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Rohit Savant is a commodity analyst.
  • In The Long Run We Are All Dead: Trading London Gold Price Fixes 0 comments
    Mar 26, 2012 4:10 PM

    In The Long Run We Are All Dead: Trading London Gold Price Fixes

    Articles have cropped up on the internet and elsewhere over the past few years discussing the perceived phenomenon that the London gold morning fix is higher than the afternoon fix, and that enormous profits could easily be made by buying on the afternoon fix and selling at the morning fix. A new round of such discussions reappeared in late 2011 and early 2012.

    The gist of these comments is that the London afternoon fix on average is below the morning fix, so that one could make a fortune by always buying on the afternoon fix and selling the next morning at the morning fix. Others have tried to paint this as evidence suggesting a conspiracy among gold bullion dealers to game the market. Neither set of conclusions are accurate. All of the articles confused the average with the range of daily results that comprise that average.

    It is true that on average the afternoon fix tends to be lower than the morning fix. However, that average masks an enormous range of results.

    Before analyzing the data, one must realize that there are two ways to make these calculations: The difference between a given day's morning fix and its afternoon fix, and the difference between a given day's afternoon fix and the following day's morning fix. Which of these formulas you use to calculate the differential yields different results.

    The average differential between a given day's morning fix and afternoon fix was 16 cents per ounce between 1968 and 2012. That average masked an enormous spread, ranging from a morning fix $80.00 higher than the afternoon fix and a morning fix $45.00 below the afternoon fix on the same day. The morning fix was higher than the afternoon fix only 49.2% of the time. Another 45.6% of the time the afternoon fix actually was higher than the morning fix. The remaining 5.2% of the time the fixes were the same in a given day. Nearly half the time this trade would have resulted in losses, up to $45 per ounce.

    Looking at it only on a more recent time period, from 2000 to 2012, as some of the articles do, the average spread was 35 cents: On average the afternoon fix was 35 cents higher than the morning spread, although the range was between $80.00 and -$42.00.

    These data drive home how deceptive averages can be. The accompanying table and chart show that on average the afternoon fix has been 30 cents higher than the next day's morning fix since 1968 and 79 cents higher since 2000. These averages mask wide ranges, from $81.00 higher than the morning fix to $87.50 lower since 1968.

    The table shows that the morning fix has been higher than the afternoon fix only 49.2% of the time since 1968 and 53.6% of the time since 2000. The afternoon fix has been higher 45.6% of the time since 1968, and 44.7% of the time since 2000. The rest of the time the fixes have been the same.

    This highlights the large risk to this strategy. On average, one theoretically could make a fortune on this trade. However, fortunes can be lost just as easily, and nearly half of the time someone trying to make this trade will lose money. Anyone committed to this must have incredible staying power. If he or she is part of an organization, using other people's money, or reporting to a manager, the institution supporting them must be willing to sustain consistent heavy losses in the expectation that in the long run the average difference between the morning and afternoon fixes will yield handsome profits.

    Some institutional investors and others with deep pockets may try this strategy, but it clearly is not the easy money machine that people looking only at the averages suggest it is.

    The distribution chart graphically portrays the risks involved in confusing long-term averages with the individual trading days of our lives.

    Another misconception is that the relationship between the morning and afternoon fixes means that the price is lower all day long after the morning fix. The articles mistook the differentials between two specific points in time - those of the morning and afternoon fixes - with all of the time in between.

    Calculations comparing prices at two specific times of the day in no way provide any insights into how the price changes during the reminder of time between those two points. Prices move up and down continually. That is how markets tend to work when they are free, unimpeded, and relatively efficient.

    Why

    There are certain reasons why the morning fix tends to be slightly higher than the afternoon fix. The morning fix is a much less liquid, and a much less traded fix. It occurs when Asia and North America are closed. The afternoon fix occurs after the North American markets are open. It is a much more liquid fix. Much more gold trades at the afternoon fix, and, importantly, based on the afternoon fix, than at or based upon the morning fix.

    Much of the gold that trades at the afternoon fix is producer selling. Producers and refiners tend to sell on the afternoon fix, in part because it occurs during their business hours in North America, because it is a more liquid price, and out of market tradition. The afternoon fix is used in contracts covering the vast majority of gold mine production and refined output. All of that selling tends to lead to the afternoon fix being lower than the morning fix on average over time. It is that simple.

    One could say that if it is so simple and obvious, why do not more producers shift their selling practices to the morning fix, or some other time or price mechanism. That is a very good question for shareholders to ask management at mining companies.

    There are inefficiencies in the bullion market like those in many other markets, which may be large and simple to fix and still remain in the market.

    This article is excerpted from CPM Group's Gold Yearbook 2012, released 27 March 2012. cpmgroup.com.

    Price Comparisons of London Morning and Afternoon Fixes

           
             

    Percentage of Times One Fix is Greater than the Other

           
             
     

    1968 to 2012

    1977 to 1982

    1977 to 2012

    2000 to 2012

             

    Morning Fix Greater Than Afternoon Fix

    49.2%

    48.5%

    45.4%

    53.6%

    Afternoon Fix Greater Than Morning Fix

    45.6%

    47.4%

    51.1%

    44.7%

    Morning and Afternoon Fixes The Same

    5.2%

    4.1%

    3.5%

    1.7%

             
             
             

    Average and Range of Price Differential Between A Given Day's Morning Fix and Afternoon Fix

       
             
     

    1968 to 2012

    1977 to 1982

    1977 to 2012

    2000 to 2012

             

    Average Difference of Morning Minus Afternoon Fix

    $0.16

    $0.15

    $0.21

    $0.35

    Maximum Premium of Morning Fix Over Afternoon Fix

    $80.00

    $25.50

    $80.00

    $80.00

    Maximum Discount of Morning Fix Over Afternoon Fix

    -$45.00

    -$45.00

    -$45.00

    -$42.00

             
             

    Average and Range of Percentage Changes in Price Differential Between A Given Day's Morning Fix and Afternoon Fix

     
             
     

    1968 to 2012

    1977 to 1982

    1977 to 2012

    2000 to 2012

             

    Average Difference of Morning Minus Afternoon Fix

    0.02%

    0.03%

    0.04%

    0.05%

    Maximum Premium of Morning Fix Over Afternoon Fix

    5.7%

    4.9%

    4.9%

    4.7%

    Maximum Discount of Morning Fix Over Afternoon Fix

    -6.8%

    -6.5%

    -6.5%

    -5.4%

             
             
             

    Average and Range of Price Differential Between One Day's Afternoon Fix and the Next Day's Morning Fix

     
             
     

    1968 to 2012

    1977 to 1982

    1977 to 2012

    2000 to 2012

             

    Average Difference from Afternoon to Next Day's Morning Fix

    $0.30

    $0.31

    $0.37

    $0.79

    Maximum Premium of Afternoon Fix Over Next Day's Morning Fix

    $81.00

    $81.00

    $81.00

    $77.00

    Maximum Discount of Afternoon Fix Over Next Day's Morning Fix

    -$87.50

    -$87.50

    -$87.50

    -$74.00

             
             

    Average and Range of Percentage Changes in Price Differential Between One Day's Afternoon Fix and the Next Day's Morning Fix

             
     

    1968 to 2012

    1977 to 1982

    1977 to 2012

    2000 to 2012

             

    Average Difference from Afternoon to Next Day's Morning Fix

    0.06%

    0.12%

    0.07%

    0.11%

    Maximum Premium of Afternoon Fix Over Next Day's Morning Fix

    13.0%

    13.0%

    13.0%

    7.8%

    Maximum Discount of Afternoon Fix Over Next Day's Morning Fix

    -11.9%

    -11.9%

    -11.9%

    -5.1%

             
             

    Note: 2012 data are through January.

           

    Source: CPM Group

           

    22 February 2012

           

    Written by Jeffrey Christian and Rohit Savant

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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