Senate report shows how easily banks can rig gold, copper, and other markets

The heavy involvement of investment banks in commodity trading creates the potential for market manipulation and conflicts of interest in the gold market, and exchange-traded gold funds may be mechanisms of market manipulation contrary to the basics of supply and demand, according to the 396-page report published last week by the Permanent Subcommittee on Investigations of the U.S. Senate's Committee on Homeland Security and Governmental Affairs.

"Possible conflicts of interest permeate virtually every type of commodity activity. If the bank's affiliate leases an electrical power plant, the bank may attempt to use regional pricing conventions to boost its profits, even at the expense of clients that pay the higher electricity costs. If the bank's affiliate mines coal while the bank trades coal swaps, the bank may ask its affiliate to store the coal rather than sell it to help restrict supplies, and benefit from long swap positions, while causing its counterparties to incur losses. If the bank's affiliate operates a commodity-based exchange-traded fund backed by gold, the bank may ask the affiliate to release some of the gold into the marketplace and lower gold prices, so that the bank can profit from a short position in gold futures or swaps, even if some clients hold long positions.

"A fourth problem with mixing banking and commerce is that, in the context of physical commodities, it invites market manipulation and excessive speculation in commodity prices. If a bank's affiliate owns or controls a metals warehouse, oil pipeline, a coal-shipping operation, refinery, grain elevator, or exchange-traded fund backed by physical commodities, the bank has the means to affect the marginal supply of a commodity and can use those means to benefit the bank's physical or financial commodities trading positions. If a bank's affiliate controls a power plant, the bank can 'manipulate the availability of energy for advantage' or to obtain higher profits."

And on Page 368: "At the same time, a commodity-backed ETF can have a significant impact on the price and volatility of the underlying commodity, even when a precious metal is involved. For example, gold-related ETFs first surfaced in 2004, with dozens of similar ETFs springing up over time. Today, it has become clear that significant movements in the gold-related ETFs have had direct impacts on the price of physical gold.

"As one analyst in the field noted: 'You watch the flow of money.... No matter what the supply-and-demand fundamentals (for physical gold) may suggest, if that moneys flowing, those prices are going to move.'

"The Wall Street Journal cited as a possible explanation for the impact of gold ETFs on physical gold prices the relatively small size of the gold market, estimated at $236 billion in annual sales in 2012, and the ETFs' significant share of those sales."

Starting on Page 353, the report describes JPMorganChase's acquisition of the copper market, thanks in large part to an exemption from position limits granted by the Federal Reserve and Office of the Comptroller of the Currency to banks trading copper, an exemption previously granted only to banks trading gold and silver. The implication of the copper exemption is that the U.S. government decided that manipulating gold and silver prices was not enough if the major industrial metal was still able to trade freely and broadcast inflation signals as gold and silver also would do if they were traded freely.

Senate report shows how easily banks can rig gold, copper, and other markets

The Senate report