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Is Investing Rigged? New Price-Fixing Allegations Could Destroy Market Confidence

By Dan Caplinger – Feb 28, 2014 at 12:30PM

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Most investors already don't trust global financial giants, but new allegations put another nail in the coffin of positive views of Wall Street and the companies that make markets work.

The Dow Jones Industrials (^DJI 0.45%) have posted an impressive gain of 124 points as of 12:37 p.m. EST. But what makes today's rise even more extraordinary is that they come amid revelations of yet another price-fixing scandal, this time involving the gold market. Even though investors have returned to Wall Street after the financial crisis, and even though similar allegations involving key interest rate benchmarks haven't led to a mass exodus of investors from the Dow and the rest of the financial markets, news of possible manipulation of the gold market represents yet another piece of data supporting the notion that the cards are stacked against individual investors.

What happened in the gold market
Earlier today, Bloomberg reported on a draft research paper from New York University Stern Business School professor Rosa Abrantes-Metz and Moody's Investors Service managing director Albert Metz. The paper asserts that a benchmark known as the London gold fix is structured in a way that makes collusion and manipulation possible, and the researchers found that data supported a conclusion that the prices determined under that benchmark could be artificial. The paper concludes that a strong likelihood existed that the banks involved in overseeing the rate -- Bank of Nova Scotia (BNS 0.45%), Barclays, Deutsche Bank, HSBC, and Societe Generale -- could have cooperated for years in setting the benchmark.

Image sources: Wikimedia Commons; Creative Commons/Armin Kubelbeck.

This is such big news because the London gold fix has been a key driver of prices for almost a century. A huge number of major players in the $20 trillion gold market use the benchmark price as a key element of business transactions, with jewelers, gold mining companies, and even central banks relying on the London gold fix. The possibility that the rate was artificially produced has huge implications for longtime participants in the gold market.

Why it matters for the Dow
To be clear, gold prices didn't crash today, and the metals markets appear to be taking the episode in stride. Even though the London gold fix plays a vital role in the economy, traders know well that prices can oscillate wildly in matters of minutes or hours, making a snapshot benchmark less relevant for their purposes.

But the bigger problem lies in the fact that this isn't the first episode of price-fixing that we've seen in the markets, nor is it likely to be the last. Allegations of price-fixing of the London Interbank Offered Rate, a key short-term interest rate used in trillions of dollars of financial transactions, did involve Wall Street banks. Goldman Sachs (GS 0.68%) and JPMorgan Chase (JPM 0.19%) were among more than a dozen defendants in a lawsuit filed by a regulator of U.S. credit unions last year alleging LIBOR manipulation.

Moreover, questionable episodes still leave questions unanswered about whether investors should have faith in the mechanisms that drive the financial markets. The Flash Crash in 2010 and other short-term trading anomalies, as well as the magnitude of the stock market's decline in 2008, led many to conclude that investing is a rigged game.

Price-fixing allegations might not move the markets in a single cataclysmic event. But over time, they have the more insidious result of eroding confidence in the way markets work. If such episodes continue, they could eventually lead to would-be investors simply giving up on the markets entirely.

Dan Caplinger owns warrants on JPMorgan Chase. The Motley Fool recommends Goldman Sachs and The Bank of Nova Scotia (USA). The Motley Fool owns shares of JPMorgan Chase. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$34,347.03 (0.45%) $152.97
Goldman Sachs Stock Quote
Goldman Sachs
GS
$388.86 (0.68%) $2.61
JPMorgan Chase Stock Quote
JPMorgan Chase
JPM
$136.74 (0.19%) $0.26
The Bank of Nova Scotia Stock Quote
The Bank of Nova Scotia
BNS
$53.36 (0.45%) $0.24

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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