A look inside the gold price mechanism

Revelations that London banks manipulated the LIBOR interest rate — misbehavior for which they have been fined billions by regulators — has prompted a closer look at the ways other financial markets are manipulated, including gold, one of the biggest — $20 trillion (trillion with a T) according to Bloomberg News.

It appears that the term “London fix” may be as problematic for gold as for LIBOR (which is a base interest rate that has spillover effects on rates you and I pay, for adjustable rate mortgages or credit cards, and much else).

Should it prove that the five banks — at least two of them already proven to be corrupt — that fix the London rate have also been gaming the gold price, that might not have a great deal of impact on our Maui pawn shop. We buy and sell gold based on the New York spot price, which is updated every 15 seconds during the business day; but we do not change our benchmark so often. Besides, our prices are flexible within a few dollars or so (out of, at this writing 1,245 dollars), so we are not playing in the same league as the arbitrageurs who may (or may not, who knows yet?) be fiddling the gold market.

As the story explains, the mischief seems to come in very short-term (minutes long) bets on futures prices. Pawn shops deal in physical gold, whose value is necessarily somewhat decoupled from the vagaries of the futures market. Nevertheless, suspicions that crooks are loose in the marketplace cannot be welcome. Crooks in banks? Who knew?

“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.”

Stay tuned. Kamaaina Loan blog will be keeping an eye on this.