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Price Manipulation: Look for Motive

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Regulators haven't been able to keep up with price manipulation in the commodities markets or any other market. Why do games persist? The short answer is because they can, and because they can be very profitable in the short run.

If you've Googled gold or silver, you've probably come across sites that are breathless about the possibility of manipulation of metals prices. The problem with the Internet is that it's new, too new to capture the rich history of the financial markets. Manipulation of metals prices -- and the prices of many other commodities -- is an old tradition. Here's one example adapted from An Alchemists Road: My transition from medicine to business, by Dr. Henry Jarecki (Dr. Jarecki is currently Chairman of Gresham Investment Management LLC.), October, 1989. This publication is not available on the Internet.

The Silver Arbitrageurs

In the 1960s Alan Rosenberg, a coin dealer, sold dollar bills that were silver certificates to a firm called Metals Quality. At the time, the Federal Reserve converted dollar silver certificates to a set amount of silver. Before the Fed finally discontinued the conversion, the converted silver was worth more than a dollar. The difference became great enough that it paid to buy up the certificates for slightly more than a dollar, convert the certificates to silver, and sell the silver for a profit. This is one of the rare instances of a true arbitrage.

Not everyone wanted to go through the trouble of handling the conversion, so people like Rosenberg collected certificates and sold them for more than one dollar each, but for less than the price of the silver represented by the certificate. It was worth it to Rosenberg to have someone else do the work of squeezing out the last bit of value.

That's where Metals Quality came in. It bought certificates from coin dealers and currency exchanges and handled the conversion to silver and sold the silver for a profit. Metals Quality paid Rosenberg for his silver certificates based on the first Comex price of silver for the day (less something for the trouble of the conversion and some profit). It made no difference whether the first price of the day was based on one contract or 100 contracts. Each contract represents 10,000 ounces of silver.

The Silver Foxes

Rosenberg figured out a way to make some extra money when he sold his certificates. He instructed his broker to go into the commodities trading pit first thing in the morning and bid up the price of the first silver contract each day.

Rosenberg overpaid and lost money on the contract's 10,000 ounces when he sold the contract later in the day. By then, the price fell back to the actual market manipulation-free price. But as a result of his price manipulation, Rosenberg sold say 100,000 ounces to Metals Quality for an extra 3 or 4 cents per ounce. His profits from the price manipulation on 100,000 far exceeded the loss and trouble on the 10,000 ounces for which he artificially overpaid.

Eager to make an even bigger profit margin, Rosenberg called Henry Jarecki, then owner of Federal Coin & Currency. Like Rosenberg, Jarecki collected bulk quantities of silver certificates for sale to Metals Quality. Rosenberg hoped that Jarecki would help him manipulate the first Comex price, the first silver trade on Comex in the spot month. Rosenberg figured Jarecki would help him pump up the price that Metals Quality would pay, and they could split the loss on the 10,000 ounces that had to be sold later at a lower price. Of course, that loss would be absorbed by the profits they made by getting Metals Quality to pay an above market price, and Rosenberg's loss would be only half his previous loss. His net profit would increase by the amount he reduced his initial loss.

The only flaw in Rosenberg's loss-sharing idea is that he didn't know that when he spoke to Henry Jarecki, he was speaking both to Federal Coin & Currency and to Metals Quality.

Silver Price War

Rosenberg was costing Jarecki money, because Jarecki sold his silver on the usually lower London fixing price the previous night and was buying the certificates from coin dealers like Rosenberg at the higher manipulated first Comex price.

Without explaining anything to Rosenberg, Jarecki sent a broker into the trading pits to do the opposite of Rosenberg's broker. Jarecki's broker sold the first contract very low, so he bought coin dealers' silver certificates cheaper than where he had sold silver on the London fixing price the night before.

After waging this price war for a while, the two brokers struck a bargain. On one day Rosenberg's broker would buy the silver high, and the next day Jarecki's broker would sell silver very low. After a week or so, they decided it was counterproductive and they gave it up.

Jarecki was lucky, because the costly silver price manipulation came to his attention through a serendipitous tip-off from the manipulator. When people slugged it out in the commodities pits, they often made their own justice. By the time regulators caught up with a price manipulator (if ever), it was too late to protect an aggrieved party.

Moreover, it isn't easy to prove someone is manipulating prices by taking a small loss for a potentially much bigger gain. Many feel this is just being sharp.

Absent Regulation

Anomalous price moves are a red flag, and it seems regulators aren't even looking at them. If regulators ever did decide to launch a genuine investigation, the place to start is with those who gained the most in the short run--or those who avoided the most short run loss--from the price moves.

The idea that the Commodity Futures Trading Commission (CFTC) can regulate credit derivatives when they aren't up to the task of regulating commodities is among the more ludicrous results of our financial crisis "regulation." The MF Global debacle and the price action in precious metals -- especially around options expiration dates -- show how lost our regulators are and how mistaken their overseers in Washington remain.