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21 May 2014

Death - (and Resurrection?) - of the Silver Fix



One of the biggest surprises of my career in metal trading was the day I heard that N M Rothschild were quitting the London Gold Fix. That bank had been so closely bound up with gold trading for pretty much its entire history that I would have put serious amounts of money on them staying wedded to the business for years and years to come. Fortunately I didn’t, so I didn’t lose it. The news that’s just out confirming that the London Silver Fix is to terminate in August of this year is frankly much less of a surprise. Since the LIBOR scandal spurred regulators into an examination of pretty much all price-determining methods, the writing was really on the wall. No major bank is going to go head-to-head with the authorities for the cause of the silver price - it’s not that important to them. Deutsche Bank’s final shrug of its corporate shoulders and decision that if it couldn’t sell the fixing seats - both gold and silver - it would just get out to prevent any potential reputational damage was the last straw (for silver, although not - possibly yet - for gold).

Does it Matter?

Not important enough - well, there are some out there for whom it is. First, there are the websites at what I would call the ‘fringe’ end of financial commentary, those (and I’m not going to name-check them) who always refer to bankers as ‘banksters’, who tell us that western Central Banks are in a conspiracy directed by the BIS and that Rothschild - well, let’s not even say what their comments there are. Anyway, they are all very happy to see the end of the silver Fix, because they see it as a part of the conspiracy to enable governments to stay in power to the detriment of their electors; at least, that’s as far as I can understand their point of view. Now, I’m not an apologist for banks, bankers, politicians or greed, neither do I maintain that the precious metal business has always been squeaky-clean, but I don’t think I’m the only one who finds some of the conspiracy theories fantastic. How emotive words can be; if only it hadn’t been christened the ‘Fix' all those years ago, when nuances of meaning were perhaps different.

The Gap to Fill

But that aside, and more importantly, the end of the Fix will leave a hole that needs filling - or at least, most thought is that it needs filling, although one of the comments on one of the websites I mention above was along the lines of ‘why do we need a reference price when we’ve now got ETFs?’ 

If we look first at the business with which I am most familiar - base metals - the reference price provided by the LME is without doubt of significant value to the trade. It’s the way of establishing the benchmark against which physical contracts can be priced and it provides a level against which company performance can be judged by managements and shareholders. It also sets a mark for daily valuation; you can argue between the traditional official price and the (more popular with some investment funds) five o’clock kerb close, but whichever you choose, the availability of a daily price to reference positions to is a vital tool in risk management. So for those who question why we need a reference price - it enables us to manage risk, to price and hedge physical contracts and to understand performance.

Physical and Futures

That’s what the Fix has been used for in silver and that’s the gap that will now be left in the market (and, incidentally, I think it probably answers the ETF comment above: it’s about identifying value). What is there available to fill it? Well, Nymex trades a silver contract, so could that be the answer? The problem there is that it is a futures contract, and although on the surface it may seem an attractive candidate, the risk of divergence between the physical and the futures price suggests that it would not be an adequate replacement for the physical spot price of the Fix. It’s not the same as the LME, which is correctly a forward physical market, where the Exchange and physical price converge at spot (although even there there can be problems as demonstrated by the current aluminium market). The same issue arises in the case of any of the other, smaller, futures contracts - referencing a physical product to a paper futures contract derived from it is unlikely to be a consistently successful model.

The LME

Where else to go? Well, lurking in the background is the LME. The last attempt at a silver contract fizzled out ignominiously in 2002, with insignificant liquidity or open interest, but things could be different now. Without the Fix as the favoured price for physical business, the opportunity surely is there. There’s plenty of crossover, with users such as miners and concentrate traders familiar with the LME’s operations from their own activities in copper, lead and zinc, for example, and the majority of LME brokers are well accustomed to the silver market. So there is a basis there.

On the other hand though, there are drawbacks, principally surrounding the question of liquidity. The Fix has been the preferred reference price, but it’s an open question as to whether the volume actually traded, rather than priced, on it -  assuming it would transfer to the LME - would be sufficient to support a contract. There is also an issue, which has been proved relevant before on the LME, around contract size; one of the conveniences of the Fix is the ability to transact precise numbers of ounces. 

But I would have thought it worth a look for the LME though, particularly if they are able to secure the goodwill of the current fixing administrators. That should be forthcoming, since the demise of the silver Fix will clearly shine the spotlight on to the gold Fix and demand that it shows its value. A messy picture in silver, with no clear succession for pricing, would not be welcome. Indeed, the interests of the LME, the LBMA and the LPPM would all seem to be aligned in keeping metals pricing centred in London. If talks between those three entities are not already advanced, I would expect them soon to be.

Chaos?....Mmm...

If the conspiracy theorists are right, of course, none of this matters, because chaos is only a heartbeat away. The theory goes that Central Banks, with the connivance of western governments, have been selling silver (and gold) through the Fixes to depress the price, as the only way they have left to prevent currency collapse as an increasingly disturbed populace swaps paper currency for hard assets (and in particular precious metals). As the quantities they have sold exceed the available supply of metal, then the result of the ending of the Fix and the opportunity it gives to keep a lid on the spot price will inevitably lead to a massive backwardation and then default. Well, I’m not going to judge governments or central banks, but I struggle with the concept of this conspiracy; the idea of all those different elements and institutions coming together just seems frankly outlandish. 

Grasp the Opportunity

It may be that the precious metal markets are less than perfect (after all, until it became public, how many people were aware that LIBOR was a dubious rate?) and regulators, with BaFin to the fore, are certainly digging, but were I the LME, I think I’d take the chance and, as long as support from the LBMA and LPPM - many of whose members are already LME members of one category or another - is forthcoming, take a serious look at grasping the opportunity to bring silver back on to the Exchange.   

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