Silver fix, fixes in silver, Holmes’ razor, poisson distributions and MRDA

Last weekend I and some others posted a working paper on gold and silver price suppression (there’s no evidence for same) on SSRN. In it we noted that there were large movements in and around the times of option expiries, and mused that this was similar to patterns in other markets where traders manipulate the price. Then this happened.

Screenshot 2016-01-30 08.06.34

Cue a plethora of suspicion. The outline of what happened is fairly simple. While prices in the market puttered along there was heavy selling in the benchmark setting process. This resulted, from the mechanisim operating as it should. Prices move in the benchmark process to equate supply (heavy selling) and demand (little buying). This resulted in a very low benchmark price being set, with a unusually large divergence between spot and ‘official’.

To conspiracy theorists this is clear evidence that the fix is fixed. They also in some cases jumped on a phrase in our paper on manipulation of prices on option expiry dates as proof. Lets stand back a little.

First, language matters. It is really unfortunate that the 2014 rejigging of the benchmark setting kept the name “fix”. To some that is a blatant admission of the rigging, the deliberate manipulation for devious means, of the price. Second, manipulation in the context of the paper we posted refers to the interaction of derivative and spot traders to close out positions to their advantage. This can sail close to “marking the close” but is just the normal process of markets settling when contracts are looming. Of course, to the tinfoil hat brigade these explanations will be so much MRDA. No explanation other than the revelation of (possible reptilian) shadowy cabals engaged in massive, decades long market rigging will satisfy some.

Second, the math….think of the math. For a massive conspiracy to last is vanishingly improbable. If you dont believe me, believe this paper instead. The more people involved in the conspiracy the less time it will last. There are at minimum several hundred if not thousands of people over the years who have been involved in the operation, regulation and investigation of the silver (and gold) markets. It is, literally, barely probable, that a conspiracy would have been sustained over the decades.






Third, extraordinary claims (“The Silver Market IS RIGGED”) require extraordinary claims. Call this Holmes’ Razor : “We must fall back upon the old axiom that when all other contingencies fail, whatever remains, however improbable, must be the truth”. This is frequently taken to be that we should try to eliminate all other possibilities before deducing something. It is similar to Occam’s Razor, that the simplest explanation (to come…) is usually the truth rather than a more complex one (rigging! manipulation! )

So what did happen? Well, Adrian Ash, who knows far far more about the operation of the markets than me or, probably, thee, takes a fairly calm view. Its one shared in the FT (but then, our metal millinery wearing friends note MRDA) . As part of the regulatory clearup that happened around the 2014 benchmark setting (im not calling it the fix any more… naming calls..) adjustment, participants in the silver market are not allowed engage in arbitrage while the benchmark setting is in operation. This is designed to allow the emerging price be cleanly determined just by those ‘in the room’ and their buy/sell orders. So when there is volatility things can get out of whack. Like them or not pretty much all the evidence is that derivatives markets are both more efficient at and lead spot markets in price discovery. Take them away, as we have here, and that discovery becomes messy and less informed.

From the FT

Everyone is extremely nervous regarding a benchmark, (adjusting an order) might be construed as untoward or front running clients,” Tom Kendall, an analyst at ICBC Standard Bank, said.

and from Bullion Vault

With spot bullion for London delivery quoted around $14.41 – only 1.1% below yesterday’s new 7-week highs – the 12 noon benchmarking auction saw what participants called “heavy selling”, with lower suggested prices failing to elicit stronger demand to balance it.
 The silver price suggested by exchange group the CME’s electronic algorithm was then cut ever lower before suddenly finding enough demand to balance the selling at the lowest price since 30 July 2009.
 Dealers blamed Thursday’s action on rules – decided by the compliance departments of banks and brokerages, and aimed at meeting the new regulatory regime – which block traders participating in the benchmark auction from “arbitrage” in other silver markets at the same time.
The Perth Mint also concurs, with a particular disdain for the breaking of the link between the markets which has resulted in (my emphasis)
A classic case of unintended consequences where regulators come up with simplistic solutions and end up throwing the baby out with the bathwater. How is a benchmark meant to represent the market if it can’t be connected back to that market? This means the LBMA Silver Price is sort of a closed-end fund without an ETF-style market making arbitrage mechanism to keep its price in line with reality.
and Bron explains what, probably, went on in the benchmark setting
The fact that the price spiralled down implies that the volume being sold was large, large enough that the banks were not confident that when the price fixed that they would be able to lay their positions off in the “free/open” market without moving the price down. It does beg the question of where were other market players to take advantage of such a divergence? I think the answer is that such trading is a tricky business as you can’t be sure that your order into the fix will balance the market and you will get set at that price – it is not a simple arbitrage where you know you can execute at two different prices, it is a much more dynamic process. Managing that risk is a skill set that, surprise, is probably only located within the LBMA market making banks. But they have their arbitrage hand tied behind their back (thank you regulators).
So. Less conspiracy, more cockup.

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