Gold Manipulation

Gold market manipulation, called also gold price manipulation, can be defined broadly as a purposeful effort to control gold prices. This sort of manipulation exists in financial markets as traders try to influence the markets (in this case, the gold market). It may be responsible for some short-term aberrations in asset prices, including the price of gold. However, there is another, more specific definition. According to the U.S. Securities and Exchange Commission, manipulation is intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security… [This includes] rigging quotes, prices or trades to create a false or deceptive picture of the demand for a security. A popular belief within the gold investing community is that gold prices are manipulated, generally downwards, in what is described as price suppression.

Are Gold Prices Manipulated?

Many gold investors believe that the market for gold is systematically manipulated. There are many variations of this theory: some say that precious metals are under the thumb of central bankers, while others blame big banks and their use of derivatives (‘naked’ shorts) and high-frequency trading for the declines in the price of gold. There are also worries about the discrepancy between paper gold and physical gold, the fairness of London trading, declining inventories at Comex and leasing of gold by central banks. At first glance, this theory makes sense, especially that the price of gold was fixed for decades by governments or suppressed under the London Gold Pool, while a few financial institutions have already been fined for influencing or manipulating gold prices.

Long-Term Cycles in Gold Market

However, academic research did not find any clear evidence of gold price suppression. Moreover, when we look at the long-term behavior of gold prices (see the chart below), we see clear cyclical patterns, not a permanent downward trend (or even a flat line).

Chart 1: Gold bull and bear markets (from April 1968 to January 2016, London PM Fix).

Therefore, from the long-term perspective, and especially looking at the 2000s, it is hard to understand the accusation of manipulation in the gold market. The cries of “suppression” are extremely selective. When the price of gold is decreasing, then this is the obvious effect of evil conspirators, but when the price of gold is rising, then there is no manipulation and the true market forces are at work. The influence on price may be only short-lived, as low prices cure low prices. The gold market is simply too big and too liquid for any person, central bank or corporation to control. Therefore, any attempts to systematically suppress gold prices would be counterproductive, since the reduction in the price of gold would trigger a market reaction in the form of higher demand and upward pressure on the price.

Naked Gold Short Selling

Many people accuse bullion banks of naked short selling of gold in order to drive down the price. What is naked gold short selling? Let’s start with gold short selling, which is the sale of bullion that is not currently owned by the seller (usually borrowed) and the subsequent repurchase of the metal. The idea is to take advantage of the price decline, as it enables to repurchase the yellow metal at a lower price.

And we say that short selling is naked when gold short selling occurs without first borrowing it, or at least ensuring that the precious metal can be borrowed. So the short-seller can sometimes fail to deliver gold to the buyer.

The impact of naked shorts is, thus, controversial. The popular story says that the Fed uses bullion banks as its agents to put on naked gold shorts on Comex to drive down the price of gold. It protects the U.S. dollar’s value and enables banks to repurchase gold at lower prices.

However, if short sellers on Comex were really as uncovered as it is claimed, there would be a huge ‘short squeeze’ and the price of gold would rise. Therefore, any manipulation using naked shorts would be short-lived. If banks had massive short positions in the gold market, they would have to buy large numbers of futures contracts to cover their position and buy the physical metal to deliver it or roll their positions, buying expiring contracts and selling the next one out. In all cases the short-term impact of selling the futures contract would be reversed as banks would have to unwind their positions (investors should also not forget that for each seller of a futures contract there must be a buyer). Thus, the practice of naked gold short selling, existing or not, cannot explain the long-term bear markets in gold.

Goldman Sachs and Gold

Goldman Sachs was founded in New York in 1869 by Marcus Goldman (later, his son-in-law, Samuel Sachs joined the company). It is one of the largest investments banks in the world. It is well known for its political connections – its former executives often work in the government. For many people, Goldman Sachs is a villain, responsible for financial crises and the suppression of gold prices. Surely, the bank is large and powerful, so it may sometimes take advantage of its position, but the gold market is liquid to such a degree that nobody can exert permanent downward pressure on it. Actually, Goldman Sachs should sometimes intervene in the gold market – it is an LBMA market maker, after all!

JP Morgan Chase and Gold

JP Morgan is an investment bank headquartered in New York. It’s the largest bank in the United States and one of the biggest in the world. Together with Goldman Sachs, JP Morgan Chase is considered to be a ‘bad dude’, a kind of greedy manipulator. In particular, many gold analysts don’t like the bank, as it is accused of selling uncovered shorts on Comex. However, these analysts seem to not understand what bullion banks are. They don’t bet on price moves. Instead, they take the opposite side of the trade with speculators. As a reminder, JP Morgan is an LBMA market maker and it’s additionally responsible (with other banks) for clearing gold, so it must engage in the gold market. But it doesn’t mean that it’s able to permanently suppress gold prices.

Conclusions

The bottom line is that despite many variations of the theory of manipulation in the gold market, their supporters hardly offer any proof. Just as with other asset classes, there are both bull markets, when the price of gold goes up, as well as bear markets, when the price goes down. Bear markets do not imply that there is a deliberate suppression of prices. They are normal market behavior resulting from changes in the gold market’s fundamentals. Indeed, the fundamental factors, such as the U.S. dollar, real interest rates or risk-aversion, do a very good job of explaining the behavior of gold prices in the long term.