For many years, it has been claimed by promoters of the yellow commodity and SPDR Gold Shares (NYSEARCA:GLD) that gold prices are "manipulated." In recent days, these promoters have been claiming "vindication" as a result of events in London that have been widely publicized. First, Barclays was fined 26 million pounds ($43.8 million USD) in connection with a gold price manipulation scandal. Second, Financial Times has recently reported that the sort of shenanigans at the heart of the Barclays case has been "routine" for many years.
Should gold bulls really take solace in this revelation? Do these events really prove that gold prices have been systematically suppressed for decades via "manipulation," as gold promoters often claim? And if gold prices are indeed manipulated, what should current or prospective gold investors do about it? And how does all of this potentially relate to claims of manipulation of the S&P 500 (SPY) and the Dow Jones Industrial Average (DIA) by the Fed?
The Barclays Case: What Kind of Manipulation?
Barclays was fined for failures in internal controls that enabled former trader Daniel James Plunkett to influence or manipulate the setting of gold prices through the traditional daily London "fix" system. According to authorities, Plunkett manipulated the market in order to avoid payment of $3.9 million to a customer under an option contract, boosting his own trading book by $1.75 million.
Do these revelations vindicate the claims of gold promoters that there is systematic manipulation markets to suppress gold prices? This particular case involved a Barclays trader that manipulated the gold price to avoid payment on an option contract. So doesn't this case prove that gold prices can be, and are, in fact, manipulated downward? The answer is both "yes" and "no." It depends what sort of "manipulation" we are talking about.
The answer is "yes" in the narrow sense that gold prices can be and are habitually manipulated by traders. However, in a deeper sense, this case shows precisely the opposite of what the promoters of gold manipulation conspiracy theories have been trying to convince the public of over the years.
One of the great ironies of this Barclays case is that it brings to public light the fact that price manipulation is not unique in any way to the gold market - it is a systematic issue that affects the prices of virtually all assets that trade in markets. It is common knowledge that option traders in virtually all markets -- including equity and commodity markets - systematically engage in gamesmanship to "influence" or "manipulate" the underlying price of securities around the time of options expiration.
It's important to understand how this works. Traders on either end of an options contract with a strike price near the money often try to manipulate the price of the underlying asset either up and down over very short-term time-frames around expiration date in order to benefit their book. For example, traders that are short call options (i.e. sellers of call options) will try to push prices down so that the options contracts expire worthless, while sellers that are short put options (i.e. sellers of put options) will try to push prices up so that the options contracts expire worthless. At the same time, owners of calls will try to push prices up in order to profit, while owners of puts will similarly try to push prices down in order to book a profit on their contracts. Traders that hold these various positions engage in "battles" with other traders that are on the opposite side of the trade. Indeed, these "battles" amongst traders around a specific strike price are so commonplace that they are routinely reported on by the financial press. The subject has been even written about extensively in academia. Thus, in this narrow sense, it is only trivially "true" that gold prices are "manipulated" by traders - in the same way that prices are manipulated in the markets for market for grains, hog bellies and Apple stock.
For this reason it should be clear that demonstrating that this sort of price manipulation exists in financial markets, or even gold markets specifically, provides no support whatsoever for the notion that there is a global conspiracy to systematically manipulate gold prices downward. Quite to the contrary, this case ironically tends to demonstrate why it is near impossible for manipulators to have any systematic or lasting effects on the prices of gold - or any other commodity or security, for that matter.
One of the revelations in this case was that after having manipulated the gold price downward, Plunkett sent an email to colleagues saying that he was hoping for a "mini puke" the following day. Why did Plunkett say this? His remarks illustrate the problem faced by traders that attempt to engage in this kind of short-term market manipulation: They expose themselves to the risk of major losses as they unwind the positions that they initiated in order to manipulate market prices. In this case, Plunkett sold short spot gold and/or futures in order to manipulate spot gold prices downwards. The following day, he was going to be forced to buy spot gold and/or futures in order to cover his recently acquired short position. Ironically, Plunkett's need to buy gold the following day, had the potential to contribute to a "short squeeze" that caused prices to rise and occasion major losses for him. This is why Plunkett was hoping for a "mini-puke" - this would enable him to get out, unscathed or even at a profit, of his short positions that he acquired in his attempt to manipulate gold prices downward. However, note that if gold prices had actually risen the next day for reasons out of his control, he would have been exposed to potentially major losses.
This is the dilemma faced by all manipulators. Manipulation is a double-edged sword. For example, if you sell large amounts of gold today in order to manipulate prices downward, you will now be a source of demand tomorrow that will tend to push prices up. Because prices - especially in large and liquid markets such as gold -- are ultimately determined by supply and demand, manipulators have little or no net effect on prices beyond the very short term. This is because manipulation provides no net supply or demand to the market. The positions taken to manipulate the market must be unwound, and so by the law of supply and demand the net impact on prices will tend to be a wash.
The Possibility of Larger Conspiracies
Clearly, the Barclays case provides no evidence whatsoever that gold prices are systematically repressed by manipulation. Quite the contrary, the case provides a clear illustration of why manipulators such as Plunkett ultimately have no systematic or lasting effect on the prices of goods in a large and liquid market.
But isn't it possible that larger actors such as central banks could manipulate prices in a more decisive way?
Wading through the enormous swamp of speculation surrounding this question goes beyond the scope of this article. However, it is possible to make a few logical observations.
The first thing one must note is that it is generally accepted, even by the advocates of gold conspiracy theories, that central banks do not engage in gold market interventions directly. It is generally accepted that to the extent that such manipulations occur at all, they are carried out by "front-men" that operate on behalf of global central banks. In this regard, the Barclays case does indirectly provide us with some interesting insights. Specifically, the Barclays case serves to highlight the fact any such front-men would be exposing themselves to enormous losses at any given point in time. Since it must be presumed that "front-men" will not collaborate with the central banks if they are exposed to net losses, then the question is how the central banks make their front-men whole when such operations move against them - as must frequently be the case. There would have to be a highly complex operation that attempted to reconcile or "true up" accounts between the central bank and its front-men that guaranteed that the front-men would not sustain losses. The problem is that any operation to reconcile such large and complex accounts would necessarily involve the knowledge of dozens if not hundreds of people that would be consciously participating in unambiguously criminal fraudulent activity. For example, it would involve the fraudulent falsification of the books of the central bank and of the companies providing the front, tax evasion (non-disclosure) by the front-men and etc. This renders the secrecy of such a conspiracy virtually impossible to sustain. In other words, since so many people inside the government and in the private sector would have to be involved in such manipulation and the subsequent criminal cover-up operations, the sustained existence of this type of conspiracy is quite implausible.
This is why the only way that sustained secrecy of such a conspiracy could be plausibly explained would be to posit that all of the people involved, both in the public and private sectors, were members of a secret society such as the "Illuminati" or Masons. I will leave it to readers to opine themselves on how plausible this is.
What Should Investors Do About The Specter of Manipulation?
Promoters of gold are the most vocal proponents of the notion that gold prices are manipulated downwards.
There is a puzzling irony in this. Imagine a promoter of Apple Computer (AAPL) saying: "Apple stock is constantly manipulated downward by powerful interests that are determined to drive its price down. Therefore, buy Apple." Such a position would be absurd.
A separate absurdity is the position held by most gold promoters: On the one hand, they like to claim that the Fed manipulates stock prices upwards as represented by the S&P 500 index and the Dow Jones Industrial Average. At the same time, they passionately try to convince investors to sell their stocks (or refrain from buying) and to buy gold. How intelligent is that?
So, what should intelligent investors do given the specter of gold price manipulation?
First, investors must clarify what is referred to when the term "manipulation" is referenced.
If it is the sort of manipulation that has been uncovered in the Barclay's case, then this is the same kind of manipulation that affects Apple stock virtually every month around options expiration day. For reasons described earlier, such manipulation can have virtually no systematic and or lasting effect on the price of Apple stock or the price of gold. For this reason, manipulation of this sort is not a reason to undertake or refrain from undertaking long-term investment - in Apple or Gold. Long-term investment is affected very little by such shenanigans. The decision to invest in Apple or Gold should rest on entirely different considerations.
Now, if you believe that the US and other global central banks are conspiring with other private sector actors to suppress the price of gold, then this is another kind of manipulation entirely that is being posited. And in this case, the answer regarding what to do about it should be clear: Stay away from gold! Why in the world would you want to invest in an asset whose prices global central banks are determined to suppress? Similarly, if you are convinced that the US government is manipulating stock prices higher, then how in the world can this be construed as an argument against equity investment?
If central bank manipulation is real and effective, why would you use your relatively meager savings to fight against it? This is not practical.
What should investors do right now in the face of the specter of manipulation in gold markets?
If the manipulation referred to concerns the sort of shenanigans that were revealed in the Barclays case, then the issue is virtually irrelevant for long-term investors. In this case, do nothing at all. Your investment stance vis a vis gold should not be affected one way or another.
On the other hand, if the manipulations you are concerned about refer to alleged massive conspiracies led by the US Fed and other global central banks, then this is a different story. In this case, stay away from gold like it is the plague. At the very least, stay away from gold at least while it remains significantly overvalued on a historical basis vis a vis the basket of goods and services that comprise the CPI. For reference, on this basis, gold is historically overvalued at any price above $850 USD.
In sum, I make two main observations in this article:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
This article was written by
Kostohryz started his investment career as an analyst at one of the world's largest asset management firms covering sectors as diverse as emerging markets, banking, energy, construction, real estate, metals and mining. Later, Kostohryz became Global Portfolio Strategist and Head of International Investments for a major investment bank.
Kostohryz currently manages JK Investment Consulting, a firm specializing in: 1) Global portfolio strategy; 2) Risk analytics; 3) Macro forecasting; 4) Business cycle analysis; 5) Quantitative analytics. Kostohryz is also founder and CEO of Investor Acumen, a service dedicated to empowering individual investors to achieve their investment goals.
Born in Mexico, Kostohryz grew up in Colombia and South Texas. He graduated with honors from both Stanford University and Harvard Law School. He is a former NCAA and international-class decathlete and has stayed active in a variety of sports. Kostohryz pursues various intellectual interests and is currently writing a book about the impact of culture on economic development.