Is the gold price manipulated? Part III

February 19, 2016 11:54 AM

The belief in manipulation in the gold market is associated with the notion of discrepancies between the paper and physical price of gold. The latter is artificially set lower by futures markets creating tons of synthetic gold. Hence the price of gold does not reflect its fundamentals. But the divergence between paper gold and ‘real’ gold cannot last forever; therefore the day of reckoning will finally come, and the paper gold market will collapse and the price of gold will skyrocket.

Why is this reasoning flawed? First, no significant and mysterious discrepancy exists between the paper and physical price of gold. Gold prices are set in worldwide trading, mainly in London and New York, which are the base for determining prices in the physical market. The price quoted by different bullion dealers is the international gold price, but with added distinct premiums, depending on the local conditions, the competitiveness and the character of products. The margin between ‘paper’ and ‘physical’ prices is hardly surprising – this is how the retail trade operates. The retail sellers, like bullion dealers, buy gold in the wholesale market (the gold OTC market) and sell them to the retail investors. They add a margin to compensate their costs and earn profits. Do not forget that physical gold is less liquid and requires incurring minting, insurance, delivery and storage costs.

Moreover, the significant and permanent divergence between paper and physical gold cannot last long due to the arbitrage process. The arbitrage traders will always operate in the markets, and seek large divergences between the prices to take advantage of them. If such a discrepancy between ‘paper’ and ‘physical’ gold prices really existed, people noticing it should be buying the paper and sell the physical gold to profit from the divergence instead of writing about manipulation. If nefarious banks sell futures to suppress the ‘paper’ price of gold, they will create a large spread between the future prices of gold and the price of the physical metal (manipulators do not sell the physical bullion which is getting scarcer and scarcer). However, the backwardation – i.e. the situation when futures are traded at a discount in comparison with spot – is very rare in the gold market. And when it exists, it is very small and short-lived. Usually, the futures prices are higher than spot prices (see contango) in the gold market, which clearly indicates that they are not relatively suppressed compared to spot prices (see the chart below).

Chart 1: Gold spot (London AM Fix) and future prices (as of 18 January 2015, 14:55)

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About the Author

Arkadiusz Sieroń is a certified Investment Adviser. He is a long-time precious metals market enthusiast, currently a Ph.D. candidate, dissertation on the redistributive effects of monetary inflation (Cantillon effects). Arkadiusz is a free market advocate who believes in the power of peaceful and voluntary cooperation of people. He is an economist and board member at the Polish Mises Institute think tank. He is also a Laureate of the 6th International Vernon Smith Prize.