The market has long written off a group of investors who claim that bullion markets are artificially suppressed, but a new investigation might change things entirely.
Just recently, Bloomberg reported that the Justice Department is investigating the allegations that gold prices may have been manipulated by major financial institutions.
Along with this probe, the DOJ is also looking into unusual variances in silver futures, U.S. Treasury markets and specific subsectors within crude oil exchanges.
Such revelations are no surprise to adherents of the “hard asset” movement, which may be best personified through the work of the Gold Anti-Trust Action Committee, an organization that has been at the epicenter of the battle against manipulation of gold prices.
The Backstory
In a world of political double-speak, GATA’s primary assertion is both reassuringly and unabashedly blunt: Gold prices are suppressed by elite powers because they stymie and compete against international fiat currencies.
But it wasn’t until the DOJ’s landmark announcement that passionate gold investors — colloquially and often pejoratively referred to as “goldbugs” — have finally had their cause pushed to the mainstream without the ridicule of being labeled as conspiracy theorists.
Recent white-collar crimes involving collusion in high-level financial transactions forced the media’s hand, rendering the attention towards improprieties in gold prices an inevitability.
In 2012, a committee of international investigators uncovered a veritable conspiracy involving globally renowned banking institutions manipulating the benchmark London Interbank Offered Rate for profit. The so-called Libor scandal rocked the public trust in the financial infrastructure, which led to leave-placement, suspension, or dismissal of more than 20 currency traders.
The heat was enough to incentivize Swiss bank UBS Group (UBS) to come clean, which provided information to the Justice Department in exchange for leniency. The request was later honored with a $545 million settlement, a penalty that was deemed lower than expected.
Utilizing the same analytical model that helped uncover the LIBOR scandal, the DOJ hopes to shed light on the controversies surrounding the fixing of gold prices and other commodities. But what would the likelihood be that the enforcement agency will find anything?
If they incorporate game theory-derived algorithms into their model, there’s compelling evidence to suggest that, at the very least, strange aberrations have an impact on gold prices and precious metals in general.
The Problem With Gold Prices
Let’s first consider the popular Market Vectors Gold Miners ETF (GDX) as a baseline for our analysis. The GDX holds many well-regarded gold and silver miners in its portfolio, including Silver Wheaton Corp. (SLW) and Royal Gold (RGLD); thus, the GDX is a company-based fund as opposed to being a commodity-centric investment. This distinction will be important.
Over the life of the GDX, if the fund manages to post positive numbers on average for the past three months, there is a 60% probability that the GDX will trade higher within the next 90 days. Since 2012, however, this statistic has dropped to 43% — thanks, of course, to a bear market in gold prices. Logically, there is also decrease in expected returns: 7.4% over the lifetime of the GDX versus 3.3% since 2012.
On the flip side for the GDX, there is naturally a 40% risk over its lifetime that even if it posts positive numbers over the past three months, shares will move lower 90 days later. Since 2012, this trend strongly favors the bears to the tune of 57%. As expected, the likelihood of losing money in the GDX increased in kind: -9.35% lifetime risk versus -12% risk since 2012.
So far, what we have established is nothing extraordinary: bull markets produce stronger gains, bear markets produce stronger losses. But this logical pattern is absent in both the SPDR Gold Shares (GLD) and the iShares Silver Trust (SLV)!
For example, the GLD and the SLV have significantly higher lifetime bullish probabilities over equivalent probabilities since 2012 — 68% versus 24% for the GLD, and 60% versus 28% for the SLV. With such a wide discrepancy in magnitude, we would then expect a devastatingly higher risk profile from 2012 onwards.
But we don’t see that kind of risk profile. Instead, the difference in risk between the lifetime period and the period since 2012 for the GLD is -3.36% compared to -4.03%. The equivalent risk difference in the SLV is more telling: -7.86% versus -7.39%.
These numbers mean that, even though the GLD and the SLV on average have become 152% more volatile since 2012, the average magnitude of risk has only increased by 13%! In comparison, the GDX has increased its volatility by a far lower rate of 41%, yet its magnitude of risk is higher at 29%.
This is where the DOJ should focus its attention. If the gold and silver markets have become wildly volatile since 2012, the risk of holding the GLD and SLV quarter over quarter should naturally explode higher as well. But that risk hasn’t exploded, which is a huge red flag.
The GDX exhibits normal market behavior — stronger in bull markets, weaker in bear markets — presumably because, as a “corporate fund,” other factors besides purely technical reasons dictate its overall trajectory. But as “commodity funds,” the GLD and SLV are subject to manipulation — provided of course that the manipulation of gold prices is an accurate assumption.
Given the intensity to which many gold investors impart on the price-fixing issue, it’s unlikely that the DOJ investigation will satisfy everyone. Nevertheless, it may be the first step towards further transparency in gold prices and other commodity markets.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
