gold Fix price till last week, to determine the value of gold. The price was set via a conference call twice a day between four market making banks—Barclays Bank Plc, HSBC Holdings Plc, Bank of Nova Scotia and Societe Generale SA. Market makers basically have orders for buying and selling gold for themselves or on behalf of their clients. Therefore, they quote both a buy and a sell price for the commodity and are ready to trade gold stock on a regular basis to create or maintain liquidity in the market. The lead member can start the process by suggesting a price closest to the current market price. This is then applied to orders and gold trading contracts to arrive at the final price. If demand or buy orders are higher, then typically, the price gets set above the previous close, and vice versa.
This pricing mechanism gave confidence to traders that transactions were being done at a price that was arrived at after due process of price discovery.
However, recently there was some uncertainty over the conduct of market makers and whether they were indeed operating in good faith without conflict of interest. In May 2014, Barclays was fined for attempted manipulation by a trader in gold price fixing and for its failure to address this through internal controls. This brought forth the vulnerability of the system, which could be manipulated. The alternative was to go digital.
Electronic price setting is expected to be more efficient and transparent. Naveen Mathur, associate director, commodities and currencies, Angel Broking Ltd, said, “Gold has a very wide market across the world, and is used as a physical asset as well. Hence, price manipulation has a limited overall effect. Nevertheless, an electronic system is more efficient and transparent."
Last year, the London Silver Fix came to an end. The LBMA decided to put in place an electronic system and made ICE Benchmark Administration, an administrator for regulated benchmarks, responsible for settling the electronic system.
Gold electronic auctions will be conducted twice daily in US dollars but reference prices will be available in pounds and euros. The objective is to increase the pricing mechanism’s transparency and efficiency. “Earlier, it was a closed-door issue and there could be room for manipulation since you knew who was bidding at the other end of the conference call. The new method is more transparent and will allow for better price discovery as participation in the bidding process widens," said Chirag Mehta, fund manager—commodities, Quantum Asset Management Co. Pvt. Ltd.
Over a period of time, this may even lead to more banks being involved in market making. Some Chinese entities are said to be in talks for direct participation in the bidding process, added Mehta. China is the world’s second-largest consumer of gold. So far, the number of banks has increased to six, with the addition of UBS AG and Goldman Sachs Group AG.
Another advantage of a screen system is better management of orders. The proprietary orders can now be segregated from client orders, and the split can be viewed by all. Moreover, since the bidding entities don’t know who is on the other side, chances of conflict and mis-management are reduced.
The effect of the new system on gold prices will not be much, but “it may be an opportunity for entities in India as well to participate directly in the price making process," said Mehta.
Gold prices haven’t changed much over the week; international price closed at $1,193.33 per ounce on 24 March compared with $1,183.10 on 20 March, the first day of the new electronic price fixing.
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