Tag Archives: SGE

The Gold-Backed-Oil-Yuan Futures Contract Myth

On September 1, 2017, the Nikkei Asian Review published an article titled, “China sees new world order with oil benchmark backed by gold”, written by Damon Evans. Just below the headline in the introduction it states, “China is expected shortly to launch a crude oil futures contract priced in yuan and convertible into gold in what analysts say could be a game-changer for the industry”. Not long after the Nikkei piece was released ‘the story’ was widely copied in sensational analyses throughout the gold space. However, ‘the story’, as presented by Nikkei, doesn’t make sense at all. Allow me to share my 2 cents in addition to what I shared previously on the Daily Coin.

All the rumours and analyses on gold, oil and yuan that are making rounds now in the blogosphere are based on the Nikkei article. But the Nikkei article itself contains zero official sources. Basically, the whole story has been invented by Damon Evans. So, let’s start addressing the claims made in the Nikkei piece.

It’s true that the Shanghai Futures Exchange (SHFE) – not to be confused with the Shanghai Gold Exchange (SGE) – has recently set up a subsidiary called the Shanghai International Energy Exchange (INE), for foreign enterprises to trade a new oil futures contract denominated in yuan which is expected to be launched later this year (product symbol: SC). Specifications of the contract can be read here. In all official sources, though, there is no mention of gold. Officially this contract is not “convertible into gold”.

The only vague connection I could find is that the INE “will accept foreign exchange as … trading margin”. If this includes gold – which technically is not foreign exchange – we will see. In any case, even if gold will be used as trading margin that doesn’t mean the contract is “backed by gold”.

The Nikkei headline clearly reads “China sees new world order with oil benchmark backed by gold”. In this context, the word “backed” for most readers will refer to a fixed parity. In the past, for example, there was a fixed parity between gold and the US dollar; this meant the dollar was backed by gold through the US Treasury; dollars could be redeemed for gold at a fixed price and vice versa. In case of the Nikkei story it would imply a fixed parity between yuan, or oil (this is not clear), and gold. But how would China back anything with gold? Would China’s central bank (the PBOC) defend a fixed price of gold in yuan? And it would do so through an oil futures contract? Impossible.

Quickly ‘the story’ by Nikkei transformed through the blogosphere where analysts suggested the gold in SGE vaults would back the yuan. The problem with this theory is that gold in SGE vaults, (i) isn’t owned by the Chinese government, and (ii) isn’t allowed to be exported from the Chinese domestic market (not very convenient for foreign oil producers). Then analysts suggested the gold in vaults of the Shanghai International Gold Exchange (SGEI) would do the job. But SGEI gold, (i) isn’t owned by the Chinese government either, and (ii) can only have been sourced in the international gold market, payed for with US dollars. So much for the oil-gold trade circumventing US dollars as presented by Nikkei.

Now, let’s zoom in on the logic behind the phrase “crude oil futures contract priced in yuan and convertible into gold”. Futures contracts are an agreement between two traders about the future price of i.e. a commodity (usually denominated in a currency, in the case of the INE contract yuan). There can be no third asset, commodity or currency involved in a futures contract. It cannot be that upon physical delivery of SC – when oil is exchanged for yuan – one of the two traders will say, “you know what, I don’t want yuan (or oil), I want gold”. And, needless to say, the Chinese government will not mingle in the futures trade. The PBOC will not jump in when a SC short or long demands gold. Again, the new INE oil futures contract denominated in yuan will have nothing to do with gold.

What is possible is that when a SC short delivers oil in exchange for yuan, he is then free to buy gold with the proceeds. One can do so directly on the SGEI where three physical gold products denominated in yuan are listed.

Though, be reminded, currently no oil producer is prohibited from buying gold (or something else for that matter) when paid in US dollars. That’s actually the very function of money. Money is used, since ancient times, for what is called indirect exchange. Stuff is sold for money, and with that money all other stuff can be bought. Gold can be bought with the proceeds from oil sales since … forever. An oil futures contract will not suddenly change all that. In the Nikkei piece one analysts was quoted saying:

It’s a transfer of holding their assets in black liquid to yellow metal. It’s a strategic move swapping oil for gold, rather than for U.S. Treasuries, which can be printed out of thin air.

But oil producers are free to buy gold with their moneys (yuan or dollars) with or without the new futures contract. The INE contract will not remove an obligation i.e. for Kuwait to invest in U.S. Treasuries. So, what will change when this new oil-yuan futures contract is launched?

Also bear in mind that futures are hardly ever physically delivered. Futures are used for hedging and speculation. In general, commodities are physically traded in the spot market. Oil for dollars, chocolate for Swiss francs, Dutch cheese for euros, etcetera. Futures contracts are not necessarily needed to sell oil for yuan. Nikkei wrote:

China’s move will allow exporters such as Russia and Iran to circumvent U.S. sanctions by trading in yuan.

But effectively, Venezuela, Russia and Iran can sell their oil to China in exchange for yuan as of this very moment, before the oil-yuan futures contract is live. They also could have done so three years ago. So, in my very humble opinion the new INE contract will not be the instant game changer everybody is talking about.

Perhaps also noteworthy, one commentator on the Nikkei story wrote:

China just announced that any oil-exporter that accepts yuan for oil can convert the oil to gold on the Shanghai Gold Exchange and hedge the hard currency value of the gold on the Shanghai Futures Exchange.

My comments on this paragraph:

  1. As shown above China hasn’t announced anything but an oil-yuan futures contract. Gold has nothing to do with it.
  2. Yuan can technically be spend on gold at the SGE, but gold in the Chinese domestic market (SGE system) is not allowed to be exported. Gold from the SGEI is allowed to be exported but is bought in the international market via yuan with US dollars.
  3. Foreign enterprises, like oil producers, cannot hedge gold on the Shanghai Futures Exchange. The SHFE is not open for international customers. There’s only a spot deferred product listed on the SGE, which is comparable to a futures contract, through which foreign enterprises can hedge gold in yuan. But why would oil producers buy gold and subsequently hedge the metal in yuan. Their end position would be merely exposure to the price of yuan. Why then, not buy a yuan denominated bond with an interest rate? Or hold gold without the hedge?

Prior to publication of the Nikkei article in question I got an email from Evans. He asked me if “China will tie a gold guarantee to the new oil contract?”. I replied, “No. I would be surprised if they did that”. But my quote wasn’t selected for the final publication. The piece only quoted analysts singing the same song. In my view, that’s not what sound journalism is about. First of all Evans didn’t use any official sources, and second he picked analysts that confirmed his bias.

Aside from all the inaccuracies in the Nikkei article, what stands out for me is that indeed a large number of countries is willing to trade oil in yuan and the new INE futures contract is important for this development as it allows oil producers and users to hedge directly in renminbi. And so the INE contract will support oil for yuan trading. That’s what the article should have focussed on.

Although not much has happened yet*, it’s clear Asia wants to get rid of the petrodollar, and it will be interesting to see how this initiative develops.

*Still the majority of global trade is conducted in US dollars, and most foreign exchange reserves are in dollars too. The share of yuan payments, compared to all other currencies,  tracked by payment service provider SWIFT were under 2 % in June, down slightly from two years ago. (I have no data on CIPS payments.)

Swift share of global payments

And even China has added over $107 billion in U.S. Treasuries since November 2016.

US Treasuries held by foreign central banks

If you would like to learn more about the Chinese gold market and the SGE(I), please read my recently updated Chinese Gold Market Essentials Guide

PBOC Gold Purchases: Separating Facts from Speculation

This post is part of the Chinese Gold Market essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated late 2017. 

In this post we will analyze everything there is to learn about PBOC gold purchases. Grasping the exact size of their official gold reserves is unfortunately impossible, assuming they have more than what is publicly disclosed (roughly 1,840 tonnes as of 2017), but there are many clues signalling they’ve covertly bought hundreds if not thousands of tonnes of gold since 2009.

The purpose of this post is to get an overview of all clues and data in order to separate the facts from speculation regarding PBOC purchases. Subsequently, we’ll estimate how much above ground gold is held in China mainland – official (PBOC) and private reserves.

I have been writing for a long time the PBOC does not buy any gold trough the SGE, and therefor PBOC purchases must be seen in addition to the flows of gold going through the famous bourse in Shanghai. Though, it’s necessary to expand on this subject in great detail.

We have a fairly good view on how much gold is going through the SGE and thus how much non-monetary gold is net imported into China from countries like the UK, Switzerland, Hong Kong and Australia (after which it’s not allowed to be exported and thus is accumulated in the mainland). If we add domestic mine supply to imported gold, we can estimate how much gold is held in reserves by the Chinese. But, are any of these visible gold flows bought by the PBOC? Not according to my investigation.

Why The PBOC Does Not Buy Gold Through The SGE

Below are the reasons why I think the PBOC does not buy gold through the SGE.

1) The PBOC prefers to buy gold with US dollars, while all physical gold on the SGE is quoted in yuan.

To get a better grip on this subject it helps if we understand why the PBOC would buy gold in the first place, so let’s sum up all possible incentives. The main objectives for the PBOC to accumulate physical gold are:

  • Supporting the renminbi for its internationalization (adding trust and credibility to the renminbi).
  • Owning hard currency (gold) as the cornerstone of capitalism.
  • Owning reserves (gold) that protect the Chinese economy from external/internal shocks and inflation.
  • Owning neutral reserves (gold) that are not controlled by a foreign nation (the US).
  • Diversifying its excessively large US dollar (USD) reserves.
  • Hedge their USD reserves.
  • Overthrow the USD hegemony.

After reading this list it should be clear the PBOC rather buys gold with their foreign exchange reserves than with renminbi – China’s FX reserves are worth about $3.0 trillion (2017) and mostly held in USD. The amount of gold currently on the PBOC’s balance sheet (roughly 1,800 tonnes) is disproportionate to the amount of USD held. Hence, the PBOC would prefer to exchange USD for gold. All gold on the SGE is quoted in yuan, meaning the PBOC can’t exchange USD for gold through the SGE. Therefor, the PBOC is more likely to buy gold abroad and these purchases should be added to the visible gold flows we see entering the mainland through the SGE.

2) The PBOC would prefer to buy gold in large 12.5 Kg bars, which are relativly more cheaper. 12.5 Kg bars have almost never traded over the SGE.

It should be said the SGE is a subsidiary of the PBOC. In 2002 China’s central bank erected the SGE to develop the domestic Chinese gold market; for the people to trade gold in yuan. The gold bar sizes available on the SGE are 50 gram, 100 gram, 1 Kg, 3 Kg and 12.5 Kg. Though, the volume of 12.5 Kg contracts (Au99.5 and iAu99.5) ever traded on the SGE is close to nil.

Weekly Volume 12.5 Kg Bars Traded On SGE:SGEI (counted unilaterally)

Only the 50g, 100g, 1 Kg and 3 Kg bars are traded, which are consumer sizes. This is a sign the PBOC is not buying gold through the SGE. Gold in large 12.5 Kg bars is relatively cheaper and more attractive for central banks. All central banks, that I know of, hold large bars.     

3) The PBOC would prefer to hide its gold purchases. The reason we don’t know how much Chinese official gold reserves are is because this is the best kept secret in China. The PBOC buys gold in utmost secret or it would influence the market and geo-politics. If we think from the PBOC’s point of view, why would they leave a single trace when buying gold? Why would the PBOC buy any gold through the SGE for the world to see? I think they wouldn’t.

4) The PBOC would prefer to import monetary gold which is exempt from being disclosed in customs reports. Let me explain. All bullion gold trade on this planet that is visible  (that shows up in customs reports) is classified as non-monetary. Monetary gold is exempt from being published in customs reports according to the guidelines in the International Merchandise Trade Statistics 2010 (IMTS) drafted by the United Nations. This is perfect for the PBOC to covertly ship gold to China.

The PBOC, having an incentive to exchange its superfluous USD in the international OTC market for gold, is actually obliged to monetize the gold it buys abroad. And when these purchases are transferred to China they will not be disclosed in foreign customs statistics. Subsequently, monetary gold imported into China does not go through the SGE, as only the non-monetary small gold bars go through the SGE.

All visible gold exports to China, traded over the SGE, are not PBOC purchases.

For more information on global trade rules for monetary and non-monetary gold, please read my blog post The London Bullion Market And International Gold Trade.

5) The PBOC would prefer to buy gold in an OTC market, not over an exchange like the SGE. The majority of global gold trade is done through the London Bullion Market; the most liquid market there is. This is not a central exchange like the COMEX, but an Over The Counter (OTC) market where buyers and sellers connect (electronically) one on one to trade gold without nosy analysts taking notes. The gold traded can be Loco London – located in London – or elsewhere. The London Bullion Market is ideal for the PBOC, as opposed to the SGE.

6) Another reason for the PBOC to buy abroad would be because it’s cheaper. Gold on the SGE often attracts a significant premium over London spot. Why would the PBOC pay that premium? Especially if it’s buying large quantities.

7) There is anecdotal evidence the PBOC covertly imports gold. Gold industry expert Jim Rickards has written in The Death Of Money (2014):

A senior manager of G4S, one of the world’s leading secure logistics firms, recently revealed to a gold industry executive that he had personally transported gold into China by land through central Asian mountain passes at the head of a column of People’s Liberation Army tanks and armored transport vehicles. This gold was in the form of the 400- ounce “good delivery” bars favored by central banks rather than the smaller one- kilo bars imported through regular channels and favored by retail investors.

This is very interesting. Not only because it demonstrates the PBOC prefers 400 ounce (12.5 Kg) bars over 1 Kg bars, but more so because it confirms the PBOC does not import gold through visible channels. This strengthens my analysis the PBOC does not buy any gold through the SGE. Again, all visible import (in general trade) is required to be sold through the SGE in China.

For information on how monetary gold might be imported into China by the military please read my post China’s Gold Army.

8) Early 2017 Jim Rickards was in a meeting with the three heads of precious metals trading desks of large Chinese bullion banks. These gold dealers told Rickards that indeed the PBOC does not buy any gold through the SGE. Jim stated in the Gold Chronicles podcast published January 17, 2017 (at 25:00)[brackets added by Koos Jansen]:

What I [Jim Rickards] don’t know is about the Shanghai Gold Exchange sales, they’re pretty transparent, how much of that is private and how much of that is the government [PBOC]. And I was sort of guessing 50/50, 70/30, whatever. What they told me, and these guys are the dealers [the three heads of the largest bullion banks in China], it’s 100 % private. Meaning, the government operates through completely separate channels. The government does not operate through the Shanghai Gold Exchange. … None of what’s going on on the Shanghai Gold Exchange is going to the People’s Bank Of China.

9) The SGE chairman has stated only consumers buy gold over his exchange. On the LBMA Forum in Singapore on June 25, 2014, a speech was delivered by Xu Luode, then Chairman of the Shanghai Gold Exchange. Below is a snippet from Xu:

Last year, China imported 1,540 tonnes of gold. Such imports, together with the 430 tonnes of gold we produced ourselves, means that we have, in effect, supplied approximately 2,000 tonnes of gold last year.

The 2,000 tonnes of gold were consumed by consumers in China. Of course, we all know that the Chinese ‘dama’ [middle-aged women] accounts for a significant proportion in purchasing gold. So last year, our gold exchange’s inventory reduced by nearly 2,200 tonnes, of which 200 tonnes was recycled gold.

Xu mentions the amount of gold imported into China mainland in 2013 (1,540 tonnes). Would Xu be allowed to break China’s best kept secret on an LBMA forum? Would any of these imports end up at the PBOC? I don’t think so. Moreover, Xu explicitly says all imports and mine output (and scrap supply) has been sold through the SGE system to consumers, not the PBOC.

10) SGE withdrawals are elevated when consumer buying is strong. When examining SGE gold purchases by withdrawals from SGE designated vaults, we can depict a seasonal trend of strong demand around New Year (and in April 2013 and mid 2015). The Chinese people typically buy gold in this period as gifts for each other. Does this trend look like PBOC activity? No.

Shanghai Gold Exchange SGE weekly withdrawals

11) The World Gold Council assumes the PBOC doesn’t buy gold through the SGE. From Understanding China’s gold market, July 2014:

China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. But there are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBoC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.

12) All reliable sources I have regarding the Chinese gold market tell me the PBOC does not buy gold through the SGE. One of these gentlemen, with ties to bullion banks worldwide, confirmed to me proxies of the PBOC purchase gold directly in the London OTC gold market that is shipped to Beijing with “own airplanes” (possibly by the Chinese gold army). In addition, a Chinese banker told me the PBOC buys gold “in the OTC market”, and, “PBOC proxies can deal directly with refineries in Switzerland and Africa, such as Rand and MKS“.

13) The SGE President of the Transaction Department confirmed to Na Liu from CNC Asset Management Ltd. the PBOC does not buy gold through the SGE. Na Liu wrote in a report about 2013 SGE withdrawals:

…none of the 2,200 tonnes of gold was bought by the Chinese central bank. The President said: “The PBOC does not buy gold through the SGE.”

14) The head of a global operations company in security transport leaked in 2013 that 12.5 Kg bars were covertly imported into China for the PBOCWhen I interviewed Alex Stanczyk, currently Managing Director of Physical Gold Fund SP, on 9 September 2013 he told me [brackets added by Koos Jansen]:

One of our partners had lunch in the recent past with the head of the largest global operations company in security transport. He said there is a lot of gold that they’re moving into China that’s not going through exchanges [SGE]. If the gold is for the government they don’t have to declare where it’s going. They don’t have to declare where it’s going in, or where it’s heading.

…We talked to the head of the largest refinery in Switzerland and he told us directly that all that metal that’s coming out of London (904 tons YTD) is being refined into kilo bars and send to China, as well as metal that’s coming in from other areas in the world, that’s all going to China. It’s way more than is being reported or moved through the exchanges. All the kilo bars go to the Chinese people but the PBOC is likely only buying good delivery.

With ‘good delivery’ Alex means the 12.5 Kg large bars that are not being sold through the SGE, but are imported as monetary gold into China without showing up in any country’s customs reports. The quote very clearly indicates that 12.5 Kg bars are imported into China for the PBOC without moving through the SGE. 

I shall rest here. The purpose of the listed arguments is to provide you with as much information about the Chinese gold market and PBOC purchases as possible.

In short: according to my analysis the PBOC does not buy gold through the SGE!

How Much Gold Does The PBOC Hold?

What do we know about how much the PBOC has bought? Allow me to present a few clues:

1) From a study by Zhang Bingnan, Vice President of the China Gold Association, we can read the PBOC buys approximately 500 tonnes a year (August 2012):

Forecast the optimal gold reserve capacity in the next 20 years. The conclusion is: 2020, China’s gold optimal reserves should be 5,787 tonnes – 6,750 tonnes. 2030 should be 8,995 tonnes – 10,532 tonnes.

Estimated PBOC gold reserves growth (by Zhang)

2) Yi Gang, deputy Chinese central bank governor, stated the PBOC is able to buy approximately 500 tonnes a year (March 2013):

We will always keep gold in mind as an option in reserve assets and investments. We are able to import 500-600 tons a year, or more, but we will also take into consideration a stable gold market. If the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers. We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small.

3) Song Xin, President of the China Gold Association, wrote on July 2014 the PBOC should first aim to reach the 4,000 tonnes mark [brackets added by Koos Jansen]:

That is why, in order for gold to fulfill its destined mission, we must raise our [official] gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.

4) According to Deutsche Bank Markets Research the PBOC buys 500 tonnes a year (November 2014):

In another example, the Chinese government’s open market purchases of roughly 500 tonnes per year have not prevented the gold price from plummeting in recent years.

5) Numerous Chinese analyst suggest the PBOC aims to hold 5,000 tonnes in official gold reserves. Roland Wang, World Gold Council China Managing Director, said (March 26, 2015):

China currently holds about 1.6 percent of its foreign exchange reserves in gold, which is relatively low compared with developed countries and some developing countries, WGC China managing director Roland Wang said.

“The ideal amount should be at least 5 percent of its total forex reserves,” Wang told Reuters in an interview in Hong Kong.

Remarkably, the exact same day Reuters published Wang’s statement Chinese newswire Caixin published a story on gold written by Hedge Fund manager Li Sheng (March 26, 2015):

Gold accounts for only 1.6 percent of China’s forex reserves. This is only a fraction of the figure in the United States and many other developed countries. If China ever increased the level to 5 percent, it would have an enormous impact on global demand for gold.

Li mentions the exact same numbers as Wang from the World Gold Council on the same day: 1.6 % and 5 % of total FX reserves. If China would announce they hold 5 % of total reserves in gold, this would translate into roughly 5,000 tonnes.

If the PBOC would have more than 5,000 tonnes of official gold reserves their ‘gold to GDP ratio‘ would be roughly on par with to the US, Europe and Russia. One of the theories about our current international monetary system – that was detached from gold in 1971 – is that it can shift to a new gold anchored system when all power blocks have equalized the chips (Jim Rickards). In other words, if the US, Europe, Russia and China all have an equal ratio of official gold reserves to their GDP, the international monetary system could make a transition towards gold.

Global Official Gold Reserves vs GDP (December 31, 2016)

6) Jeremy East, Managing Director Global Head, Metals Trading, Standard Chartered Bank, stated the PBOC is planning to support the renminbi with gold for internationalization (June 25, 2014):

I was at the Shanghai Derivatives Forum at the end of May and one of the speakers was a representative of the [China] Gold Association. He gave us quite an interesting insight into the flavor of what is going on in China from a strategic perspective. Some of the things he talked about included that China planned to change the landscape of world gold markets. He talked about having a strong currency and about having that currency backed by gold, like the US dollar. He also talked about people holding more gold and encouraging more people to hold gold. That is not just individuals, but also the central bank. …

(By the way, China is not planning to “back” their currency with gold in my opinion, they’re more likely to “support” their currency with gold at no fixed parity.)

7) The PBOC could have bought as much as 1,750 tonnes of gold in London in between 2011 and 2015. Although, it’s virtually impossible to track monetary gold flows around the world, as these are exempt from international merchandise trade statistics, the least we can do is try. In September 2015 Ronan Manly and Nick Laird conducted an investigation with respect to how much monetary and non-monetary gold was present in the UK. Luckily, the London Bullion Market Association (LBMA) had published a few estimates in recent years about the total amount of physical gold in London (monetary and non-monetary). In 2011, there were 9,000 tonnes in London. In 2015, there were 6,256 tonnes in London – likely all in 12.5 Kg Good Delivery (GD) bars. These estimates from the LBMA combined with Manly and Laird their investigation have resulted in the next charts (conceived by Nick Laird, Sharelynx):



For a better understanding of physical gold located in London you can read this post by Ronan, this post by Nick or have a look at the next illustration conceived by Jesse from Cafe Americain:


Remarkably, according to estimates by the LBMA the total amount of gold in London decreased by roughly 2,750 tonnes in the period from 2011 until early 2015, while UK’s customs department discloses only 1,000 tonnes were net exported as non-monetary gold during this period. Implying, 1,750 tonnes have been (covertly) exported as monetary gold.

For more information please read my post The London Float And PBOC Gold Purchases.

UK Gold Trade 2011 - June 2015

8) Dutch newspaper NRC Handelsblad published an article in 1993 about a 400 tonnes gold sale from the Dutch central bank that was partially bought by the PBOC (you can read a translation of the article here). From NRC:

“With 99 percent certainty we know that the People’s Bank of China has been one of the buyers of the Dutch gold”, said Philip Klapwijk from Goldfields Mining Services, an institute in London affiliated with the South African gold mines that specializes in research into the gold market. Also other London bullion dealers have a strong suspicion that China was involved in the gold sales of DNB. “We have noted that the Chinese central bank has bought gold in recent months”, said John Coley of the London bullion dealer Sharp Pixley and spokesman of the London Bullion Market Association.

I should add, in the nineties the PBOC was the primary (monopoly) dealer in the Chinese domestic gold market and in theory could have sold the gold to Chinese jewelry fabricators.

Facts And Speculation

Let’s chew on some numbers. In the first chart below I’ve plotted a conservative estimate of the total above ground gold reserves in China mainland in June 2017. This conservative estimate is based on the assumption the PBOC owned 1,842 tonnes in June 2015 (this is what the PBOC officially discloses), and the rest of imports and mining were added to private holdings.

Estimated Total Chinese Gold Reserves low june 2017

What about the amount of private reserves displayed in the chart? Let me explain my calculations from the starting point in 1994. Precious Metals Insights (PMI) has estimated that 2,500 tonnes of gold where held by population in the mainland in 1994, that’s the dark grey jewelry base you can see in the chart. The PBOC official reserves in 1994 accounted for 394 tonnes. In addition, Chinese domestic mining was 90 tonnes in 1994. Below is a chart showing historic Chinese domestic mining output.

Yearly Gold Mine Production China Mainland

China is said to be a gold “importer since the 1990s”, suggesting domestically mined gold was not exported after 1994. In the next screen shot from the China Gold Market Report 2010 we can read “China has been a gold importer since the 1990s”.

Screen Shot 2015-05-17 at 11.48.53 PM
Courtesy China Gold Market Report 2010

Furthermore, China began importing (non-monetary) gold a few years ago, have a look the next chart that shows historic gold trade between Hong Kong and China. Net imports ramp up in 2010. Other countries than Hong Kong, such as Switzerland, also started to visibly export to China after 2010.

Hong Kong - China gold trade historic

So, the starting point in the first chart on Estimated Total Gold Reserves in 1994 in China mainland is computed as:

2,500 (jewelry base) + 394 (official reserves) + 90 (mining) = 2,984 tonnes

Subsequently, I’ve added annually domestic mining output – as the Chinese didn’t net export any gold since 1994 – and net imports every succeeding year in the chart. I’ve subtracted all PBOC official reserves gains before 2007 from cumulative domestic mining, the gains after 2007 have I have not subtracted from cumulative domestic mining. Why? Two reasons:

  1. The Chinese domestic gold market (SGE) was fully liberalized in 2007 after which I think the PBOC stopped taking in any gold from domestic mines. (Prior to the liberalisation of the Chinese domestic gold market the PBOC was the primary dealer.)
  2. According to my calculations, from 2003 until 2009 total Chinese gold supply (scrap + mine + import from Hong Kong) wasn’t sufficient to meet total consumer demand and 454 tonnes in PBOC purchases over that period. Although the PBOC claims all purchases before 2009 were done from domestic mines and scrap, I don’t think that’s possible. Hence, I think the PBOC started invisible import somewhere in between 2003 and 2009. And therefor, anything the PBOC added to its official gold reserves after 2007 I did not subtract from cumulative domestic mining.

Lead by the aforementioned calculations, the PBOC had accumulated 1,843 tonnes and the Chinese private sector 16,193 tonnes in June 2017 2016 (in total 18,036 tonnes). This does not capture gold in the black market, that thrived before 2002, neither any assets from wealthy Chinese families. It’s the most conservative estimate I can make using all data I could find.

However, in my opinion the PBOC has bought a lot more gold in recent years. What all the clues mentioned above have in common, is that the PBOC has bought roughly 500 tonnes of gold per year since 2009. Let’s make a new more speculative chart:

Estimated Total Chinese Gold Reserves high June 2017

The above chart is a copy of the previous conservative estimate, supplemented by 500 tonnes per year since 2009 in PBOC purchases, which I have not subtracted from cumulative domestic mining or cumulative import, as my assumption is this gold has invisibly been imported and not bought through the SGE. (I stopped adding 500 tonnes per year after 2015 because evidence is lacking.)

Speculating: the PBOC has accumulated at least 4,000 tonnes and the Chinese private sector 16,193 tonnes as of late June 2017 (in total 20,193 tonnes).


Above you could read clues from Song Xin (China Gold Association, July, 2014) and Jeremy East (June 25, 2014) about China working on a ‘new monetary system’ that will include gold. Something similar was said by Zhou Ming, General Manager of the Precious Metals Department at ICBC, when Jeremy East asked him at the LBMA forum in Singapore (June, 2014) if the statement “Western gold moves East” was true:

With the status of the US dollar as the international reserve currency is shaky, a new global currency setup is being conceived. Uncertain changes will happen to gold’s traditional dollar-pricing so the US dollar’s influence on gold pricing needs to be re-evaluated.

But, of course, this could also relate to Ming bragging about renminbi internationalisation.

Why SGE Withdrawals Equal Chinese Gold Demand And Why Not – The Argument List

This post is part of the Chinese Gold Market Essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated in 2017. 

The difference between SGE withdrawals and Chinese consumer gold demand as disclosed by GFMS has aggregated to a staggering 6,032 tonnes from 2007 until 2016 (the period this article will focus on). To explain the difference, GFMS and other Western consultancy firms have presented several arguments in publications and lectures at conferences throughout the years, though none of them can really explain the difference in full. This post is an overview of all such arguments – supplemented by my own arguments.

Chinese Gold Supply & Demand sge gfms
Exhibit 1.

The reason I tend to compare SGE withdrawals to Chinese gold demand as disclosed by  GFMS, and not Metals Focus or CPM Group, is because the GFMS is globally the easiest (free) accessible data source for investors (next to the World Gold Council). Usually investors and news agencies worldwide consult GFMS (or WGC) for supply and demand statistics, which make this the most important firm to test for accurate numbers. Below we’ll examine to what degree the arguments can or cannot have caused the difference.

This is the argument list (by GFMS, WGC and CPM Group) in chronological order:

  1. Industrial demand (August 2013)
  2. Stock movement change (August 2013)
  3. Round tripping (April 2014)
  4. Leasing (April 2014)
  5. Official purchases (April 2014)
  6. Recycled distortion (November 2014, February 2015, March 2016)
  7. Export (May 2015)
  8. Chinese commercial banks’ balance sheets 
  9. Financial statement window dressing (March 2016)
  10. Retailers selling unsold inventories directly to refiners (March 2016)

These are my arguments:

  1. The Shanghai International Gold Exchange
  2. Smuggling

In 2014 the World Gold Council (WGC) came out with two special reports about the Chinese gold market that for the first time ‘should have’ shine a light on the difference (China’s Gold Market: Progress And Prospects from April 2014, and Understanding China’s Gold Market from August 2014). However, these reports contained many false statements and the segments on the difference failed miserably. As I’ve pointed out in several posts (one, two, three, four, five, six, seven, eight).

Surprisingly, after the reports were published and I had debunked the arguments in it, the WGC and GFMS swiftly came up with brand new arguments. Note this shift in arguments; when the old ones failed, the firms impudently moved on and came up with new ones. The fact the argument list is constantly changing confirms the weakness of all arguments it holds, and the apparent ‘ignorance’ of Western consultancy firms regarding the Chinese gold market. (By the way, eventually in late 2016 I found out why Western consultancy firms lie about Chinese gold demand, which is explained in my post The Great Physical Gold Supply & Demand Illusion.)

First, let’s go through all the arguments to investigate which ones make any sense. At the end of the post we’ll do some number crunching.

1) INDUSTRIAL DEMAND. The first argument ever presented to me came from the WGC. In August 2013 I’ve asked the Council what their explanation was for the difference between their Chinese gold demand numbers and demand as disclosed in the CGA Gold Yearbooks co-written by the PBOC – the latter exactly equals SGE withdrawals. They replied to me by email:

The data that we publish in Gold Demand Trends are collected for us by Thomson Reuters GFMS. Our data represent jewelry and bar & coin demand and do not incorporate any industrial demand or fabrication, which is included in the PBoC figures. As I am sure you will appreciate, data collection of this sort relies on a number of proprietary sources and these will not necessarily be the same for both GFMS and PBOC. It is, therefore, perhaps not surprising that the estimates of demand differ somewhat.

The WGC identified a gap of, at that point, 2,000 tonnes of gold with industrial demand. Not very credible. Additionally, in Q1 2015 the WGC started including industrial demand (technology) in its data, and as far as I know GFMS has always included industrial demand in its data. So, for our comparison of SGE withdrawals versus GFMS demand this argument is irrelevant.

2) STOCK MOVEMENT CHANGE. When I asked GFMS in August 2013 about net investment – which is how the difference was titled in the CGA Gold Yearbooks – they wrote me by email:

We have checked with our Data Specialist and confirmed that we use a different methodology. Total Chinese demand used by Thomson Reuters GFMS only includes jewelry, physical bullion bars/coins and all industrial demand. Any stock movement change (which is essentially the item 6 net investment) will not be included as underlying demand.


So according to you category six is “stock movement change”? This would be gold added to the stocks from jewelers, the mint, industrial companies, etc? (this is a few hundred tons each year!)


That’s correct based on the resolution provided by our data specialist.

Because SGE withdrawals capture wholesale demand the difference is partially what jewelry companies, refineries, industrial companies and the mint have purchased at the SGE, but not yet sold in retail. And so, stock movement change is a legitimate argument, though the amount of gold in stock can never explain the full difference of 6,032 tonnes.

According to an estimate by the WGC as much as 125 tonnes of gold can have been absorbed as inventory in the Chinese domestic gold market from 2009 until 2013:

… It is, however, indicative that as jewelers expanded, so too did their inventory levels and it is our judgment that across the industry between 75t to 125t may have been absorbed in the supply chain since 2009.

Stock movement change is a legitimate argument and its volume, 125 tonnes, will be taken into account for our calculation of true Chinese gold demand at the end of this post. I will stick to the number 125 because in my opinion the jewelry and coin industry in China hasn’t grown since 2013 (meaning inventory stayed flat).

3) ROUND TRIPPING. In April 2014 the WGC published a report titled China’s Gold Market: Progress and Prospects. It certainly was not the first WGC report on China – in 2010 China Gold Report was released – but it was the first time the Council elaborated on the structure of the Chinese gold market, the Shanghai Gold Exchange and the “supply surplus” in the Chinese gold market. Logically, the Council had some explaining to do, as it was clear China imported substantially more gold than what they disclosed as demand.

For the first time Chinese Commodity Financing Deals (CCFD) were introduced to the Council’s wide reader base. This type of financing is pursued to acquire cheap funds. It can be done trough round tripping or gold leasing. The Council wrote:

These operations fall into two broad categories, although there is some overlap between the two. Firstly, there is the use of gold via loans and through letters of credit (LCs) as a form of financing. Secondly, there is the use of gold for financial arbitrage operations that will also be based upon gold loans or LCs. In most cases the gold is quickly re-exported to Hong Kong, often as very crude jewellery or ornaments to get round tight controls on bullion exports. (This is the practise commonly referred to as ‘round-tripping’. Moreover, because nearly all gold flowing into China goes through the SGE, round-tripping can inflate the SGE delivery figures.) In other cases the metal is stockpiled in vaults in China or Hong Kong.  

In particular the part in bold is not true, as we could read in my previous posts Chinese Cross-Border Gold Trade Rules and The Chinese Gold Lease Market And Chinese Commodity Financing Deals Explained. Basically, round tripping gold flows are completely separated from the Chinese domestic gold market and the SGE system, therefor they can not inflate SGE withdrawals. 

So round tripping is not a legitimate argument. To my understanding the WGC has abandoned this argument all together, though GFMS still thinks round tripping inflates SGE withdrawals. In their Gold Survey 2015 it’s written (page 78):

…the round tripping flows between Hong Kong and the Chinese mainland, which also inflates the SGE turnover and withdrawal figures…

4) GOLD LEASING. The other CCFD is leasing. In the WGC report from April 2014 it’s stated:

No statistics are available on the outstanding amount of gold tied up in financial operations linked to shadow banking but Precious Metals Insights [PMI] believes it is feasible that by the end of 2013 this could have reached a cumulative 1,000t…

PMI insinuated 1,000 tonnes is tied up in CCFDs, but as I’ve clearly demonstrated in The Chinese Gold Lease Market And Chinese Commodity Financing Deals Explained, this is not true. There is no need to go over this again – if you wish please read my previous post for a detailed analysis. (Even the WGC has turned its back on this argument.)

5) OFFICIAL PURCHASES. Often it’s being thought in the gold space SGE withdrawals end up in the vaults from the People’s Bank Of China (PBOC). Early 2014 the WGC (in China’s Gold Market: Progress And Prospects) speculated the difference could be explained by official purchases, though, later that year the Council changed its mind. From the July 2014 WGC report on China, Understanding China’s Gold Market, we can read:

China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. But there are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBoC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.

In my post PBOC Gold Purchases: Separating Facts from Speculation I’ve analyzed why the PBOC does not purchase gold through the SGE. The firms (WGC and GFMS) must agree with me by now and thus official purchases cannot make up the difference we’re after.

6) RECYCLED DISTORTION. The most obvious argument to explain elevated SGE withdrawals, one would think, is recycled gold through the bourse counted over and over as withdrawn. However, SGE rules state bars withdrawn are not permitted to re-enter the vaults before being remelted and assayed by an SGE approved refinery. Which is not say it doesn’t happen.

Arguments presented by the firms regarding recycled gold must be divided in subcategories. There is process scrap, arbitrage refining, and there are VAT schemes.   

6.1) Process scrap. This argument was first presented by CPM Group. In short, CPM states industrial companies produce 50 – 70 % scrap supply of the gold used in manufacturing. The scrap spillover flows directly back to the SGE. Process scrap thus inflates SGE demand and supply, because the gold was bought at the SGE (demand), but a significant part flows back to the SGE (supply). The part that is recycled through the SGE has no impact on the price.

Although, it’s unknown how much of process scrap actually flows back to the SGE or is brought to a refinery for toll refining (a refinery producing bars or wire from the process scrap for the industrial company in return for a fee).

Process scrap, described first in detail by Jeffrey Christian in November 2014 in the chapter “CPM Group” at the very end of this post, is a form of recycled distortion, and is a legitimate argument.

6.2) Arbitrage refining. This argument was brought forward by GFMS on 17 February 2015 at the Reuters Global Gold Forum when Jan Harvey interviewed Samson Li (GFMS).

Jan Harvey:

Some people see withdrawals on the Shanghai Gold Exchange as a proxy for Chinese demand. Do you think this is valid?

Samson Li:

It depends on the methodology used. For example there are refiners that would, at times, withdraw 9995 gold bars from the SGE, refine it into 9999 bars whenever there is profitable opportunity, and then deposit it back into SGE vault……

Presumably, there can be an arbitrage opportunity at the SGE if Au99.95 gold is an X percentage cheaper than Au99.99 gold. Such a spread would be a classic example of one of the contracts being under or overvalued relative to the other.

I’m not a trader, but I can imagine a way to close the arbitrage through gold leasing. This is my theory: if a spread occurs Au99.95 is bought, concurrently Au99.99 (LAu99.99) is borrowed and immediately sold. Then the Au99.95 is withdrawn, refined into Au99.99 and returned to the lender.

If the arbitrage described above exists, inter alia depends on the speed to which a lease contract can be settled. If a spread occurs and the refiner has to wait 2 days before it can take delivery of Au9999, the arbitrage won’t fly. I’ve asked the ICBC gold lease desk what would be the fastest possibility to sign a lease contract. They told me usually it takes several days or weeks as the lessee’s credit rating must be determined. Though, for regular customers the lease ca be executed in one hour.

It’s hard for me to say if arbitrage refining is really possible according to the aforementioned theory, because it depends on many variables and the established relationship between lessor and lessee. In addition, why would anybody sell Au99.95 if it was undervalued? In my opinion the argument that arbitrage refining inflates SGE withdrawals can be doubted.

6.3) VAT schemes. This argument brought forward by GFMS in The Gold Survey 2016 is legitimate. Though, it’s unknown to what extent it has been used. Read more about the value-added tax system in China’s domestic gold market by clicking here, and read why I think the VAT scheme can only have had a limited impact on SGE withdrawals in the chapter “Tax Avoidance” in this post.

7) EXPORT. This argument was brought forward by PMI. On a conference in London (2 May 2015) Phillip Klapwijk, Managing Director of Precious Metals Insights Limited (PMI), stated China exports about 1,000 tonnes a year from the domestic gold market. However, at this stage the rules prohibit gold export from the Chinese domestic gold market. I’ve written an extensive analysis on Klapwijk’s presentation (click to read), no need to go over this again here. The export argument is not legitimate.

8) CHINESE COMMERCIAL BANK BALANCE SHEETS. Over the years, on countless gold blogs the “precious metals” (more than 2,500 tonnes by now) on Chinese commercial banks’ balance sheets have been identified as the “surplus” in the Chinese gold market. But not according to my research. After a thorough study I think the gold on the banks’ balance sheets reflect a mixture of GAP gold, retail inventory, gold held for hedging, gold outside China, but most importantly back-to-back leasing and synthetic leasing. The leasing business by banks can make it appear the banks “own” gold assets, while in fact it’s just accounting that makes it seem that way.

For a full analysis read my post What Are These Huge Tonnages In “Precious Metals” On Chinese Commercial Bank Balance Sheets?. The commercial bank balance sheets are not a legitimate argument in my very humble opinion.

9) FINANCIAL STATEMENT WINDOW DRESSING. Another argument that was presented by GFMS in their Gold Survey 2016. In short, the argument is false. If you want to know why please read the chapter “Financial Statement Window Dressing” in this post.

10) RETAILER SELLING UNSOLD INVENTORIES DIRECTLY TO REFINERS. Another argument that was presented by GFMS in their Gold Survey 2016. The argument can be true. If you want to learn more please read the chapter “Retailers Selling Unsold Inventories Directly to Refiners” in this post.

11) THE SHANGHAI INTERNATIONAL GOLD EXCHANGE. This argument was conceived by myself. As we could have read in The Workings Of The Shanghai International Gold Exchange (and SGE Withdrawals In Perspective)the gold withdrawn from the SGEI vaults in the Shanghai Free Trade Zone (SFTZ) – note, this tonnage is included in “SGE withdrawals” – can, (i) either be imported into the Chinese domestic gold market, or, (ii) exported abroad and thereby distorting Chinese wholesale gold demand when measured by SGE withdrawals. However, up until December 2015 we know SGEI withdrawals have rarely been exported abroad, according to several sources.

Another way of checking possible SGEI withdrawals that have been exported abroad is simply examining the gold imports of all countries on earth from China since 2014. As far as I can see the exports from China have been tepid. For example, 7 tonnes were exported to Thailand in 2015 and 8 tonnes to the UK in 2016, but that’s about it. Except for Chinese exports to Hong Kong: in 2016 these accounted for roughly 90 tonnes. But, most likely this gold didn’t come from the SFTZ (SGEI), but from the Shenzhen Free Trade Zone just across the border from Hong Kong where China’s jewelry manufacturing base is located. Gold export from the Shenzhen Free Trade Zone to Hong Kong has existed long before the SGEI was erected (and these flows are offset when I compute net gold flows into China from Hong Kong). How it works is that Shenzhen gold manufacturers import gold through processing trade, fabricate the materials into jewelry and ornaments after which the finished products are exported through processing trade back to Hong Kong where they are sold locally or distributed across Asia.

All in all, I’m still not seeing a lot of gold being withdrawn from SGEI vaults and exported abroad.

One last possibility that would inflate “SGE withdrawals” is when (Asian) central banks buy gold on the SGEI, after which it’s withdrawn and exported. Because central banks can monetise gold, which is exempt from being disclosed in customs data, we would never see these exports out of the SFTZ. Effectively we would only see export to China and high SGE withdrawals, while gold is withdrawn in the SFTZ and covertly exported abroad. At this point not a very plausible scenario because SGEI gold trades at a premium from gold in London, Singapore, Hong Kong, etc, but certainly possible.

12) SMUGGLING. Naturally, smuggling can cause SGE withdrawals to be inflated. Indians could buy gold in Shenzhen, withdraw from the SGE vault and smuggle it home. Although, we have no numbers on smuggling so I can’t take it into account for our calculation of true Chinese gold demand.

How Much Is True Chinese gold Demand?

The answer is we don’t know. But we can set a lower and upper bound. Remember the equations and the graph from The Mechanics Of The Chinese Domestic Gold Market

True Chinese Gold Demand = Import + Mine + Scrap Disinvestment = SGE Withdrawals – Recycled Distortion

Exhibit 2.

Unfortunately we don’t know how much disinvestment is in China, and as a consequence neither do we know recycled distortion. But we’ll set the lower bound by apparent supply and upper bound by SGE withdrawals, and work from there.

From 2007 until 2016 apparent supply in the Chinese domestic gold market – assuming all net exports from the UK, Switzerland, Australia and Hong Kong went to the domestic market and SGEI vault inventory is insignificant – was 12,183 tonnes, and total SGE withdrawals over this period accounted for 13,388 tonnes.

data china 2007 2016 gold
Exhibit 3.

So the lower bound of true Chinese gold demand over 2007-2016 was 12,183 tonnes, and the upper bound was 13,388 tonnes. Adjusting the upper bound by wholesale inventory increase (125 tonnes) makes 13,263 tonnes. Effectively, true Chinese gold demand must have been somewhere in between 12,183 tonnes and 13,263 tonnes (instead of the 7,356 tonnes GFMS has presented the world). Let’s, for the sake of simplicity, take the middle of the 12,183 and 13,263 as a number for true Chinese gold demand to work with – which is 12,723 tonnes.

The gap between GFMS demand (7,356 tonnes) and our estimate of true demand (12,723 tonnes) is a staggering 5,367 tonnes. It’s impossible to deny this immense tonnage has not been demand from high net worth individuals and institutions, purchased directly at the SGE. Although, the remaining difference between 12,723 tonnes and 13,263 tonnes could have been caused by process scrap, VAT schemes, retailers selling unsold inventory to refiners etc.

Ironically, the WGC wrote in its recent GDT Q2 2017:

Purchases made directly from the SGE continued to gain traction accounting for a significant proportion of Q2 bar demand. Investors benefit from better pricing bars from the SGE are usually 5-10 yuan per gram lower than those bought from commercial banks – and a sense of security from knowing they are buying gold from a trusted provider. With a minimum lot size of 100 gram direct withdrawals from the SGE largely serve China’s high net worth individuals.

Finally, after four years of debating (between me and the WGC/GFMS)  the WGC admits that the majority of the difference simply reflects direct purchases of high net worth individuals and institutions at the SGE. Case closed.

To this date, October 2017, I still think SGE withdrawals provide a useful indicator of Chinese wholesale gold demand.

How The West Has Been Selling Gold Into A Black Hole

Kindly be advised to have read my posts The Mechanics Of The Chinese Domestic Gold Market and The Great Physical Gold Supply & Demand Illusion before continuing.

In December 2016 Chinese wholesale gold demand, measured by withdrawals from the vaults of the Shanghai Gold Exchange (SGE), accounted for 196 tonnes, down 9 % from November. December was still a strong month for SGE withdrawals due to the fact the gold price trended lower before briefly spiking at the end of the month, and the Chinese prefer to buy gold when the price declines (see exhibit 1).

In total Chinese wholesale gold demand reached an astonishing 1,970 tonnes in 2016. But will these huge tonnages bought by China ever have an impact on the gold price? I think it will.

Exhibit 1.
Exhibit 2.

As in previous years, SGE withdrawals were mostly supplied through imports, in 2016 at approximately 1,300 tonnes. And as in previous years, SGE withdrawals were roughly twice the size of Chinese consumer gold demand. The latter is published by all “leading” consultancy firms, such as the World Gold Council and Thomson Reuters GFMS. Because these firms have systematically underreported and eclipsed Chinese gold demand since 2007, a significant share of the financial industry is unaware China has imported 5,000 tonnes in the past years, which is not allowed to be exported. My hypothesis is that this 5,000 tonnes decline in above ground gold reserves outside of the Chinese domestic market will make gold rally stronger in a future bull market than it did in previous bull markets. To the extent many investors are uninformed about the shrinking volume of troy ounces available outside of China, their ignorance will boost any price rally coming.

In this post I would like to share my thoughts on how the gold price is correlated to trade in above ground reserves, and how China has slashed these reserves to the tune of 5,000 tonnes, which will significantly impact the next leg up in gold.

Correlated: The Gold Price And UK Gold Trade

Since many decades large investors in the West set the price of gold. Ever since, the heart of the Western gold wholesale market has been London in the United Kingdom. There is thus a correlation between the gold price and the volume of gold net imported or exported by the UK.

In Asia, on the other hand, gold market participants are more price sensitive, implying they buy low and sell high (the opposite of Western investors). I’ve described this trend frequently on these pages, but the same can be read in books by gold author Timothy Green. In The Prospect For Gold from 1987 Green states:

Exhibit 3. Thank you Nick Laird from Goldchartsrus.com for the book tip!

Before we discuss the connection between Western supply and demand trends to developments in the Chinese gold market of the past decade, let me first recapitulate that global physical gold supply and demand is far in excess of the statistics the World Gold Council and GFMS publish. Below is a chart that shows the quarterly averages of all physical supply and demand categories as disclosed by the World Gold Council from Q1 2002 until Q4 2015. These numbers are more or less the same as figures by GFMS.

Exhibit 4.

We can see that over the course of 13 years, the majority of supply consisted of mine output (73%) and the majority of demand consisted of jewelry consumption (64%).

(Note, the categories official sector, net producer hedging and ETFs can be either supply or demand and volumes can greatly vary per quarter. Though, only in 1 of 52 quarters examined has ETF demand been greater than jewelry consumption (Q1 2009). In all other quarters official sector, net producer hedging and ETFs supply or demand has not been greater than mine output or jewelry consumption.)

If the data by the World Gold Council regarding physical gold supply and demand would be exhaustive, mine output and jewelry consumption should have a positive correlation to each other and the price of gold. But they don’t. Have a look at the next chart.

Exhibit 5.1.

During the bull market from 2002 until 2011 jewelry consumption decreased and it hardly ever transcended mine output. In turn, mine output gradually ascended over this time horizon while the gold price increased six fold! Are the forces between jewelry demand and mine supply driving the medium/long term price of gold? No, clearly not. This shows the data by the World Gold Council is incomplete.

(I should add that mine output does have a correlation to the gold price in the very long term as it can take more than ten years to setup a gold mining project. See the next chart.)

Exhibit 5.2.

In contrast to the data by the World Gold Council, we can observe a strong correlation between the medium/long term gold price and institutional supply and demand flowing through London. View the chart below.

Exhibit 6.

Strangely, institutional supply and demand are categories not included in the World Gold Council’s data – or in any other precious metals consultancy firm’s data that I’m aware of.

Because in the UK there are no refineries, no gold mines and local consumption demand and scrap supply is immaterial, all gold that is visibly (non-monetary) imported and exported must either relate to ETF holdings stored in London, or Western institutional supply and demand. When we compute the ratio between both, ETF flows compound to roughly 35 % of the UK’s net flow (import minus export) and as a consequence approximately 65 % is Western institutional supply and demand. Effectively the majority of the UK’s net flow is Western institutional supply and demand.

Hereby, consider that all supply and demand categories disclosed by the World Gold Council more or less equal each other (exhibit 4), so for the sake of simplicity we‘ll state that total mine output + scrap supply versus jewelry consumption + bar and coin + industrial demand meets outside the UK and doesn’t set the medium/long term price of gold.

The UK’s net flow, on the other hand, is highly correlated to the medium/long term price of gold. Note how nearly every month the change in net flow corresponds with the direction of the gold price (exhibit 6). Less granular, from the moment my data starts in 2005 the UK has been a net importer until 2012 on a rising price of gold. From 2013 until 2015 the UK was a net exporter on a declining price of gold. And in the first quarter of 2016, when the gold price saw its strongest move up since 1986, the UK was a net importer. Coincidence? I think not.

We can conclude that Western institutional supply and demand in above ground gold reserves is driving the medium/long term price of gold. As it’s likely the price of gold could not have gone up from 2002 until 2011 if there had been no UK net imports, and it’s likely the price of gold could not have gone down from 2013 until 2015 if there had been no UK net exports. (Short term the gold price is pushed around in the paper markets.)

We can think of Western institutional supply and demand (the UK net flow) like this: the majority of the gold gross imported into the UK is demand from above ground reserves outside the UK, and the majority of the gold gross exported from the UK is supply to above ground reserves outside the UK. When the UK is a net importer that means there is a net pull on above ground reserves outside the UK, which corresponds to a rising gold price. When the UK is a net exporter the inverse is true.

Here it becomes apparent that the amount of above ground bullion is essential for future price developments.

The Chinese Black Hole

Let’s turn to China. In the introduction I stated China is importing a lot more gold than is known in the financial industry because most investors base their knowledge on data by the World Gold Council. More precise, China has imported 5,000 tonnes from 2007 until 2016 in addition to what the World Gold Council has portrayed through their demand statistics.

Let’s get our minds around this through some charts. As an example, I’ve drawn a chart showing Chinese gold supply and demand for 2015 (last year I have complete data of).

Exhibit 7.

We don’t know every exact data point for China, but we do know GFMS demand (purple) and apparent supply, consisting of domestic mine output (green), scrap supply (yellow) and net import (blue). From here on we’ll use GFMS data, as GFMS publishes scrap supply numbers for China and the World Gold Council doesn’t.

According to GFMS Chinese consumer gold demand in 2015 was 867 tonnes. To meet demand GFMS presents 450 tonnes was domestically mined and scrap supply accounted for 225 tonnes. Indirectly GFMS states China net imported 192 tonnes to complete the supply and demand balance in the Chinese domestic market (exhibit 7). For the additional 1,383 tonnes imported GFMS has floated all sorts of excuses, which I‘ve debunked here and here.

The bottom line is, in addition to the 192 tonnes GFMS reports as imported in 2015 to meet consumer demand, China imported 1,383 tonnes to meet institutional demand and all this metal is not allowed to be exported.

If we repeat the same exercise for every years since 2007, the aggregated net imports by China that have not been included in the statistics by GFMS account for 5,000 tonnes. See the next chart.

Exhibit 8.


You can see now, China has enormously diminished above ground reserves outside of the Chinese domestic market without all investors around the world being fully aware. In my humble opinion this will make the price of gold go up turbo charged next time the West shows interest in the metal.

In The Prospect For Gold Green states:

Exhibit 9.

“Selling gold is not a one way street”, wrote Green in 1987. But guess what. Since a few years – from the moment China became an elephant player in the physical market – selling gold is a one way street! Western sell-offs are transhipped to China but do not return. The global gold game has changed.

Exhibit 10.

The consequence is that there are less above ground reserves outside of China for Western investors to buy in a forthcoming bull market, which will elevate the dollar bid per unit gold – in other words the gold price measured in US dollars per troy ounce.

Courtesy BBC.

Keep in mind, this phenomenon (China importing vast quantities in addition to Chinese consumer gold demand as disclosed by GFMS) has greatly materialized in 2013, when gold entered a bear market after an 11-year run up. In the previous bull market (2002-2012) above ground reserves outside of China had not been slashed yet. So the ramifications of this phenomenon will only be felt during the next leg up.

Is there any proof to substantiate my hypothesis? I think so. Early 2016 there was some renewed interest in yellow metal from large Western investors. When the price of gold started to climb it went practically vertical ending the first quarter of 2016 up 16.7 %, the strongest quarter since 1986. Coincidence? I think not. It went up strong as it did because there were fewer ounces in above ground reserves available.


A study on how much above ground reserves there are outside China will be saved for a future blog post.

NOVEMBER: Gold Price Down, Chinese Demand Strong Despite Import Curbs

From the moment Donald J. Trump got elected as the next President of the United States, on November 8, 2016, the price of gold tumbled 8 % in the remainder of the month – from $1,282 USD/oz to $1,178 USD/oz. Usually these cascades in the gold price go hand in hand with physical sell-offs in the West and strong demand Asia. It appears November has been no exception. The volume of physical gold withdrawn from vaults of the Shanghai Gold Exchange (SGE) in November accounted for 215 tonnes, the highest amount in ten months. Year to date SGE withdrawals have reached 1,774 tonnes. 

There have been rumours in the gold space about the People’s Bank Of China (the PBOC) curbing gold import into the Chinese domestic market in response to capital flight. Although my sources have confirmed these rumours, Chinese gold import in November was still very strong at an estimated 140 tonnes. I don’t expect the PBOC will halt gold import all together.

Exhibit 1. Chart by Nick Laird from Goldchartsrus.com. The international gold price in USD/oz (yellow), the SGE gold price in USD/oz (red), the SGE premium over the international price in percentages (blue, left axis) and the SGE premium over the international price in USD/oz (black, right axis).

The first mention of the rumour was by Reuters on November 25. By then the premium on physical gold trading at the SGE, which more or less reflects the strength of local demand versus international supply, had reached 2 % (from ~ 0.2 % on November 1). Reuters wrote:

“While we don’t have the exact numbers, we hear that they (Chinese government) have limited the number of importers,” said Dick Poon, general manager at Heraeus Precious Metals in Hong Kong.

In a previous blog post I stated the quote from Poon was not likely to be accurate, because there are 15 banks that have PBOC approval to import gold, but for every shipment a new License must be requested at the central bank. This protocol is referred to as “one batch one License”. Bullion cannot cross the Chinese border without a License. From the PBOC:

There shall be one Import … License of the People’s Bank of China for Gold … for each batch … and the License shall be used within 40 work days since the issuing date.

If the PBOC desires to curb gold import it can simply hand out less Licenses to approved banks, instead of deleting banks from the approved list. The former has happened as far as I can see. The next mention was by the Financial Times on November 30 [brackets added]:

Some banks with licences [approval] have recently had difficulty obtaining approval [Licenses] to import gold, they said — a move tied to China’s attempts to stop a weakening renminbi by tightening outflows of dollars, the banks added. 

Although the Financial Times exchanged the terms “approval” and “License”, this is what I thought that was happening: banks are obtaining less import Licenses from the PBOC, which is obstructing supply, pushing up the SGE premium.

Either way the PBOC effort has not severely impacted the volume of Chinese gold demand as SGE withdrawals set a ten-month record at 215 tonnes in November, up 40 % from October. Premium or no premium the Chinese still ‘accumulate on the dips’. Additionally, mainlanders buy gold in Hong Kong where jewelry is cheaper as it doesn’t enjoy VAT. From Live Trading News we read:

“Gold sellers in Hong Kong, where mainland Chinese often buy gold, report an increase in purchases, …” according to published reports. “Some of the buying is also because of the Lunar New Year period next month, a time when buying normally picks up.”

Exhibit 2. Monthly SGE withdrawals versus the SGE gold price in yuan per gram.

How much of SGE withdrawals were supplied by import? Let’s make an educated guess. In the first nine months of 2016 SGE withdrawals accounted for 1,407 tonnes and China net imported 908 tonnes over this period, implying 65 % of SGE withdrawals was imported. If we use the past months as a reference China imported 140 tonnes of gold in November (=0.65*215). Year to date (-November) China has imported and estimated 1,147 tonnes.

An other possibility would be that elevated SGE withdrawals in November were supplied by scrap and disinvestment from within China (domestic mine output is fairly constant at 38 tonnes per month). Though this is not very plausible because the renminbi gold price went down in November (red line in exhibit 1). Normally scrap supply increases on a rising gold price. And hence, I assume the majority of SGE withdrawals in November were supplied by imports.

There have been concerns in the gold community with respect to a full stop on Chinese gold import. In my humble opinion the PBOC will not completely block imports for a number of reasons:

  1. Despite the rumours of obstructed imports SGE withdrawals were strong in November.
  2. The PBOC hasn’t released an official statement to curb imports.
  3. The PBOC has just spent decades to develop the Chinese gold market in order to strengthen the Chinese economy and internationalize the renminbi. Why cancel the project for problems that can be solved differently?
  4. Curbing gold imports would improve China’s current account. But China has a current account surplusthe capital account is in deficit. Why doesn’t the Chinese government tighten the capital account? In Q3 2016 China’s capital flow was minus 71 billion US dollars. In the same quarter gold import was valued at an estimated 13 billion US dollars. The problem is in the capital account.
Exhibit 3. China current account. Courtesy Trading Economics.
Exhibit 4. China capital flows. Courtesy Trading Economics.
  1. SGE premiums started to rise on November 8 exactly when the gold price went down (which SGE premiums often do when the price goes down, exhibit 5). So are these elevated premiums of late fully caused by curbed imports, or simply strong demand? It’s probably a mix of both; in any case there is no full stop on imports. What probably happened is that imports exploded when the price tanked after November 8. As a result the PBOC decided to block shipments.

In the next chart we can see SGE premiums move inversely to the price of gold. When the price of gold goes down the Chinese ramp up purchases and SGE premiums rise.

Exhibit 5. End of Day SGE premiums versus gold price.

The PBOC has added zero ounces of gold to its monetary reserves in November. It’s total monetary gold reserves currently account for 1,843 tonnes.

Debunking GFMS’ Gold Demand Statistics

What came to light as on odd discrepancy between GFMS’ Chinese gold demand and “apparent supply” has proven to be a tenacious cover-up by the oldest consultancy firm in the gold market. And not only does GFMS publish incomplete and misleading data on Chinese gold demand, all its supply and demand data is incomplete and misleading. As a result, the vast majority of investors across the globe has been brainwashed to believe total gold supply and demand mainly consists of global mine output and jewelry demand. In reality, the supply and demand data GFMS publishes is just the tip of the iceberg. But the firm is reluctant to admit this publicly, lest their business model would be severely damaged.

GFMS has denied all allegations about their incomplete Chinese gold demand statistics by continuously making up false arguments. Therefore, BullionStar will debunk, once more, such arguments spread by GFMS – which are supposed to explain how from January 2007 until September 2016 the difference between GFMS’ Chinese gold demand and apparent supply reached over 4,500 tonnes – in order to expose true Chinese gold demand.

Exhibit 1. Chinese gold supply and demand data. Apparent supply is reflected by the center columns (mine output + import + scrap supply). Withdrawals from the vaults of the Shanghai Gold Exchange serve as a proxy for Chinese wholesale gold demand. True Chinese gold demand is somewhere in between SGE withdrawals and apparent supply.

Since 2013 I’ve witnessed GFMS shamelessly present nine arguments in their Gold Survey reports, but along the way abandoned the arguments that I had debunked on these pages. Indeed, few of all these arguments have ever proven to be valid, illustrated by the fact that GFMS perpetually keeps making up new ones. What’s left is to disparage are the final three arguments from GFMS’ most recent annual report: the Gold Survey 2016 (GS2016). Because GFMS chooses their arguments to be ever more complicated, I’ll have to be precise in my wordings not to allow any margin for interpretation errors. For detailed information regarding the mechanics of the Chinese gold market and supply & demand metrics readers can click the links provided.

Debunking Final GFMS Arguments

In the Chinese domestic gold market nearly all supply (import, mine output, scrap supply) is sold through the Shanghai Gold Exchange (SGE), and so Chinese wholesale gold demand can be measured by the amount of gold withdrawn from the SGE vaults; data published on a monthly basis. As I’ve been reporting on withdrawals from the Chinese core exchange since 2013, the debate between me and Western consultancy firms like GFMS with respect to true Chinese gold demand has centered around these infamous SGE withdrawals (exhibit 1). Per mentioned above, GFMS has put out nine arguments in recent years explaining their reader base why SGE withdrawals do not reflect gold demand. Firstly, let us have a look at the five arguments now abandoned by GFMS:

  1. Wholesale stock inventory growth (Augustus 2013) (Gold Survey 2014, page 88)
  2. Arbitrage refining (Gold Survey 2014, page 88) (Reuters Global Gold Forum 2015)
  3. Round tripping (Gold Survey 2014, page 88) (Gold Survey 2015, page 78, 82)
  4. Chinese commercial bank assets to back investment products. “The higher levels of imports, and withdrawals, are boosted by a number of factors, but notably by gold’s use as an asset class and the requirement for commercial banks to hold physical gold to support investment products.” (Gold Survey 2015, page 78).
  5. Defaulting gold enterprises send inventory directly to refiners and SGE (Gold Survey 2015 Q2, page 7)

No need to discuss these anymore, as GFMS dedicated a full chapter in the GS2016 report titled, “A Review And Explanation Of How China’s SGE’s Withdraw Numbers Are Impacted By Other Trading Activities”, in which the arguments above are not listed, implying GFMS ceased to recognize them as relevant. However, there are three new arguments listed, and one old one, that will be discussed in this post:

  1. Tax avoidance (Gold Survey 2016, page 56).
  2. Financial statement window dressing (Gold Survey 2016, page 58).
  3. Retailers selling unsold inventories directly to refiners (Gold Survey 2016, page 58)
  4. Gold leasing activities and arbitrage opportunities (in China gold is money at lower cost) (Gold Survey 2016, page 57, Gold Survey 2015, page 78)

Because gold leasing is an old argument it will only briefly be addressed here.

1. Tax Avoidance

This argument entails an illegal Value-added tax (VAT) invoice scheme. Although this scheme exists, it can not have the impact on SGE withdrawals like GFMS wants you to think.

GFMS introduces its special investigation chapter by stating:


The first and foremost factor behind why we believe the SGE’s withdrawal number differs from the country’s total gold demand is related to China’s current tax system, with some people exploiting this grey area.

… the number of industry participants mushroomed in 2014 and 2015 as other traders became aware of the potential loophole.

The GFMS team uses the terms “tax avoidance” and “loophole”. For the ones that don’t know, tax avoidance and tax evasion are two opposing practices. Tax avoidance is the legal usage of a tax regime to one’s advantage in order to reduce the amount of tax payable by means that are within the law (Wikipedia). Tax evasion is the illegal evasion of tax payable (Wikipedia). In other words, tax avoidance is legal while tax evasion is illegal. In the introduction the GFMS team pretends the tax scheme is legal, while this is anything but true. In China one can risk life imprisonment or the death penalty when caught for tax evasion:

Whoever forges or sells forged special invoices for value-added tax shall, if the number involved is especially huge, and the circumstances are especially serious so that economic order is seriously disrupted, be sentenced to life imprisonment or death and also to confiscation of property.

Then, to add to the confusion, further down the GFMS team writes, “of course, all of the activities are considered illegal by the Chinese government.” Maybe GFMS doesn’t understand the difference between tax avoidance and tax evasion, two diametrically different practices, which makes their professionalism highly questionable.

GFMS writes, “the first and foremost factor behind why we believe the SGE’s withdrawal number differs from the country’s total gold demand is related to China’s current tax system”. So we’re supposed to believe that after all these years – GFMS is operational for decades – and all that has been written on the Chinese gold market, now GFMS has finally found the “first and foremost reason” why SGE withdrawals do not reflect demand? Or did it recently stumble upon this scheme to use in its defence? I think the latter.

The understand the details of this illegal VAT invoice scheme please read my post The Value-added Tax System In China’s Domestic Gold Market, written to substantiate this blog post.

Regarding using VAT invoices for tax evasion, the GFMS team must have read this news article by the Shenzhen Municipal Office. In the news, a company called Longhaitong used SGE VAT invoices for tax evasion. How does it work? For example: the prevailing spot gold price on the SGE is 234 CNY/gramme. Company X tells a mom-and-pop jewelry fabricator that they can supply good quality cheap gold, say the SGE spot price minus 2 CNY/gramme, but without a VAT invoice. The mom-and-pop fabricator wants to buy 1 Kg so it gives 232,000 CNY to company X (the mom-and-pop shop will fabricate jewelry from the gold to be sold covertly without VAT to consumers). Company X buys 1 Kg of gold on the SGE at the spot price of 234 CNY/gramme, paying 234,000 CNY. Then company X gives the gold to the mom-and-pop fabricator but keeps the VAT invoice. Up till now, company X has incurred a loss of 2,000 CNY (bear in mind, because of China’s VAT system buyers pay the spot price at SGE which doesn’t include any VAT, but when companies withdraw the metal they receive a VAT invoice from the tax authority that describes 17 % of the all-in price is VAT, because the gold leaves a VAT exempt environment). However, company X can then sell the VAT invoice for 4,000 CNY to, in example, a brick trader. Company X effectively makes 2,000 CNY. If the brick trader alters the subject header on the invoice from “gold” into “bricks” he can tax deduct 34,000 CNY (234,000 / (1+17%) * 17%) from his VAT payable. In this scenario, the brick trader effectively makes 30,000 CNY (34,000 CNY minus the 4,000 it paid to company X). Naturally, all exemplar numbers can vary.

For sure this illegal VAT scheme exists and has been used. But, only to a limited extent – in my conclusion I will tell you the upper bound. Mind you, in the scenario I just described the gold does meet demand, albeit through an illegal scheme!

In addition, the discrepancy between the GFMS Chinese demand figures and SGE withdrawal numbers first appeared in 2008, and have exploded since 2013.

Exhibit 2. Chinese gold supply and demand data.

In the GS2016 GFMS writes:

We initially became aware of the scheme in 2013 when it first emerged, but based on information gathered from our contacts, the number of industry participants mushroomed in 2014 and 2015 as other traders became aware of the potential loophole.

The GFMS team wants readers to believe that it was the tax scheme that caused the discrepancy between GFMS Chinese demand and SGE withdrawals since 2013, but the VAT regulation regarding gold has remained unchanged since 2002. Is it believable that criminals found the possibility of these illegal practices 11 years later, exactly when Chinese demand exploded? No. If you click this link, you will see a similar incident that happened in 2010 and was reported at the end of 2011. The VAT scheme has existed for many years and crime incidents happen, but not like GFMS wants you to think.

If the GFMS team was indeed aware of the illegal practices as late as 2013 and thought that was the year when these practices first emerged, then GFMS is not properly informed in the Chinese gold market.

More from GS2016:

One of our contacts with some understanding of this activity estimated that just from Shenzhen alone, such trading activities could have possibly impacted the SGE’s withdrawal volumes by a few tonnes per day. Approximately half of the gold being sold in the black market at discounts would eventually flow back to the SGE.

In my opinion this is speculation. According to the news available, buyers in the black market are those who want the gold to fabricate jewelry that eventually is being met by true demand. In contrast, GFMS wants readers to believe half of the gold involved in the scheme flows back to the SGE. But bars withdrawn from the SGE vaults are not allowed to re-enter, only if they’re recast into new bars by SGE approved refineries (the gatekeepers of the Chinese chain of integrity). For gold involved in VAT invoice schemes to flow back to the SGE, technically SGE approved refineries would be complicit. Though the SGE conducts a campaign to crack down on such illegal tax activities.

As stated above, the VAT scheme is real, though it can not involve as much gold as GFMS wants you to believe. Unfortunately we can’t compute the exact amount recycled through the SGE through this practice, we can only identify the upper bound, which we’ll do in the conclusion.

As background information: when gold is withdrawn from SGE vaults and promptly flows back to the SGE, this overstates withdrawal numbers as it creates equal demand and supply that has no net effect on the price. Therefore, such recycle flows should not be counted in supply and demand statistics. Readers can click this post for more information.

Financial Statement Window Dressing

The GFMS team writes:

Some companies attempted to build up their revenues by merely trading and withdrawing physical gold from the SGE vault so it would appear they have a high level of business activity, while in reality there is no real genuine demand behind this.

Trading can build up revenues but why do these companies withdraw gold? That doesn’t make economic sense. If a company buys gold on the SGE and leaves the gold in the SGE vault, the gold will be recorded as “inventory” on the company’s balance sheet. If the company then withdraws the gold, the gold is still regarded as “inventory”, so what’s point of withdrawing gold? Changing the location of the gold doesn’t change the accounting nature of the gold.

It is technically possible to buy gold on the SGE, withdraw, refine it into new bars, redeposit the bars into SGE vaults and sell the bars. However, this will incur expenses. When the point is “window dressing”, why incur unnecessary expenses? More logic would be to leave the gold in the SGE system. This argument is false.

Retailers Selling Unsold Inventories Directly to Refiners

In this section, the GFMS team writes:

Retailers often prefer to sell a portion of their working stock at a discount directly to refiners in order to maintain inventories at a desirable level.

Why waste the fabrication costs of jewelry when retailers can sell the products at a discount to customers?

GFMS writes:

By selling to refiners, even if such a transaction may result in a financial loss, it still counts as revenue; but doing the latter only increases the expense category and provides no benefits to the company’s revenues or asset value.

Let’s assume an unsold jewelry stock is worth of 1,000 CNY. The retailer sells it to a refiner at 800 CNY, which results in a loss of 200 CNY. The inventory item on the retailer’s balance sheet is reduced by 1,000 CNY and the cash item increases by 800 CNY. The net result is that the total asset value of the retailer decreases by 200 CNY, then how can this practice provide benefits to the asset value?

GFMS writes:

As an example, during a field research trip earlier this year, a local refiner indicated that one jewellery retailer has sold approximately 40 tonnes of unsold jewellery pieces to them in a single two month period.

But this quote doesn’t mention what the unsold jewelry pieces become in the end. Possibly, these pieces become gold wires, which might be used by jewelry fabricators instead of becoming gold bars that flow back to the SGE. GFMS pretend the majority of gold in China is continuously recycled through the SGE, which is not true. Many refineries are note even approved by the SGE to supply gold bars.

Gold Leasing Activities And Arbitrage Opportunities

This argument is one of the oldest and most persistent. But we can be short about this; in the Chinese gold lease market nearly all trades are conducted within the SGE system. Any speculator borrowing gold for cheap funding will not withdraw his metal loan, as his incentive is to sell spot for the proceeds. GFMS fools readers by mentioning high leasing activity, but it neglects to mention leases aren’t withdrawn from the vaults. Only a jewelry fabricator would withdraw borrowed gold because he wants to fabricate products to meet demand. For more information you can read this post on the Chinese gold lease market.

Even the World Gold Council has recently stated little borrowed gold leaves the SGE system [brackets added by me]:

Over recent years we have observed a rising number of commercial banks participating in the gold leasing market. … It’s estimated that around 10% of the leased gold leaves the SGE’s vaults. The majority is for financing purposes and is sold at the SGE [and stays within the SGE vaults] for cash settlement.

This argument is false.

Furthermore, it’s noteworthy that GFMS writes:

From the perspective of the bank, lending physical gold is an off-balance sheet item,…

But as I’ve demonstrated in this and this post the majority of the “precious metals” on the Chinese bank balance sheets reflects back-to-back leasing. Meaning banks borrow gold in the SGE system to subsequently lend out at a higher lease rate. So neither do the Chinese bank balance sheets influence SGE withdrawals. What withdrawals largely reflect are direct purchases by individual and institutional investors at the SGE. True demand.


There is a very limited extent to which the VAT scheme can explain the difference between GFMS’ demand and SGE Withdrawals. I wrote previously that indeed there is certain amount of gold being withdrawn from SGE vaults, which, for various reasons, finds its way back to the SGE in newly cast bars – overstating SGE withdrawals as a proxy for wholesale demand. Unfortunately nobody knows exactly the volume flowing through the SGE that distorts withdraw data. But, we do know the upper and lower bound. The upper bound is the difference between SGE Withdrawals and apparent supply, the lower bound is zero.

Exhibit 3. Chinese gold supply and demand data. As supply and demand are always equal, to estimate demand we can measure supply.

GFMS only measures consumer demand (jewelry, retail bar and coin, and industrial demand) and not institutional demand (direct purchases at the SGE). This is not speculation this is a fact, and in China everyone can buy gold directly at the SGE so this explains the immense withdrawals. GFMS is fully aware of this but refuses to acknowledge it – because that would ruin their business model. Instead GFMS pretends that the difference between consumer demand and SGE withdrawals is all caused by gold being recycled through the central Chinese exchange. But how is this possible? If the Chinese gold market would simply be a merry-go-round fest, how come the Chinese import thousands of tonnes of gold that are not allowed to be exported? What GFMS suggests is not possible. The fact China keeps importing reveals demand. Another chart:

Exhibit 4. Chinese gold supply and demand data. Apparent supply is reflected by the center columns (mine output + import + scrap supply).

Theoretically the upper bound for the VAT scheme to have recycled gold through the SGE equals the difference between SGE withdrawals and apparent supply (the difference in exhibit 4 between the red and center columns). That’s the sole leeway we can debate about. As supply equals demand, demand cannot be lower than apparent supply. I should add, not unimportant, we know GFMS’ scrap supply data does not include disinvestment (institutional selling directly to refineries). So disinvestment must be included in the difference between SGE withdrawals and apparent supply as well. Have another look at exhibit 3. But, because we don’t know the amount of disinvestment, neither do we know the amount of distortion (VAT scheme and other recycling flows).

That’s why in exhibit 1 I’ve disclosed the aggregated difference between apparent supply and GFMS demand. There can be no mistake about this volume, it reflects true demand and it has mushroomed into +4,500 tonnes since 2007. GFSM can present many more arguments in future reports, but it won’t change the fact that true demand is at least equal to apparent supply.

To be exact, from January 2007 until September 2016 apparent supply accounted for 11,541 tonnes, and GFMS’ Chinese gold demand accounted for  6,903 tonnes. The difference, which GFMS has pursued to conceal, has aggregated to 4,638 tonnes. And according to my analysis this was not bought by the Chinese central bank.

As over the aforementioned period SGE withdrawals accounted for 12,825 tonnes, we get…

True Chinese gold demand ballpark = 11,541 – 12,825 tonnes

GFMS’ Chinese consumer gold demand = 6,903 tonnes

Let’s see how much longer GFMS can deny reality.

Exhibit 5. Chinese gold supply and demand data. Apparent supply is reflected by the center columns (mine output + import + scrap supply).

For more detailed information with respect to GFMS’ incomplete global gold supply and demand metrics view this post.

The Value-added Tax System In China’s Domestic Gold Market

This post is part of the Chinese Gold Market Essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated in 2017.

In the Gold Survey 2016 by Thomson Reuters GFMS there is a complex illegal scheme described whereby criminals obtain VAT invoices from the Shanghai Gold Exchange (SGE) for tax evasion. According to GFMS this scheme is one of the reasons why SGE withdrawals are significantly higher than “Chinese consumer gold demand”. To be able to properly clarify this scheme I will expand in this post on the workings of the VAT system in China’s Gold Market. The scheme has certainly existed for years, but not anywhere near the volume and frequency GFMS portrays.

The Current VAT system in China was adopted in 1994 as part of the economic reform and is often regarded as one of the most complex systems in the world. Here the discussion is simplified somewhat, not to get entangled in details that are not important. Be aware this article does not discuss income tax.

The General VAT System In China 

China’s VAT is chargeable on the sale of goods, provision of processing and repair services, and the importation of goods. The standard VAT tax rate is 17 %, a couple of household necessities enjoy a preferential 13 % VAT rate. When visiting any shop or supermarket in China, you will never see any VAT disclosed separately from the unit price. In China it’s common practice to show customers VAT-inclusive prices. In addition, all the prices listed on China’s Commodity Exchanges, the Shanghai Futures Exchange, Dalian Commodity Exchange, Zhenzhou Commodity Exchange and Shanghai Gold Exchange, are VAT-inclusive prices. As a result, if you see a notepad computer priced at 3,510 CNY (onshore renminbi) in China, the VAT is 510 CNY and the VAT-exclusive price is 3,000 CNY.

The “VAT-liable entities” are responsible for collecting the VAT and hand in the money to the tax authority. The VAT-liable entities in China are divided into two categories: general VAT taxpayers and small-scale VAT taxpayers. General VAT taxpayers are large firms that have annual sales large enough and the ability to maintain an accounting system sophisticated enough to accurately calculate output VAT and input VAT. Small-scale VAT taxpayers are firms that don’t satisfy these criteria. Since small-scale VAT taxpayers are not relevant to our discussion, so the focus will be put on general VAT taxpayers.

The formula for computing the VAT payable to the tax authority for a general VAT taxpayer is:

VAT payable = output VAT – input VAT

Output VAT = current period taxable sales * applicable VAT rate

Input VAT = current period costs of eligible purchases * applicable VAT rate

Here is a small example to illustrate VAT computing. Suppose company A is a laptop wholesaler that purchases laptops from Dell, and re-sells them to local retailer B. Company A buys 100 laptops from Dell at the VAT-exclusive unit price of 3,000 CNY. The total VAT-exclusive amount for the goods is 300,000 CNY and total VAT is 51,000 CNY.

VAT-exclusive amount for laptops = 3,000 * 100 = 300,000 CNY

VAT = 3,000 * 100 * 17 % = 51,000 CNY

Dell then issues a VAT invoice on which the 300,000 CNY and 51,000 CNY are recorded.

From Dell’s perspective, the 51,000 CNY is Dell’s output VAT, but from company A’s perspective the 51,000 CNY is its input VAT.

After having bought the laptops from Dell, company A then re-sells them to retailer B at the VAT-exclusive unit price of 4,000 CNY. Implying, the total VAT-exclusive amount for the laptops is 400,000 CNY and the total VAT is 68,000 CNY.

VAT-exclusive amount for laptops = 4,000 * 100 = 400,000 CNY

VAT = 4,000 * 100 * 17 % = 68,000 CNY

Company A then issues to retailer B a VAT invoice on which the 400,000 CNY and 68,000 CNY are recorded. From company A’s perspective, the 68,000 CNY is its output VAT but from retailer B’s perspective the 68,000 CNY is its input VAT.

At the end of the month, the VAT payable by company A is 17,000 CNY, which is to be paid to the tax authority.

VAT payable by company A = output VAT – input VAT = 68,000 – 51,000 = 17, 000 CNY

Company A has to keep Dell’s VAT invoice safe and demonstrate the invoice to the tax authority. If company A couldn’t produce Dell’s invoice to the tax authority, then the 51,000 CNY wouldn’t be allowed to be deducted and company A would have to pay the tax authority 68,000 CNY.


They are four kinds of receipts and invoices in China we will discuss:

  1. Special VAT invoice (SVI)
  2. Customs office special receipt for the payment of import VAT
  3. General VAT invoice
  4. Shanghai Gold Exchange invoice (SGE invoice)

1. Special VAT invoice (SVI). In order for input VAT to be used as a tax credit to offset the output VAT, the input VAT must be substantiated by a “special VAT invoice” (SVI) or “customs office special receipt for the payment of import VAT”. SVIs are issued when a general VAT taxpayer sells taxable goods and services. General VAT taxpayers must purchase blank SVIs from the tax bureau. In China, entities can’t produce any VAT invoice of their own – or it will be fake – but all transaction need to be recorded through an invoice. An SVI looks like this:

Exhibit 1. Special VAT invoice (SVI): 上海增值税专用发票 Shanghai SVI, 开票日期 Invoice issuance date, 购买方 Purchaser, 名称 Name, 纳税人识别号 Taxpayer code, 地址,电话 Address, telephone, 开户行及帐号 Bank & bank account number, 密码区 Secret code area, 货物,应税劳务及服务 Goods, taxable labour and services, 规格型号 Type, 单位 Unit, 数量 Quantity, 单价 Unit Price, 金额 Amount, 税率 VAT Rate, 税额 VAT amount, 合计 Total, 价税合计(大写)Sum of price and VAT (in traditional Chinese characters), 小写 In Arabic numbers, 销售方 Seller, 备注 Note, 收款人 Payee, 复核人 Double-checked by, 开票人 Invoice issuer.

2. Customs office special receipt for the payment of import VAT. A “customs office special receipt for the payment of import VAT” is used for imported goods. Suppose company A buys a computer from Australia at the price 10,000 CNY, assuming no tariffs. The exporter in Australia can never give company A a Chinese SVI, but the imported computer does enjoy VAT. Therefore company A must pay the Chinese Customs Office 1,700 CNY (10,000 CNY * 17 %). Upon receiving the money, the Chinese customs office will issue a “customs office special receipt for the payment of import VAT”. With this special receipt, company A can obtain the tax credit (input VAT) from the imported computer.

3. General VAT invoice. A general VAT invoice looks like this:

Exhibit 2. General VAT invoice: 上海增值税普通发票 Shanghai general VAT invoice.

A general VAT invoice looks very similar to an SVI, though a general VAT invoice cannot be used in obtaining VAT credits when calculating payable VAT. In other words, if you declare to the tax authority that you have 1,000 CNY input VAT but can only produce a general VAT invoice to substantiate your declaration, the tax authority will not recognize the invoice. General VAT invoices are issued by general VAT taxpayers strictly for accounting purposes when they make sales to consumers that will not use the purchase for input VAT. Effectively, general VAT taxpayers issue SVIs for sales to other general VAT taxpayers, and general VAT invoices for sales to consumers.

4. Shanghai Gold Exchange invoice (SGE invoice). The “Shanghai Gold Exchange invoice”, or SGE invoice, is designed by the Shanghai Gold Exchange under the supervision of the national tax authority. It’s a pity I can’t find an image of a SGE invoice.

VAT Policy For Gold In China

In China, gold is divided in several categories. There are gold, gold products and ore, and gold is subdivided in standard gold and non-standard. Gold is unwrought/unforged gold, like bars and ingots (HS code 7108120000 and 7108200000). Standard gold refers to gold bars or ingots having a fineness of 9999, 9995, 999 or 995, and a weight of 50g, 100g, 1kg, 3kg or 12.5kg. On the Shanghai Gold Exchange and the Shanghai Futures Exchange (SHFE) only standard gold can be traded. Non-standard gold includes any gold that doesn’t satisfy standard gold criteria, in example 200g ingots. Gold products mean semi-finished gold and finished products of gold, like coins, jewelry and ornaments.

When gold producers and gold traders (general VAT taxpayers and small scale VAT payers) sell non-standard gold off-SGE the VAT is exempt. Gold imported into the domestic market (non-standard and standard gold), for the ones that have an import license, is also VAT exempt.

If standard gold is not sold through the Shanghai Gold Exchange (or Shanghai Futures Exchange), a 17 % VAT tax rate will apply. If standard gold is sold through the Shanghai Gold Exchange (or the Shanghai Futures Exchange), then the VAT is exempt. But it’s the invoicing procedure that is quite complex. An example will follow to illustrate the whole process.

Exhibit 3. For gold products, the VAT rate depends on the exact gold products you sell or import, it can be different from 17 %.

Let’s tie everything together. Suppose the following trades occur. ICBC imports 1 kg of Au99.99 (SGE 1 Kg 9999 gold ingot), which is standard gold, from Switzerland at the price of 230 CNY/gramme (around 1,033 USD/oz). ICBC then sells the gold on the SGE at the price of 234 CNY/gramme. Jewelry manufacturer Laofengxiang is on the other side of the trade. Laofengxiang then withdraws the gold, makes it into gold ornaments, and sells all of them to a retailer at the VAT-exclusive price of 300 CNY/gramme. The VAT payable and receipts and invoices of different parties are as follows:


When ICBC imports the gold, it receives a “customs office special receipt for the payment of import VAT”. On this receipt the total VAT-exclusive amount for the gold is 230,000 CNY and the VAT is 0 (ICBC’s input VAT), because imported standard gold is VAT exempt. When ICBC sells the gold at the price of 234 CNY/gramme on the SGE, it needs to issue to the SGE a general VAT invoice, on which it’s recorded 234,000 CNY for the gold and 0 VAT (ICBC’s output VAT), because selling standard gold on the SGE is also exempt from VAT. Upon issuing the general VAT invoice, ICBC will receive an SGE invoice from the exchange.

ICBC VAT payable = output VAT – input VAT = 0 – 0 = 0


After ICBC and Laofengxiang have concluded the deal, the SGE will issue both ICBC and Laofengxiang an SGE invoice respectively. After Laofengxiang withdraws the gold from the vault, the tax authority will issue a SVI on behalf of the SGE, which the SGE distributes to Laofengxiang. On the SVI, the total VAT-exclusive amount for gold is 200,000 CNY and the amount of VAT is 34,000 CNY. The tax authority decides these two numbers using the following formula:

The total VAT-exclusive amount for gold on the SVI = SGE transaction price * quantity / (1+17%) * 100 % = 234 * 1,000 / (1+17%) * 100% = 200,000 CNY

The VAT amount for gold on the SVI = SGE transaction price * quantity / (1+17%) * 17 % = 234 * 1,000 /(1+17%)* 17 % = 34,000 CNY

To understand the reasoning behind this calculation, please note that after withdrawing the metal, this standard gold leaves a VAT exempt environment (the SGE system), for an environment that is not exempt from VAT, and hence VAT is born into existence. When Laofengxiang doesn’t withdraw the gold, the SGE invoice is the only invoice it will receive for accounting purposes – Laofengxiang needs some evidence for accounting entries. If it withdraws the gold, then it will receive an SVI because the standard gold withdrawn can be manufactured into new gold products and sold off-SGE. Therefore Laofengxiang will need to claim input VAT. General VAT taxpayers that withdraw will get a SVI, individuals that withdraw from the SGE will not. The input VAT noted on Laofengxiang’s SVI from the SGE is not an amount Laofengxiang paid to ICBC as VAT, but Laofengxiang is allowed to deduct this amount from its output VAT.


As mentioned, after concluding the purchase of 1kg 9999 gold on the SGE at the price of 234 CNY/gramme, Laofengxiang receives an SGE invoice and also an SVI after it withdraws the gold. The input VAT is 34,000 CNY, which is described above. Laofengxiang then fabricates and sells all the gold ornaments made from the 1kg of gold at the VAT-exclusive price of 300 CNY/gramme. Therefore the output VAT is 51,000 CNY.

Output VAT = ornaments sales price * quantity * 17 % = 300 * 1,000 * 17 % = 51,000 CNY

VAT payable = output VAT – input VAT = 51,000 – 34, 000 = 17,000 CNY

Therefore, the VAT payable for Laofengxiang is 17,000 CNY. Since Laofengxiang has the SVI from the SGE, the tax authority will accept the 34,000 CNY input VAT as a tax credit to deduct from the output VAT.

Up till now, readers will have a general idea on how the VAT system works in China’s gold market.

Q1 – Q3 2016 China Net Gold Import Hits 905 Tonnes

Withdrawals from the vaults of the Shanghai Gold Exchange, which can be used as a proxy for Chinese wholesale gold demand, reached 1,406 tonnes in the first three quarters of 2016. Supply that went through the central bourse consisted of at least 905 tonnes imported gold, roughly 335 tonnes of domestic mine output, and 166 tonnes in scrap supply and other flows recycled through the exchange.

Core Supply & Demand Data Chinese Gold Market Q1-Q3 2016

Chinese gold demand is still going strong this year, albeit less than in 2015. The most likely reason for somewhat lower demand has been the strength in the price of gold in the first three quarters of this year, to which the Chinese reacted by subduing purchases. From 1 January until 30 September 2016, the gold price went up 24 % in US dollars per troy ounce, from $1,061.5 to $1,318.1; measured in renminbi the price went up 28 % over the same period.

Now I have proven the gold on Chinese commercial bank balance sheets has little to do with physical gold ownership of these banks, but mainly reflects back-to back leases and swaps, we can be positive that data on withdrawals from the vaults of the Shanghai Gold Exchange (SGE) roughly equals Chinese wholesale demand. For now that is, as future developments can always alter our metrics.

Below is a chart showing withdrawals from the vaults of the SGE and the price of gold in yuan per gram. The most significant trends of recent years are still in effect; in the short term, when the gold price is falling Chinese demand increases (2013 and 2015), when the gold price is rising Chinese demand declines (2016). This trend is supported by SGE premiums that have an inverse correlation with the price of gold, when the price of gold declines, SGE premiums escalate and vice versa – I will show charts below. Furthermore, in the long term we can observe consistent growth in Chinese gold demand due to the opening up and development of the domestic market.

Exhibit 1. SGE withdrawals versus the gold price in yuan per gram.

SGE withdrawals in the first three quarters of 2016 accounted for 1,406 tonnes – still impressive – down 29 % from 1,986 tonnes in 2015, which was a record year. Annualized SGE withdrawals are set to hit 1,877 tonnes in 2016.

Notable, “known net import” by China is relatively strong compared to SGE withdrawals in 2016. Total net import in the first three quarters of this year has aggregated to 905 tonnes – annualized 1,206 tonnes – or 64 % of SGE withdrawals, versus an import/withdrawals ratio of 53 % in 2015. As mine supply to the SGE is fairly constant, recycled gold through the SGE must be lower this year than last year. As a rule of thumb, we use the equation:

SGE withdrawals = domestic mine output + import + recycled

For Q1-Q3 2016 that gives:

1,406 tonnes = 335 tonnes + 905 tonnes + 166 tonnes

The largest net exporter to China is still Hong Kong, having transhipped 608 tonnes to the mainland from January until September 2016, up 5 % compared to 2015. The volume Hong Kong exports to the mainland has been quite constant since 2014, while in 2013 China’s special administrative region was a substantial larger supplier.

(There have been rumors that Hong Kong ’s export to China is overstated in the official data by the Hong Kong Census & Statistics Department, caused by fake exports. In the chart below you can see that the share of exports relative to re-exports from Hong Kong to China this year has increased from previous years. Potentially this signals fake exports, as it’s easier to over invoice an export than re-export, though I haven’t found hard evidence for this scheme. When I do I will report accordingly.)

Exhibit 2. Hong Kong cross-border gold trade with China mainland. Any potential “export scheme” can have nothing to do with “round-tripping” as Hong Kong’s gross import from China is very low.
Exhibit 3. Monthly Hong Kong cross-border gold trade with China mainland. The exports/re-exports ratio has fallen since July. 

The second largest exporter to China is Switzerland, having supplied a net 229 tonnes so far this year, which is 22 % more than last year. Clearly, direct shipments from Switzerland to China have replaced shipments via Hong Kong.

Direct net exports by the UK to China mainland have collapsed by 92 % this year compared to 2015, from 210 tonnes to a mere 18 tonnes. The reason being, the UK has been the largest net importer globally this year, which is related to the strength in the gold price early this year. UK net gold trade is a proxy for Western institutional supply and demand.

Exhibit 4. Monthly UK net gold flow and GLD inventory change versus the gold price in US dollars per troy ounce. Note, the strong correlation between the price and UK net flows.

Australia’s direct export to China is down this year as well (in the first eight months, data for September has not yet been released). I’ve computed the data as described in my post Australia Customs Department Confirms BullionStar’s Analysis On Gold Export To China. Following this method, the land of down under has sent 50 tonnes of gold directly to China during the first eight months of this year, down 23 % from 65 tonnes in 2015.

Despite press releases suggesting Russian gold enterprises are strengthening ties with the SGE, I have identified only one shipment of 30 Kg by the Russian Federation directly to China in 2016. In 2013 the Russians directly net exported 50 Kg to China.

Exhibit 5. Gold export Russia to China.

Data on gold export from South Africa to China is not publicly available.  

Exhibit 6. Chinese monthly gold supply and demand data.
Exhibit 7. Chinese gold supply and demand data for Q1-Q3 2013, 2014, 2015 and 2016.

In exhibit 7 we can see that, although the level of SGE withdrawals in 2016 is lower than in 2013, 2014 and 2015, net imports are higher than in 2014. It’s very difficult to know the exact explanation for relative high imports this year. Though, in my opinion, it’s connected to increased Chinese ETF demand, which grew by 34 tonnes and is all required to be stored in SGE vaultsand less gold being recycled through the SGE.

Since 2014, when the Shanghai International Gold Exchange (SGEI) was erected, there is a possibility “SGE withdrawals” are inflated by withdrawals from vaults in the Shanghai Free Trade Zone; gold that is allowed to be exported abroad – the free trade zone is not part of the domestic market. But as far as I know any activity on the SGEI lacks foreign enterprises that buy gold to withdraw and export. A couple of months ago a source at a large Chinese bank told me the SGEI is mainly used by Chinese banks to import gold into Chinese domestic market. In addition, I haven’t bumped into any large importers from China. Occasionally India imports a few hundred Kg, but that’s it.

The emblematic difference between “Chinese gold demand as disclosed by GFMS” and SGE withdrawals – displayed in exhibit 7 – is due to GFMS’ incomplete metrics. For decades this consultancy firm has been denying the existence of institutional supply and demand in above ground gold, which is far more important to price formation than retail sales and mine supply, the predominant flows published by GFMS. The essence of this swindle can be read in my blog post The Great Physical Gold Supply & Demand Illusion. I also have a few more blog posts in the pipeline that discuss GFMS’ most recent gold supply and demand data.

All supply and demand data presented above excludes purchases by the People’s Bank of China, which sources physical gold in the international OTC market. 

SGE Premiums November Highest Since 2013

I expect November to be a very strong month for SGE withdrawals. Mentioned in the introduction segment of this post, there is a trend in Chinese wholesale gold demand in relation to the gold price. Whenever, the gold price is climbing, Chinese demand is subdued, accompanied by low SGE premiums; when the gold price is decreasing, SGE withdrawals and premiums in China shoot up. The relationship between the gold price and SGE withdrawals can be viewed in exhibit 1. Below in exhibit 8 & 9, readers can see the relationship between “SGE end of day prices and premiums”.

Exhibit 8. SGE end of day prices and premiums.
Exhibit 9. SGE end of day prices and premiums, including moving averages which make the inverse correlation more visible.

Note, the gold price on the SGE and the premium have an inverse correlation.

I already mentioned that SGE withdrawals in the first nine months of 2016 have been subdued due to a rally in the gold price. However, high premiums at the SGE in November forecast elevated withdrawals for the month. Since Trump got elected on November 9, and price of gold started tumbling, SGE premiums have broken a three-year record. This signals strong demand.

In the next chart from Goldchartsrus.com we can see the premium on the SGE’s most traded physical contract Au99.99 has risen since November 9 and reached 3 % by 24 November. Levels not seen since 2013 (exhibit 8).

Exhibit 10. Intraday SGE premium (Au99.99 versus XAUUSD)

Although the relationship between the gold price and SGE premiums has been in place for years, Reuters reports the high premiums in November are caused by worries on import restrictions. From Reuters:

Gold premiums in top consumer China jumped to the highest in nearly three years this week on worries over a supply shortage that traders said were due to Beijing’s efforts to restrict import licenses.

“While we don’t have the exact numbers, we hear that they (Chinese government) have limited the number of importers,” said Dick Poon, general manager at Heraeus Precious Metals in Hong Kong.

To me this statement doesn’t make sense. At this moment that are 15 banks approved by the PBOC to import gold. Limiting the number of importers would cause less importers to import more gold in order to balance the domestic market (supply gold from abroad when necessary). In the Measures for the Import and Export of Gold and Gold Products drafted by the PBOC in March 2015 it states:

… An applicant for the import … of gold … shall have corporate status, … it is a financial institution member or a market maker on a gold exchange [SGE] approved by the State Council.

… The main market players with the qualifications for the import … of gold shall assume the liability of balancing the supply and demand of material objects on the domestic gold market. Gold to be imported … shall be registered at a spot gold exchange [SGE] approved by the State Council where the first trade shall be completed.

The Chinese government could lower imports by distributing less “import licences” to approved banks. As, every approved bank still needs to submit for a license for every gold import batch. Logically, lowering imports would be done by the PBOC through handing out less licences.

From the PBOC:

There shall be one Import … License of the People’s Bank of China for … Gold Products for each batch … and the License shall be used within 40 work days since the issuing date.

If the PBOC wanted to lower imports, it would simply hand out less licences. No need to “limit the number of importers”.

Either way, I expect SGE withdrawals to be strong for November.

Synthetic Gold Leasing: More Details Regarding The “Precious Metals” On Chinese Commercial Bank Balance Sheets.

More proof the “precious metals assets” on Chinese commercial bank balance sheets have little to do with the “surplus” gold in China’s domestic market.

The “surplus” in the Chinese gold market is the difference between withdrawals from the Shanghai Gold Exchange vaults and gold demand as measured by consultancy firms like the World Gold Council and Thomson Reuters GFMS. The “surplus” accounts for over 4,000 tonnes. In reality the “surplus” is true gold demand by Chinese individuals and institutional investors directly at the SGE. Some analysts think the huge tonnages in “precious metals assets” on the balance sheets of Chinese commercial banks have anything to do with the “surplus”, but this is not true. And I prefer to explain in detail. 


One of the topics about the Chinese gold market that has not been fully illuminated is the “gold” on the 16 Chinese commercial banks’ balance sheets. At the end of 2015 the aggregated “precious metals assets” on the bank balance sheets accounted for 598 billion yuan (RMB), which translates into approximately 2,682 tonnes of gold – if all the precious metals were gold related, which is very likely.

In my previous post on this subject we learned from examining the banks’ annual reports from 2015, that there are at least five gold assets that can appear in the “precious metals” line item on the balance sheets. Namely:

  1. Gold savings that belong to the banks’ customers (Gold Accumulation Plans, GAP)
  2. Gold inventory for the banks’ retail gold bar business
  3. Gold leasing business
  4. Gold held for hedging purposes
  5. Gold held outside China

In this post we’ll examine more thoroughly the (Chinese and English) annual reports from 2007 until 2014 of the 16 banks, to learn more on what these huge tonnages represent. The most significant new finding is that Chinese banks conduct synthetic leases – in other words: swapsBy performing synthetic leases,  Chinese banks can show “precious metals assets” but no “precious metals liabilities” on their balance sheets. Then, at the very surface it seems these banks own gold, in reality they own zero gold. 

Exhibit 0. Precious Metals Assets Chinese Banks.

Also note, swaps can be executed with foreign banks, through which gold is subsequently imported into the domestic market. And because the Chinese banks have been importing thousands of tonnes in recent years, it should come as no surprise these trades have influenced the “precious metals” line item on their balance sheets.

More findings that will be addressed in this post are:    

  1. Chinese reported lease volume reflects yearly turnover.
  2. Gold stored in Shanghai Gold Exchange (SGE) designated vaults owned by commercial banks does not to appear on the custodial bank’s balance sheet.
  3. More confirmation some gold on the balance sheets is stored outside China.

My conclusion is that the “precious metals” on the Chinese commercial bank balance sheets do not account for the “surplus” gold in the Chinese domestic market Western consultancy firms pretend to be ignorant about. The Chinese banks do not own much gold of themselves, as some analysts have speculated, nor are these banks preparing for a new gold standard designed by the PBOC, according to my sources and analysis.

This post is divided in three segments. The first segment is about accounting, which supports the second segment about swaps and other gold related line items on the Chinese bank balance sheets. The first segment can be skipped if you already posses thorough knowledge on accounting. The third segment displays all the “precious metals” related data of the 16 bank balance sheets from 2007 until 2015.

I Accounting Background

Before we can discuss the details of the “precious metals” mentioned in the financial statements of the annual reports of the 16 banks, we need to do some studying on accounting structures (study the definitions of a financial statement, balance sheet, an income statement, assets/liabilities, financial assets/liabilities and derivative financial assets/liabilities). This study will prove valuable for future posts as well. The bank balance sheets are an important topic in the Chinese gold market; understanding accounting helps us to illuminate the Chinese gold market.

Financial Statement

Financial statements of banks are divided in three main segments: a balance sheetan income statement and a cash flow statement.

Balance Sheet

On Investopedia we can read the definition of a balance sheet:

Balance Sheet

A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders.

The balance sheet adheres to the following formula:

Assets = Liabilities + Shareholders’ Equity

A number of ratios can be derived from the balance sheet, helping investors get a sense of how healthy a company is. These include the debt-to-equity ratio and the acid-test ratio, along with many others. The income statement and statement of cash flows also provide valuable context for assessing a company’s finances, as do any notes or addenda in an earnings report that might refer back to the balance sheet.

An example would be, ICBC holding 1 tonne of gold in small ICBC brand bars as inventory for retail sales. This gold is an asset of ICBC.

Income Statement

Next to a balance sheet, banks disclose an income statement in their annual reports. From Investopedia we read:

Income Statement

An income statement is a financial statement that reports a company’s financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses …. It also shows the net profit or loss incurred over a specific accounting period.

Unlike the balance sheet, which covers one moment in time, the income statement provides performance information about a time period.

In example, ICBC buys gold at the SGE worth 1,000,000 RMB and has the metal recast in small 200 gram ICBC brand bars. If ICBC subsequently sells the newly casted bars for in total 1,100,000 RMB, then 100,000 RMB is profit and will be included in the income statement.

Cash Flow Statement

Next are the cash flows, from Investopedia:

Cash flow is the net amount of cash … moving into and out of a business.

Total aggregated cash flows are measured over the course of a period, for example one year, as with the income statement. But unlike the income statement, it records all things related to cash flows. For example, if ICBC buys a new building worth 10,000,000 RMB, this will affect the balance sheet (cash decrease, asset increase) and the cash flow statement, but not the income statement.

An Asset

From China’s Accounting Standard for Business Enterprises: Basic Standard we can read how an asset is defined:

Article 20 An asset is a resource that is owned or controlled by an enterprise as a result of past transactions or events and is expected to generate economic benefits to the enterprise.

“Past transactions or events” mentioned in preceding paragraph include acquisition, production, construction or other transactions or events. Transactions or events expected to occur in the future do not give rise to assets.

“Owned or controlled by an enterprise” is the right to enjoy the ownership of a particular resource or, although the enterprise may not have the ownership of a particular resource, it can control the resource.

“Expected to generate economic benefits to the enterprise” is the potential to bring inflows of cash and cash equivalents, directly or indirectly, to the enterprise.

Article 21 A resource that satisfies the definition of an asset set out in Article 20 in this standard shall be recognized as an asset when both of the following conditions are met:

(a) it is probable that the economic benefits associated with that resource will flow to the enterprise;


(b) the cost or value of that resource can be measured reliably.

Article 22 An item that satisfies the definition and recognition criteria of an asset shall be included in the balance sheet. An item that satisfies the definition of an asset but fails to meet the recognition criteria shall not be included in the balance sheet.

Financial assets/liabilities

Financial assets/liabilities can be subdivided in several categories, such as financial assets/liabilities designated at fair value through profit and loss, financial assets/liabilities held for trading and derivative financial assets/liabilities. Financial assets/liabilities are included on the balance sheet and the change in fair value of most financial asset/liabilities will appear in the income statement. Not all banks subdivide financial assets/liabilities in the same manner. For example, ICBC lists “financial assets/liabilities held for trading” parallel to “financial assets/liabilities designated at fair value through profit and loss”. Other banks only disclose “financial assets/liabilities designated at fair value through profit and loss” as a total. The details on accounting are beyond the scope of this post.

Let’s have a look at an example of a financial liability. We’ll use plain gold leasing. Suppose ICBC borrows 1 Kg of gold for 1 year and instantly sells the gold at 280 RMB/gram. ICBC will then record a cash asset of 280,000 RMB and a financial liability held for trading of 280,000 RMB on its balance sheet. Say, after one month the gold price surges to 380 RMB/gram. For ICBC the cash asset remains at 280,000 RMB, but the bank will increase the carrying amount of the financial liability held for trading to 380,000 RMB. The 100,000 RMB, which is a loss, will go into the income statement. In the income statement there is a separate line for this called net profit or loss on financial assets or liabilities designated at fair value through profit and loss.

Below is part of the income statement from ICBC’s 2015 annual report.

Exhibit 1. Courtesy ICBC. “Consolidated Statement of Profit or Loss” is the income statement. In accounting amounts in between brackets are negative.

Derivative financial assets/liabilities

Derivative financial assets/liabilities on balance sheets must not be commingled with derivative instruments such as futures or forwards, of which the notional values are recorded off-balance sheet. Let me show how derivative financial assets/liabilities are acquired.

We’ll use futures as an example. Suppose ICBC buys long a SHFE gold futures (1,000 grams) contract at 280 RMB/gram on 1 November 2016 that is to expire in June 2017. The futures contract itself (derivative instrument) is recorded off-balance sheet, but the profit or loss arising from it creates a “derivative financial asset/liability” recorded on the balance sheet and the income statement. At 1 November 2016 the fair value of the futures contract is 0 because the future price has not moved yet so there is no profit or loss. The notional value of the futures contract is 280,000 RMB (1,000*280). On 1 November 2016 ICBC’s financial statement would be:

  • ICBC’s derivative financial asset/liability held for trading on the balance sheet = 0
  • Fair value ICBC’s derivative financial asset/liability held for trading recorded in the income statement’s “net profit or loss on financial assets or liabilities designated at fair value through profit and loss” = 0 RMB
  • Notional value of ICBC’s derivative financial instrument recorded off-balance sheet = 280,000 RMB

Suppose one month later, on 1 December 2016, the gold price has surged to 380 RMB/gram. ICBC is long gold so it will have a mark-to-market profit of 100,000 RMB. This profit will go into the income statement in “net profit or loss on financial assets or liabilities designated at fair value through profit and loss”. At the same time ICBC has created a derivative financial asset held for trading worth 100,000 RMB. (If gold would sink below 280 RMB/gram, ICBC would record a derivative financial liability held for trading.) On 1 December 2016 ICBC’s financial statement would be:

  • Derivative financial asset held for trading on the balance sheet = 100,000 RMB
  • Fair value ICBC’s derivative financial assets held for trading recorded in the income statement’s “net profit or loss on financial assets or liabilities designated at fair value through profit and loss” = 100,000 RMB
  • Notional value of ICBC’s derivative financial instrument recorded off-balance sheet = 380,000 RMB

Below you can view a balance sheet and an off-balance sheet account from ICBC’s 2015 annual report.

Exhibit 2. Courtesy ICBC. Balance sheet from ICBC’s 2015 annual report.
Exhibit 3. Courtesy ICBC. Off-balance sheet account from ICBC’s 2015 annual report. 

Having said this, the practice of categorizing precious metals assets and liabilities varies from bank to bank in China. Nevertheless, there are excellent observations to make from the financial statements of the banks. This will be quite complex, if I didn’t explain it properly, please refer to the introduction of this post that serves as a simplified summary.

II Findings

Banks Do Synthetic Back-To-Back Gold Leasing Through Swaps

From the previous post, we know that gold leasing – mainly back-to-back borrowing and lending – overstates the precious metals assets and liabilities of Chinese banks. However, what was not mentioned in the previous post was that banks do synthetic back-to-back leasing through swaps. This way, it’s possible that banks that are active in the gold lending market, will show precious metals assets on their balance sheet – without precious metals liabilities, while not owning a single gram of metal themselves. The bank will synthetically borrow gold through a swap, and lend it out for a few extra basis points. The result is synthetic back-to-back leasing.    

From a Chinese bank’s perspective a synthetic gold lease is conducted by borrowing RMB to buy spot gold, lend that metal to a customer, and at the same time sell short a forward contract. When the gold loan to the customer comes due the metal is returned to the bank, which then will be sold through the forward contract to repay the bank’s RMB loan. That’s the definition of a swap: buy spot and sell forward (sell spot and buy forward for the counterparty).

If gold is in contango, and the forward price is higher than spot, the Chinese bank will make a profit on the swap. However, in contango, the costs for the RMB loan transcend the swap profit. The difference between both is the cost equal to the gold lease rate (GLR). In my previous post Understanding GOFO And The Gold Wholesale Market we could read about these relationships (and the exact workings of swaps).

Fiat interest rate – swap rate = GLR

Effectively, by borrowing RMB for a swap the bank pays GLR to synthetically borrow gold.

As the international gold lease rate is likely lower than the gold lease rate in China, Chinese banks can make a profit by (synthetically) borrowing gold abroad, import the metal and lend it through the SGE system at a higher GLR. (Whenever a gold loan is to be repaid from the Chinese domestic gold market to an international lender, not the physical metal is exported, but funds cross the Chinese border, as physical gold export is prohibited from the Chinese domestic gold market.)

For example, Minsheng Bank can synthetically borrow gold for 3 months from HSBC at GLR in the interbank market. When Minsheng lends the gold for 3 months to a jeweler at GLR + 30 BPs, then Minsheng earns 30 BPs in this trade.

Exhibit 4. All precious metals related data from Minsheng Bank’s financial statements 2007 – 2015. We can observe a significant surge in precious metals assets, lease volume and precious metals derivatives in 2014.

In the real world, this is exactly what banks have been doing. Let’s still use Minsheng Bank as an example. Please view the table above. We can see Minsheng’s gold lease volume jumped from 13 tonnes in 2013 to 101 tonnes in 2014, and the precious metals assets surged from 2,913 million RMB in 2013 (~12 tonnes) to 25,639 million RMB in 2014 (~107 tonnes). The surge in precious metals assets was fully caused by the increment in the gold lease business, as can be seen in the excerpt below from Minsheng Bank’s 2014 annual report. All the numbers are in millions of RMB.

Exhibit 5. Courtesy Minsheng Bank. 

It’s disclosed the precious metals assets jumped from 2,913 million RMB in 2013 to 25,639 million RMB in 2014, due to a 22,726 million “increase in precious metals lease business”. 

But note we can only see an increase in “precious metals assets” on Minsheng’s balance sheet (exhibit 4), there are no “precious metals liabilities”. This is because the gold lend by Minsheng was sourced through swaps. Minsheng didn’t literally borrow gold (precious metals liability), it swapped gold for RMB collateral.

This is how it works in Minsheng’s case. When it enters a swap transaction these are the spot and the forward legs to be recorded in the financial statement. Minsheng borrows RMB and buys spot gold to lend out to a customer at GLR plus a few basis points. At that moment a precious metals asset (the gold loan) is recorded on the balance sheet, but not a precious metals liability (the related RMB liability is not disclosed in exhibit 4). Simultaneously, Minsheng sells short a forward contract that is recorded off-balance sheet. In due time the gold loan is repaid, the forward settled, etc.

The off-balance activities are shown in exhibit 4, additionally they’re disclosed in Minsheng’s financial statement to be viewed below. Again all numbers are in millions of RMB.

Exhibit 6. Courtesy Minsheng Bank.

We can see that the large increase in precious metals derivatives trading from 2013 to 2014 was mainly caused by “3 months to 1 year” “forwards and swaps”, of which most have been swaps used for synthetic back-to-back leasing.

Also note:

  • Exhibit 5 shows there was a 22,726 million RMB (~ 94 tonnes) increase in leases from 2013 to 2014. Exhibit 6 shows ~ 24 billion RMB (~ 100 tonnes) in “3 months to 1 year” swaps have been executed in 2014, over zero in 2013. Likely, the majority of the swaps have been in tenors close to 1 year, as by 31 December 2014 roughly 107 tonnes in precious metals assets were on the balance sheet.
  • In 2014 the “3 months to 1 year” “cash inflow” (Minsheng’s sell forward leg) transcended the “cash outflow” (buy spot leg) because gold was in contango that year in China. (Exhibit 6)
  • Perhaps you have noticed that Minsheng Bank counts only 1 leg of the gold swap off-balance sheet. Yes, if we compare the total “precious metals forwards and swaps” “cash outflow” 32,865 million RMB with the total notional amount in precious metals derivatives off-balance sheet, 32,844 million RMB, the two numbers are roughly equal.

All in all, at the surface it seems Minsheng Bank holds approximately 100 tonnes in precious metals assets, in reality this is merely reflecting synthetic back-to-back leasing through swaps. More proof there can be little “surplus” gold on the commercial banks balance sheets. 

As long as Chinese annual lease volume grows, the commercial bank balance sheets can mushroom as a consequence.

Estimated Chinese Gold Leasing Turnover
Exhibit 7. 

Chinese Lease Volume Reflects Yearly Turnover. 

In the past there has been some doubt whether the reported Chinese gold lease volume reflected the total turnover over a certain period, or the gold that has been leased out at a certain point in time. Already in May 2015 I wrote China’s reported gold lease volume reflects turnover – because traders at Chinese banks told me – and now there is more confirmation to be presented. From Minsheng Bank’s financial statements we can understand that the gold lease volume means the lease turnover per annum. Have another look at exhibit 4.

Minsheng bank leased out 116 tonnes of gold in 2015, which was an increase from 2014. But at the end of 2015, the “precious metals assets” wherein gold leasing is recorded, decreased to 83 tonnes. This can only be possible if the lease volume is annual turnover. Apparently, in 2015 Minsheng’s leasing business grew, but it conducted more deals in tenors shorter than 1 year, causing the annual turnover to increase (to 116 tonnes) but the outstanding leases at year-end on the balance sheet to decline from the previous year.  

The World Gold Council (WGC) seems the have come to the same conclusion recently. In the Gold Demand Trends Q2 2016 report, it stated (page 15) the gold lease volume “captures the total amount of gold leased in the reporting period, for example, if Commercial Bank A lends 1t to Jeweller B for three months and Jeweller B returns it back for the Commercial Bank A to lend again to Bank C, a total of 2t of leasing volume will be recorded for the period”. This confession by the WGC is remarkable, because from April 2014 until early 2016 the WGC was spreading a myth about the gold involved in the Chinese lease market. From the WGC’s China’s Gold Market Progress And Prospects, April 2014:

No statistics are available on the outstanding amount of gold tied up in financial operations [leases] linked to shadow banking but Precious Metals Insights believes it is feasible that by the end of 2013 this could have reached a cumulative 1,000t.

For several years the WGC pretended any lend/borrowed gold was “tied up in illegal leasing schemes”, and if the leases would be unwound this event would flush the physical market dragging down the price. Although this was nonsense, copy-paste media outlets like Reuters and the Financial Times simply reproduced what the WGC was writing, adding to the confusion in the gold community. (By the way, the consfusion simply appeared to be a pack of lies invented by Western consultancy firms that were trying to uphold the illusion the supply and demand data they had been selling for decades was complete.)

While at it, the WGC admitted most of the leased gold doesn’t leave the SGE vaults:

It’s estimated that around 10 % of the leased gold leaves the SGE’s vaults. The majority is for financing purposes and is sold at the SGE for cash settlement.    

This is what I’ve written since February 2015: gold leasing has little impact on SGE withdrawals, as the vast majority of leases are for financing purposes and are thus settled within the SGE system.

Gold In SGE Vaults Is Not On The Custodian’s Balance Sheets

In China, most of the SGE vaults are actually owned by commercial banks but approved by the SGE as “designated vaults”. In addition there are other types of enterprises that own “SGE designated vaults” – probably jewelry companies in Shenzhen, the heart of China’s jewelry manufacturing industry. In my previous post I shared the possibility that SGE vaulted gold appears on the balance sheets of custodian commercial banks. But further research has pointed out that is not the case. SGE vaulted gold does not appear on the balance sheet of the custodians, only on the balance sheet of the owner.

As has been written at the beginning of this post, in order for a custodian, in this example ICBC, to recognise the gold owned by another entity, in this example BOC, in its SGE-designated vault as an asset, the gold has to be “owned or controlled” by ICBC. In reality ICBC wouldn’t have any ownership of this gold. ICBC would have, to a certain extent, some control over BOC’s gold, but in order for ICBC to recognise the gold as an asset on its balance sheet, it should be “probable that the economic benefits associated with that resource will flow to the enterprise”. In other words, ICBC should be able to sell or lease out BOC’s gold in its vaults to record the metal as asset. Though, an SGE custodian would never go there or its business would collapse promptly.

Exhibit 8. Balance sheet of Ping’ An Bank.

There is more confirmation. On the balance sheet of Ping’ An Bank, the volume of precious metals holdings for 2011 and 2010 were both nil. At the same time, according to Ping’ An’s annual report of 2010, its total gold withdrawals ranked No. 8 among all SGE designated vaults. 


Gold vaulting service keeps increasing and the withdrawal number is listed the eighth among SGE designated vaults.

And in 2011 Ping’ An’s gold deposit and withdrawal total accounted for 10% of all SGE warehouse activity. It is hard to believe that Ping’ An had no gold in its SGE-designated vaults at the end of 2010 and 2011, while Ping’ An’s vaults were such an important part of the SGE system. Concluding, Ping’ An didn’t recognize other SGE clients’ or members’ gold in its vaults as its assets. Hence we have for 0 for Ping’ An’s precious assets in 2010 and 2011.

Some readers may point out the following paragraph in ICBC’s 2015 annual report:

The Group records the precious metals received as an asset. A liability to return the amount of precious metals deposited is also recognised.

However, if readers check ICBC’s 2015 annual report in Chinese, they will find the original paragraph was written like this:


The group recognises an asset when the group receives the precious metals deposited by the customer for accumulation, and at the same time recognises the related liability.

Therefore, ICBC was actually referring to the gold in its Gold Accumulation Plan (GAP) and the key information was lost in translation.

Gold in Chinese ETFs is neither recognized by its custodian as an asset. 

Some Of Chinese Banks’ Gold Is Indeed Outside China

I mentioned in the previous post that some of Chinese banks’ precious metals holdings could be outside China. ICBC acquired Standard Bank in 2015 and Standard Bank’s precious metals are outside China. However, even some medium-sized Chinese banks hold precious metals outside China. The following table is from Ping’ An’s 2014 annual report (page 196, numbers are in millions of RMB).

Exhibit 8. Screen shot of Ping’ An Bank’s annual report 2014.

What we see is that Ping’ An held gold assets in US dollars worth 2,420 million RMB. The disclosed “foreign exchange equivalent” for Ping’ An’s precious metals would only be mentioned like this if the precious metals are held outside China. If the precious metals would have been located inside China, Ping’ An never would have listed the value of the assets as “USD (in CNY equivalent)”.

III Data

We will not extensively analyze every Chinese bank’s financial statement like we’ve done with Minsheng Bank and Ping’ An Bank above, though I do like to share all the data I’ve collected. The practice of categorizing precious metals assets and liabilities varies from bank to bank so readers should pay attention to the notes below the tables and are recommended to read the original annual reports for more information. The derivative instruments are listed according to the notional amount (off balance sheet) instead of the fair value. The notional amount is not comparable between banks because for swaps, some banks only consider one leg while others add both the spot and forward legs, for example Bank of Ningbo, together.

Assuming all precious metals mentioned are gold related.

1. Industrial and Commercial Bank of China (ICBC)


We can observe ICBC precious metals assets started to transcend its financial liabilities related to gold in 2014. The possible causes are increases in ICBC brand gold bar sales (more inventory), customers purchased more options (ICBC would need to buy more gold to hedge), and more synthetic gold leasing.

2. Bank of China (BOC)


“Commodity derivatives and others” were called “precious metals derivatives and other derivatives” before 2010. BOC doesn’t have any significant numbers related to precious metals in financial liabilities designated at fair value through profit and loss.

Noteworthy, at the end of 2007 BOC had 7,982 million RMB (~ 41 tonnes of gold) in precious metals pledged as collateral, and late 2009 this figure had grown into 27,271 million RMB (~ 114 tonnes of gold). The precious metals were used as collateral in swap transactions for financing, according BOC’s accounting practice.

From BOC’s 2009 Annual Report:

贵金属互换交易,根据其交易实质,按照在抵押协议下出售的贵金属交易处理。抵押的贵金属不予终止确认,相关负债在“拆入资金” 中反映。

Precious metals swap transactions, based on the transaction nature, are treated as precious metals sales under collateral agreement. The precious metals pledged as collateral are not ceased to be recognized and the related liability is reflected in “borrowings through interbank lending”

3. Bank of Communications


Bank of Communications lists precious metals assets in two separate categories. I’m not sure what is identified with “precious metals contracts”.

Bank of Communications reported in its 2013 annual report that it conducted overseas gold swap business:


[Bank of Communications] successfully conducted overseas gold swap transactions.

In 2013, Bank of Communications conducted gold interbank lending with HSBC and HSBC became the most important source of physical gold for the Bank of Communications:


The two parties [Bank of Communications and HSBC] not only conducted “first deal” cooperation in gold consignment and gold borrowing, but also realized surging cooperation volume. HSBC has become an important import source of physical gold for the bank.

4. China Construction Bank

4-china-construction-bank-2007-2015Not everything in the “other derivatives” category are precious metals.

China Construction Bank (CCB) wrote in its annual reports that the market share of physical sales to the public was No. 1 in 2010, and in the same year the market share of gold leasing was 40 %. From CCB’s 2010 annual report:


The Bank [China Construction Bank] has maintained the rank of No 1 in branded physical gold to individuals. The market share of gold leasing was 40.30 %. The market share of account gold was 37.41 %.

CCB offered physical withdrawal on precious metals accounts since 2013 and its own gold accumulation plan since 2015.

5. Agricultural Bank of China


Before 2014 “precious metals contracts” were called “precious metals lease contracts”. Not sure what “precious metals contracts” can be next to “precious metals lease contracts” – perhaps SGE physical contracts like Au99.99.

Before 2011, precious metals derivatives were reported separately as forwards and swaps. The precious metals lease business was reported to be launched in 2010.

6. Shanghai Pudong Development Bank


The change in “Financial liabilities at fair value through profit and loss” was caused by precious metals shorts (?) according to Shanghai Pudong Development Bank’s annual reports.

7. China Merchants Bank


The increase in “precious metals assets” was caused by the increase in proprietary trading and gold lease according to the annual reports. From China Merchants Bank’s 2014 annual report:


In 2013, China Merchants Bank reported to have conducted precious metals leasing of 60 tonnes, a 203 % increase from 2012. 

8. China Minsheng Bank

8-china-minsheng-bank-2007-2015The fine data was discussed in the previous chapter.

9. Industrial Bank


The 644 million RMB precious metals related liabilities were caused by “gold pledge business” according to Industrial Bank’s 2008 annual report.

“Precious metals shorts and leased precious metals” are a subcategory under “financial liabilities held for trading”.

10. China CITIC Bank

10-china-citic-bank-2007-2015According to the annual reports, the surge in the precious metals and precious metals contracts in 2014 was caused by the increase of precious metals lease and proprietary business.

According to CITIC bank’s 2014 annual report:


In the reporting period, the gold lease business and precious metals proprietary trading business all achieved rapid growth.

11. Ping’ An Bank (former Shenzhen Development Bank)


Before 2014 precious metals derivatives were called gold derivatives. Before 2009, Ping’ An only gave a lump sum of all the derivatives. Just in case there were any gold derivatives in this category, I’ve included the lump-sum numbers.

The increase in the “financial liabilities designated at fair value through profit and loss” in 2013 was caused by the increase in “financial liabilities held for trading” related to “gold business”, according to the annual report. Therefore all the numbers in “Financial liabilities designated at fair value through profit and loss” are listed here, although this category may include some liabilities not related to precious metals. From Ping’ An’s 2013 annual report:

ping-an-bank-pic-212. Huaxia Bank


The precious metals assets in 2007 and 2008 were a result from physical gold sales according to the annual reports.

13. Everbright Bank


According to the annual reports, Everbright Bank started to conduct gold consignment sales and gold leasing in 2013. Therefore, the increase in precious metals holding in 2013 was probably caused by these activities. From to Everbright Bank’s 2013 annual report:


[Everbright Bank] acquired the gold import qualification, started to conduct gold consignment and gold lease business.

14. Bank of Beijing


Clearly the Bank of Beijing participates in back-to-back leasing, as precious metals leased out are exactly equal to precious metals leased in.

15. Bank of Nanjing

The Bank of Nanjing only disclosed 6 million RMB in precious metals assets in 2014 and 7 million RMB in 2015.

16. Bank of Ningbo


The Great Physical Gold Supply & Demand Illusion

Gold supply and demand data published by all primary consultancy firms is incomplete and misleading. The data falsely presents gold to be more of a commodity than a currency, having caused deep misconceptions with respect to the metal’s trading characteristics and price formation.

Numerous consultancy firms around the world, for example Thomson Reuters GFMS, Metals Focus, the World Gold Council and CPM Group, provide physical gold supply and demand statistics, accompanied by an analysis of these statistics in relation to the price of gold. As part of their analysis the firms present supply and demand balances that show how much gold is sold and bought globally, subdivided in several categories. It’s widely assumed these balances cover total physical supply and demand, which is incorrect as the most important category is excluded. The firms though, prefer not to share the subtle truth or their business models would be severely damaged.

The supply and demand balances by the firms portray gold to be more of a commodity than a currency, as the gist of the balances reflect how much metal is produced versus consumed – put differently, the firms mainly focus on how much gold is mined versus how much is sold in newly fabricated products. However, in reality gold is everlasting and cannot be consumed (used up), all that has ever been mined is still above ground carefully preserved in the form of bars, coins, jewelry, artifacts and industrial products. Partly because of this property the free market has chosen gold to be money thousands of years ago, and as money the majority of gold trade is conducted in above ground reserves. Indisputably, total gold supply and demand is far in excess of mine production and retail demand.

As most individual investors, fund managers, journalists, academics and precious metals analysts consider the balances by the firms to be complete, the global misconception regarding gold supply and demand is one of epic proportions. Physical gold is a profound anchor in our global financial system and thus it’s of utmost importance we understand the fine details of its trading characteristics. 

Supply & Demand Metrics By The Firms

The firms can argue that the difference between what they present as supply and demand (S&D), as opposed to what I deem to be a more unadulterated approach of S&D is due to contrasting metrics. Accordingly, we’ll discuss their metrics to reveal their infirmity. In a nutshell, the firms only count the physical gold S&D flows that are easy to measure, while leaving out the most important part: institutional supply and demand. 

Although the firms all have slightly different methodologies to measure S&D, from comparisons the numbers appear to be quite similar. For our further investigation we’ll spotlight the metrics and models by GFMS. The reason being, GFMS has been the only firm that was willing to share a full description of their methodology for publication – to be viewed here. Metals Focus (MF) provided a partial methodology, the World Gold Council and CPM Group declined to comment.

Let’s have a look at GFMS its S&D categories. On the supply side is included:

  • Mine supply (newly mined gold)
  • Scrap supply (gold sourced from old fabricated products)

On the demand side is include:

  • Jewelry demand (gold content used in newly manufactured jewelry products bought locally at retail level, adjusted by jewelry exported and imported).
  • Industrial demand (the volume of gold used in industrial applications, for example bonding wire, products used in semiconductors/electronics and dental alloys).
  • Retail bar investment (the net volume of bars that are purchased by individual investors through retail channels).
  • Coin investment (a combination of published data from mints and also a proprietary survey conducted by GFMS detailing where coins are sold).

The above four demand categories summed up are often referred to as “consumer demand” by the firms.

Furthermore GFMS includes:

  • Net hedging (change in physical market impact of mining companies’ gold loans, forwards, and options positions)
  • Net official sector (total central bank selling or buying)
  • ETF inventory build (change in ETF inventory)
  • Exchange inventory build (change in exchange inventory)

The last four categories can be either supply or demand. In example, when central banks (the official sector) in total are net sellers this will be listed as a negative demand figure, as is shown in the S&D balance by GFMS below from 2006 until 2009, when central banks in total are net buyers this will be listed as a positive demand figure, as is shown in the balance from 2010 until 2015. For a clear overview of the GFMS S&D balance please have a look at all line items below.

Exhibit 1. Courtesy GFMS. Global gold S&D balance as disclosed in the Gold Survey 2016.

According to GFMS Supply consists of Mine production, Scrap and Net Hedging. In turn, Demand consists of Jewelry, Industrial Fabrication, Retail Investment, and Net Official Sector. After balancing Supply and Demand this results in a Physical Surplus/Deficit. Then, ETF Inventory Build and Exchange Inventory Build are added/subtracted from the Physical Surplus/Deficit to come to a Net Balance.

GFMS likes to pretend their balance is complete and occasionally articulates any surplus or deficit arising from it is positively correlated to the price of gold, which is anything but true, as I will demonstrate step by step.  

The Firms Exclude Majority Gold Supply & Demand

Most important what’s excluded from the balance is what we’ll refer to as institutional supply and demand, which can be defined as trade in bullion among high net worth individuals and institutions. Usually the bullion in question comes in 400-ounce (12.5 Kg) London Good Delivery (GD) bars having a fineness of no less than 995, or smaller 1 Kg bars having a fineness of no less than 9999. In addition, bullion bars can weigh 100-ounce or 3 Kg, among other less popular sizes, generally having a fineness of no less than 995. Bullion can be traded without changing in weight or fineness, but it can be refined and/or recast for transactions as well, in example from GD bars into 1 Kg bars. In some cases institutional supply and demand involves cross-border trade, when bullion is sold in country A to a buyer in country B, in other cases the bullion changes ownership without moving across borders.

Provided are two exemplifications of institutional S&D:

  • An (institutional) investor orders 400 Kg of gold in its allocated account at a bullion bank in Switzerland – which would be purchased in the Swiss wholesale market most likely in GD bars. This type of S&D will not be recorded by GFMS.
  • A Chinese (institutional) investor buys 100 Kg of gold directly at the Shanghai Gold Exchange (SGE), the Chinese wholesale market, in 1 Kg 9999 bars and withdraws the metal from the vaults. Neither this transaction will be registered by GFMS – or any other firm.

These examples show the S&D balances by GFMS are incomplete.

For illustrational purposes, below is a chart based on all S&D numbers by GFMS from 2013, supplemented by my conservative estimate of institutional S&D. Including institutional transactions total S&D in 2013 must have reached well over 6,600 tonnes.

Exhibit 2. Global gold S&D 2013 by GFMS, including conservative estimate institutional S&D.

GFMS Covers The Tracks With Help From The LBMA

Although GFMS intermittently admits their number are incomplete (they have to), at the same time they’ve been battling for years to eclipse apparent institutional S&D for its audience. Dauntless tactics were needed when in 2013 institutional demand in China reached roughly 1,000 tonnes and over 500 tonnes in Hong Kong. Institutional demand in the East was predominantly sourced through GD bars from the London Bullion Market, which were refined into 1 Kg 9999 bars that are more popular in Asia. For the cover up GFMS went to great lengths to refute the volumes of gold withdrawn from SGE vaults, and accordingly have the London Bullion Market Association (LBMA) adjust statistics on total refined gold by its member refineries. Remarkably, the LBMA cooperated. Allow me to share my analysis in detail.

In 2013 something unusual happened in the global gold market as Chinese institutional demand exploded for the first time in history. Hundreds of tonnes of institutional supply from London in the form of GD bars were mainly shipped to Switzerland to be refined in 1 Kg 9999 bars, subsequently to be exported via Hong Kong to meet institutional demand in China. From customs data by the UK, Switzerland and Hong Kong the institutional S&D trail was clearly visible. From 2013 until 2015 there was even a strong correlation between the UK’s net gold export and SGE withdrawals. Demonstrated in the chart below.

Exhibit 3. Correlation between UK net gold export and SGE withdrawals.

Because of the mechanics of the gold market in China, Chinese institutional demand roughly equals the difference between the amount of gold withdrawn from SGE designated vaults (exhibit 4, red bars) and Chinese consumer demand (exhibit 4, purple bars). In the exhibit 4 below you can see this difference that brought GFMS in a quandary, especially since 2013. For more information on the workings of the Chinese gold market and the size of Chinese institutional demand please refer to my post Spectacular Chinese Gold Demand Fully Denied By GFMS And Mainstream Media.

Exhibit 4. Chinese wholesale demand (SGE withdrawals), versus GFMS consumer demand versus apparent supply.

Stunningly, since 2013 GFMS has tried to convince its readers through numerous arguments why SGE withdrawals crossed 2,000 tonnes for three years in a row, while Chinese consumer demand reached roughly half of this. Yet the arguments have failed miserably to explain the difference – they rationalize only a fraction, read this post for more information.

And GFMS did more to eclipse apparent institutional S&D. They colluded with the LBMA.

To be clear, I cannot exactly measure global institutional S&D. However, let me make an estimate of apparent institutional demand for 2013. Notable, in 2013 a flood of gold crossed the globe from West to East. Chinese institutional demand accounted for 914 tonnes and Hong Kong net imported 579 tonnes – the latter we’ll use as a proxy for additional Asian institutional demand, as Hong Kong is the predominant gold trading hub in the region. 

In total apparent institutional demand in 2013 accounted for (914 + 579) 1,493 tonnes. If we add all other demand categories by GFMS shown in exhibit 1, total demand in 2013 was at least 6,619 tonnes. Be aware, this excludes non-apparent institutional demand.

Exhibit 5. Global gold demand 2013 by GFMS, including apparent institutional demand.

Because nearly all wholesale gold demand in Hong Kong and China is for 1 Kg 9999 bars, the global refining industry was working overtime in 2013, mainly to refine institutional and ETF supply in GD bars coming from London. In December 2013 I interviewed Alex Stanczyk of the Physical Gold Fund who just before had spoken to the head of a Swiss refinery. At the time Stanczyk told me [brackets added by me]:

They put on three shifts, they’re working 24 hours a day and originally he [the head of the refinery] thought that would wind down at some point. Well, they’ve been doing it all year [2013]. Every time he thinks it’s going to slow down, he gets more orders, more orders, more orders. They have expanded the plant to where it almost doubles their capacity. 70 % of their kilobar fabrication is going to China, at apace of 10 tonnes a week. That’s from one refinery, now remember there are 4 of these big ones [refineries] in Switzerland.

As a consequence, statistics on “total refined gold production” in 2013 by “LBMA accredited gold refiners who are on the Good Delivery List”, which the four large refineries in Switzerland are part off, capture the immense flows of institutional S&D – next to annual mine output and scrap refining. On May 1, 2015, the LBMA disclosed total refined gold production by its members at 6,601 tonnes for 2013 in a document titled A guide to The London Bullion Market Association. It’s no coincidence this number is very close to my estimate on total demand (6,619 tonnes), as apparent institutional demand in Asia was all refined from GD into 1 Kg bars.

Here’s exhibit 2 from another angle.

Exhibit 6. Global gold S&D by GFMS, including apparent institutional S&D, versus total refined gold production 2013.

In the table below we can see the LBMA refining statistics for 2013 at 6,601 tonnes.

Exhibit 7. Courtesy LBMA. Screenshot from A guide to The London Bullion Market Association captured by Ronan Manly in May 2015.

After this publication GFMS was trapped; these refining statistics revealed a significant share of the institutional S&D flows they had been trying to conceal. What happened next – I assume – was that GFMS kindly asked the LBMA to adjust downward their refining statistics. First and painstakingly exposed by my colleague Ronan Manly in multiple in-depth posts, the LBMA kneeled and altered its refining statistics to keep the charade in the gold market going.

On August 5, 2015, the LBMA had edited the aforementioned document, now showing 4,600 tonnes in total refined gold production. (Click here to view the original LBMA document from the BullionStar server, and here to view the altered version from the BullionStar server.) Have a look.

Exhibit 8. Courtesy LBMA. Altered document on refining statistics by the LBMA August 2015.

In the altered version it says:

Total refined gold production by the refiners on the List was estimated to be 4,600 tonnes in 2013, owing to recycling of scrap material, above world mine production of 3,061 tonnes (source Thomson Reuters GFMS).

A few important notes:

  • In the altered version the LBMA mentions “an estimate” for “total refined gold production”, while it doesn’t need to make an estimate as all LBMA accredited gold refiners who are on the Good Delivery List are required to provide exact data to its parent body. The exact data was disclosed in the first version of A guide to The London Bullion Market Association, and it stated, “total refined gold production by the refiners on the List was 6,601 tonnes”.
  • In the altered version the LBMA states the refining statistics were sourced from Thomson Reuters GFMS, but the LBMA doesn’t need GFMS for these statistics. The fact they mention GFMS, though, suggests a coordinated cover up of institutional S&D. Not only the firms, also the LBMA publishes incomplete and misleading data.
  • The altered version stated refining production totaled 4,600 tonnes, which is a round number and obviously quickly made up. A few weeks after the numbers were adjusted, the LBMA adjusted the numbers again, this time into 4,579 tonnes (click here to view from the BullionStar server). Clearly, on several occasions there has been consultation with the LBMA to get the statistics in line with GFMS.
  • In the original document the LBMA states, “Total refined gold production by the refiners on the List was 6,601 tonnes in 2013, more than double world mine production of 3,061 tonnes”, while in the altered version they state, “Total refined gold production by the refiners on the List was estimated to be 4,600 tonnes in 2013, owing to recycling of scrap material, above world mine production of 3,061 tonnes”. Notable, GFMS prefers to have total supply focused around mine and scrap production, instead of including institutional supply.
  • The original refining statistics (6,601 tonnes) are still disclosed in the LBMA magazine The Alchemist (#78 on page 24), to be viewed from the LBMA server here.
  • The fine details about how often and when the LBMA changed its refining statistics can be read in Ronan Manly’s outstanding post Moving the goalposts….The LBMA’s shifting stance on gold refinery production statistics.

And so nothing is spared in trying to uphold the illusion of the GFMS S&D balance to be complete. In another example GFMS excluded gold purchases by the central bank of China from its S&D balance. In June 2015 the People’s Bank Of China (PBOC) increased its official gold reserves by 604 tonnes, from 1,054 tonnes to 1,658 tonnes. During that quarter (Q2 2015) all other central banks worldwide were net buyers at 45 tonnes. Thus, in total the Official Sector was a net buyer at 649 tonnes. Now, let’s have a look at GFMS’ S&D balance for Q2 2015:

Exhibit 9. Courtesy GFMS. Global gold S&D balance as disclosed in the Gold Survey 2015 Q2. 

Net Official Sector purchases are disclosed ay 45 tonnes. GFMS decided not to include the 604 tonnes increment by the PBOC simply because it didn’t fit their balance model. A 604 tonnes increment in would have set the “net balance” at -480 tonnes. Readers would have questioned the balance from this outlier, and so GFMS decided not to include the tonnage.

According to my sources PBOC purchases were sourced from institutional supply (from abroad and not through the SGE), which is a supply category not disclosed by GFMS and therefore the tonnage was a problem. (Note, GFMS disclosed the PBOC increment in text, but not in their balance.) For more information read my post PBOC Gold Purchases: Separating Facts from Speculation.

Gold Is More A Currency Than A Commodity

The biggest flaw of the balance model by GFMS is that it depicts gold to be more of a commodity than a currency. It’s focused on mine output and gold recovered from old fabricated products on the supply side, versus retail sales of newly fabricated products on the demand side. In parlance of the firms, how much is produced (supply) versus consumed (demand). Official sector, ETF and exchange inventory changes are then added to the balance. This commodity S&D balance approach by GFMS has caused deeply rooted misconceptions about the essence of gold and its price formation.

The price of a perishable commodity is mainly determined by how much is annually produced versus how much is consumed (used up). However, gold is everlasting, it cannot be used up and its exchange value is mainly based on its monetary applications, from being a currency, or money if you will. Logically the best part of its trading is conducted in above ground reserves. From my perspective the impact of global mine supply, which increases above ground stocks by roughly 1.5 % annually, and retail sales have less to do with gold’s price formation than is widely assumed.

Back to GFMS. Have a look at the picture below that shows their S&D flows for 2015. 

Exhibit 10. Courtesy GFMS. The global S&D flows for 2015.

GFMS pretends total supply is mine production plus some scrap, which is then met by jewelry demand in addition to retail investment, industrial fabrication and official sector purchases. The way they present it is misleading. These S&D flows are incomplete; they suggest gold is traded like any other commodity. But what about institutional S&D in above ground bullion? Trades that define gold as an international currency.

Let’s do another comparison; this time between what GFMS calls Identifiable Investment demand, consisting of…

  • Retail bar & coin
  • ETF demand

…versus my what I deem to be a more unadulterated approach of investment demand, consisting of…

  • Retail bar & coin
  • ETF demand
  • Institutional demand

According to my estimates, in 2015 apparent Chinese institutional demand accounted for roughly 1,400 tonnes (exhibit 4). In the Gold Survey 2016 GFMS states on page 15 [brackets added by me]:

Total [global] Identifiable Investment, … posted a modest 5 % increase in 2015, to reach 990 tonnes.

That’s quite a tonnage between global Identifiable Investment by GFMS at 990 tonnes and apparent Chinese institutional demand at 1,400 tonnes. We should also take into account non-apparent institutional demand, gold that changes hands in trading hubs like Switzerland. Unfortunately we can’t always measure institutional S&D, but that doesn’t justify denying its subsistence.

Have a look at the chart below that shows the large discrepancy. In the next chapter we’ll specifically discuss the significance of investment demand in relation to the price of gold.

Exhibit 11. Global Gold Investment Demand 2015.

My point being: what many gold market participants and observers think is total supply and demand is just the tip of the iceberg. This truly is a staggering misconception created by the firms.

The global gold market. H/t Dan Popescu.

When observing the GFMS balance in exhibit 1 its incompleteness is self-evident. At the bottom we can see the line item “net balance”, which reflects the difference between total supply and total demand. According to GFMS, if the “net balance” is a positive figure there was a surplus in the global gold market, and if “net balance” is a negative figure the market has been in deficit. In the real world this figure is irrelevant. Gold supply and demand are by definition always equal. One cannot sell gold without a buyer, and one cannot buy gold without a seller. Furthermore the gold market is deep and liquid. So how come there is a difference between total supply and total demand in the GFMS balance? As I’ve demonstrated before, because GFMS doesn’t include institutional S&D that in reality makes up for the difference and far beyond. In all its simplicity the “net balance” item reveals their data is incomplete.

Let’s have another stab at this. How can “net balance” exist in the real world, for example in 2009? According to GFMS the gold market had a 394 tonnes surplus in 2009. But how? Were miners left with 394 tonnes they couldn’t sell? Or some supranational entity decided to soak up the surplus to balance the market? Naturally, this is not what happens. Total supply and total demand are always equal, but GFMS doesn’t record all trades.

Moreover, in my opinion the words “surplus” and “deficit” do not apply to gold. There can be no deficit in gold; there will always be supply. At the right price that is. Sometimes Keynesian economists claim there is not enough gold in the world for it to serve as the global reserve currency. Austrian economists then respond by saying that there will always be enough gold at the right price. I agree with the Austrians and their argument also validates why there can be no deficit in gold.  

There is more proof the “net balance” item presented by GFMS is meaningless. Although according to GFMS the market had a 394 tonnes “surplus” in 2009 the price went up by 25 % during that year. This makes no economic sense. A surplus suggests a declining price, not the other way around. Tellingly, S&D forces presented in GFMS balances are often negatively correlated to the gold price, as was the case in 2005, 2006, 2009, 2010 and 2014 (exhibit 1). In conclusion, GFMS S&D balances are not only incomplete, the resulting “net balance” items are misleading with respect to the price. Below are a few charts that demonstrate this conclusion.

If we plot “net balance” versus the end of year price of gold we can see the correlation is often negative. Have a look below. Green “net balance” chart bars show a positive correlation to the gold price, red chart bars show a negative correlation (note, the left axis is inverted for a more clear overview between any “deficit/surplus” and the price of gold). As you can see nearly half of the “net balance” chart bars are negatively correlated to the price of gold.

Exhibit 12. GFMS’ gold market “net balance” versus the gold price. We can quarrel if the “net balance” in 2014 was positively or negatively correlated to the price. I say the correlation was negative as the gold price in 2014 remained flat in US dollars but was up in all other major currencies, in contrast to the “surplus” presented by GFMS.

Mind you, although the “net balance” item is often negatively correlated to the gold price, in the Gold Survey 2016 GFMS states on page 9:

In terms of the Net Balance, 2015 marked the third year in which the gold market remained in surplus, and therefore it is not surprising that the bear market continued.     

And on page 14:

The forecast reduction in global mine output and a gradual recovery in demand will see the physical surplus narrow in 2016, providing support to the gold price and laying the foundation for better prospects.  

GFMS likes to pretend any “surplus” or “deficit” arising from their balance is correlated to the price, but the facts reveal this is not true.

Let us plot the “physical surplus/deficit” line item by GFMS (exhibit 1) versus the gold price. This results in even more negative correlations.

Exhibit 13. GFMS gold market “physical surplus/deficit” versus gold price.

This exercise reveals that a positive correlation between either a “surplus” or “deficit” arising from a GFMS balance and the price of gold is just a coincidence. No surprise when one is aware their S&D data is incomplete.

Remarkably, the last chart was also published in the Gold Survey 2016, but GFMS chose not to invert the left axis and doesn’t disclose what we see is a surplus or deficit. As a result the largest surpluses (2006, 2007, 2009, 2010) seem to correlate with a rising price, though in reality they did the opposite. Compare the chart below with the one above.

Exhibit 14. Courtesy GFMS.

GFMS also publishes S&D balances for silver (a monetary metal that is comparable to gold). For silver the presented correlations by GFMS between a “surplus” or “deficit” in relation to the price are even weaker.

Exhibit 15. GFMS silver market “net balance” versus silver price, as disclosed in the Silver Survey 2016.
Exhibit 16. GFMS silver market “physical surplus/deficit” versus silver price, as disclosed in the Silver Survey 2016.

According to GFMS the silver market is always in deficit, but the price goes up and down. Obviously GFMS neglects to measure institutional S&D for silver. 


In my opinion, when Gold Fields Mineral Services (GFMS) was erected many decades ago they made a mistake to adopt a commodity S&D balance approach. Surely with the best intentions they gather intelligence and retrieve data from the market. But we must be aware this is not the full picture. The most significant data is not disclosed by GFMS.

When it comes to what drives the price of gold GFMS and I agree it’s determined by gold’s role as a currency in the global economy. When reading the chapter PRICE AND MARKET OUTLOOK in the Gold Survey 2016, GFMS shares its insights with respect to the gold price. Factors mentioned are:

  • Turmoil in global stock markets
  • A Chinese hard landing
  • Geopolitical tensions in the Middle-East
  • Central bank stimulus (QE)
  • Global economic weakness
  • Interest rates policy by central banks
  • Low risk asset / safe haven demand

So if these factors drive the gold price, in what S&D category would this materialize? Would (large) investors buy and sell jewelry? Or bullion bars? I think the latter. According to my analysis the price of gold is largely determined by institutional demand, and to a lesser extent ETF and retail bar & coin demand.

Let’s do an exercise to see what physical gold S&D trends correlate to the price. The majority of supply on the GFMS balance consists of mine output and the majority of demand on the GFMS balance consists of jewelry consumption. But if we plot these volumes versus the price of gold in a chart, there is no push and pull correlation*. For example, when the gold price surged from 2002 until 2011 jewelry consumption was not rising. Neither was it outpacing mine supply. The opposite happened, to be seen in the graph below. This is because jewelry demand is price sensitive – when the price goes up jewelry demand goes down, and vice versa. Jewelry demand is not driving the price of gold.

Exhibit 17. GFMS retail demand, versus mine and scrap supply versus the gold price.

I also added retail bar & coin demand. Interesting to see is that retail bar & coin demand is on one hand a price driver, moving up and down in sync with the gold price, on the other hand it can be price sensitive having brief spikes when the price of gold declines.

The best correlation between physical S&D in relation to the gold price can be seen in institutional and ETF S&D. One of the largest gold trading hubs in the West is the UK, home of the London Bullion Market that also vaults the largest ETF named GLD. The UK has no domestic mine production, no refineries and national gold demand is neglectable in the greater scheme of things. Therefore, by measuring the net flow of the UK (import minus export) we can get a sense of Western institutional and ETF demand and supply. For example, if the UK is a net importer – import demand being greater than export supply – that signals a net pull on above ground stocks. Approximately one third of the UK’s net flow corresponds to ETF inventory changes, the other two thirds reflect pure institutional S&D.

Exhibit 18. UK net flow versus the gold price.
Exhibit 19. UK net flow, GLD inventory change, gross import and gross export versus the gold price.

In the charts above we can observe a remarkable solid correlation between the UK’s net flow and the gold price. The UK is a net importer on a rising price and net exporters on declining price. The shown correlation can’t be a coincidence, though there’s no guarantee it will prevail in the future.

The two charts above show the (medium/long term) gold price is mostly determined by institutional supply and demand in above ground reserves. Effectively, GFMS is hiding the most important part of global physical gold flows.

When I asked an analyst at one of the leading firms why his company doesn’t measure institutional S&D he told me candidly, “because it’s extremely difficult to accurately estimate it”. And it is. As I wrote previously, I can’t exactly measure global institutional S&D either. However, very often publicly available information gives us a valuable peek at it, and it shows to be more relevant to the gold price than what the firms keep staring at. Not knowing exactly what institutional S&D accounts for doesn’t mean GFMS shouldn’t pay attention to it.

But the firms keep trying to uphold the illusion the data they’ve been selling for decades is complete. For if they would plainly confess it was incomplete, future business could be severely damaged.

What I blame these firms is that they’ve created a meme that the gold market is as large as annual mine supply. This has caused all sorts of misconceptions. Often I read analyses based on a comparison between quantitative demand and mine output. Such analyses are likely to jump erroneous conclusions.

H/t Ronan Manly, Bron Suchecki, Nick Laird from Goldchartsrus.com


Simplified overview gold flows 2015:


China’s Rising Gold ETF Market: A Hybrid

This post is part of the Chinese Gold Market Essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated in 2017.

In 2013 we’ve witnessed the inception of the Chinese gold ETF market. At first demand for the gold ETFs was neglectable, as investors mostly preferred to buy the physical gold directly at the Shanghai Gold Exchange (SGE) or buy jewelry or investment bars through retail channels. In 2016, however, there has been a major shift towards gold ETF demand in China.

The physical holdings of Chinese gold ETFs have surged five-fold from 7 tonnes at the end of January 2016, to 35 tonnes at end of August 2016. The Huaán Yifu Gold ETF, which was holding 23 tonnes in August 2016, even entered the global top 15 list.  Since 2016 total Chinese gold ETF holdings (all stored within SGE designated vaults) have dwindled  to an aggregated 25 tonnes in September 2017.   

Chinese Gold ETF Physical Holdings
Exhibit 1. All physical holdings of Chinese gold ETFs are stored within SGE designated vaults.

The interest in China’s gold ETF market was even mentioned by the World Gold Council in a Gold Demand Trends report. In this post, we’ll add some texture to China’s gold ETF market; how are the gold ETFs constructed and how can they be compared to the largest Western gold ETF, the SPDR Gold Trust. At this moment the market share of Chinese gold ETFs is small – within China as well as globally, but knowledge about the workings of these ETFs will be valuable if they acquire significant market share in the future.

Kindly note, all mechanics and examples presented in this post are simplified.

What Is A Gold ETF?

ETF is short for Exchange Traded Fund. ETFs trade like stocks and its price usually tracks an underlying asset or index. Like stocks, ETFs have a primary market and a secondary market. The secondary market is the stock exchange where most ETF investors trade. What makes ETFs special is the primary market where ETF shares are created and redeemed. Let us use the SPDR Gold Trust (symbol: GLD) to illustrate how the primary market works. Mainly through the creation and redemption process of shares, the GLD share price tracks the gold price.

Primary GLD market participants include (from the prospectus):

  • The Sponsor (World Gold Trust Services, LLC, which oversees the performance of the Trustee and the Custodian)
  • The Trustee (BNY Mellon Asset Servicing, which is responsible for the day-to-day administration of GLD)
  • The Custodian (HSBC Bank plc, which holds the gold bars in custody, there can be sub custodians)
  • The Authorised Participants (the institutions which are authorised to create and redeem GLD shares, at this moment the Authorised Participants are Barclays Capital, Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co., Goldman Sachs Execution & Clearing, L.P., HSBC Securities (USA) Inc., P. Morgan Securities Inc., Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co. LLC, RBC Capital Markets, LLC, Scotia Capital (USA) Inc., UBS Securities LLC and Virtu Financial BD LLC).

GLD is traded on the New York Stock Exchange Arca (NYSE Arca)

Exhibit 2. The (simplified) process of creation and redemption of GLD shares by an Authorised Participant through the Trustee.

If an Authorised Participant (AP) wants to create GLD shares, it needs to deposit gold into the account of the Trust and subsequently the Trustee will provide the AP with GLD shares. The creation application must be made in multiples of 100,000 shares (a block of 100,000 shares is called a basket). Since every GLD share represents approximately 0.1 ounce of gold, in order to create 100,000 GLD shares the AP needs to deposit 10,000 ounces of gold into the account of the Trust. (In reality, 1 GLD share actually represents a little less than 0.1 ounce of gold, the reason for this will be explained later on in this post.)

The redemption process works the other way round. If an AP wants to redeem GLD shares, it deposits 100,000 GLD shares at the Trust and subsequently the AP receives 10,000 ounces of gold.

The purpose of APs creating and redeeming GLD shares is usually arbitrage. As previously mentioned the gold equivalent of 1 GLD share is roughly 0.1 ounce, nevertheless GLD shares and actual gold are traded in two different markets. As a consequence, the price of 1 GLD share can differ from the price of 0.1 ounce of gold. If the price of GLD and the price of gold diverge, this is where arbitrage comes into play for the APs. Accordingly, the arbitrage by APs through creation and redemption of shares contributes to GLD’s price tracking the gold price.

Suppose (simplified), the price of 1 GLD share is $110 – caused by supply and demand for GLD shares at the NYSE Arca – while the price of 0.1 ounce of gold is $100 in the gold market. An AP can grasp this opportunity by buying (or first leasing) 10,000 ounces of gold to deposit in the GLD Trust account after which the Trustee will create 100,000 GLD shares for the AP. The new shares created are then sold by the AP on the stock market, which will cause the price of GLD to go down. The arbitrage opportunity will be used by APs until it’s closed.

If the price of GLD shares is lower than the price of gold, the arbitrage opportunity works the other way around, APs can buy shares, redeem them for gold at the Trustee and sell the gold.

In the aforementioned example trade when the AP (via the Trustee) created 100,000 GLD shares his investment was $10,000,000 (10,000 ounces at $100 per 0.1 ounce). The AP’s revenue was $11,000,000 (100,000 GLD shares worth $110 a piece). The AP’s profit in this exercise was $1,000,000.

($110-$100)*100,000 = $1,000,000

As readers can see from the example, the holdings of GLD were increased by 10,000 ounces of gold. Almost every day the holdings of GLD vary and the change is often caused by arbitrage of APs.

One theory is, when demand for GLD shares is strong (usually by Western investors) and the share price is trending higher than the price of the gold equivalent, the APs jump the arbitrage, create shares and GLD inventory swells. Then, if growth in GLD inventory correlates to a surging gold price (which can be observed in exhibit 3 below) we can speculate the gold bull market in part has been caused by Western investment demand in GLD.

Exhibit 3.

Now we have established the workings of the largest Western gold ETF, we will have a look at how the Chinese gold ETFs are constructed, and compare them to GLD.

China’s Gold ETF Market

Below are the 4 Chinese gold ETFs currently in existence that we’ll discuss.

  1. - Bosera Gold Exchange Open-Ended Securities Investment Fund
  2. - Guotai Gold Exchange Open-Ended Securities Investment Fund
  3. - Huaán Yifu Gold Exchange Open-Ended Securities Investment Fund
  4. - Efund Gold Exchange Open-Ended Securities Investment Fund

In China every gold ETF share represents approximately 0.01 gram of gold. By creating or redeeming gold ETF shares (Chinese) APs receive or deliver a basket of 300,000 shares, which equals to 3Kg of gold. This threshold is much lower than that of GLD, of which a basket equals to 310Kg of gold. The gold acceptable for Chinese ETFs are the spot (physical and spot deferred) gold contracts listed on theSGE – for example Au99.99. Therefore, all the physical holdings of China’s gold ETFs are stored within SGE designated vaults.

Moreover, there is a range of features that make China’s gold ETFs quite different from GLD.

1. Chinese Gold ETF Shares Can Also Be Created Or Redeemed Through Cash

Unlike GLD, which only allows the use of gold to create shares, and only allows the use of shares to redeem gold, China’s gold ETFs also allow shares to be created and redeemed through cash in the primary market. An AP can present cash to the Fund Manager who handles the creation and redemption process for a Chinese gold ETF. The Fund Manager is comparable to the Trustee of GLD. Thereby, through an AP individual investors can create or redeem gold ETF shares with cash as well.

Suppose, a Chinese investor wants to arbitrage the difference between the price of a gold ETF and the price of gold. In this example the price of the gold ETF is higher than the price of gold, so the investor want use cash to create shares to sell on the stock market. The investor can present cash to an AP who in turn will create shares via the Fund Manager. The amount of cash used in this transaction to create shares is equal to the cash value of the spot gold contracts that are needed to create the shares without the use of cash.

Vice versa, in case an investor wants to arbitrage the price of a gold ETF when it’s lower than the price of gold, the investor can present shares to an AP to redeem for cash.

Exhibit 4. Creation and redemption process of Chinese gold ETF shares through cash.

In China the APs can be securities firms and commercial banks. The securities firms are often not SGE members. Therefor, the number of APs that support gold ETF shares creation and redemption through cash is often larger than the number of those that support shares creation and redemption through spot gold contracts. For example, in the case of Efund Gold ETF, the fund has authorised 13 securities firms (APs) to process creation and redemption through cash, but only 2 banks (APs) to process creation and redemption through spot gold contracts (Industrial and Commercial Bank of China and Bank of Communications).

2. The Flexibility Of The Fund Manager

The Trustee of GLD doesn’t have much flexibility in managing the assets. Its duty is mainly processing the creation and redemption orders of GLD shares. Therefore, the gold holdings of GLD are mainly allocated gold and according to the prospectus [brackets added by me]:

Gold held in the Trust [GLD]’s allocated account is the property of the Trust and is not traded, leased or loaned under any circumstances.

In China, the Fund Managers of the gold ETFs have more flexibility. The gold contracts that China’s gold ETFs hold include not only spot physical contracts like Au99.99 and Au99.95, but can also be spot deferred contracts like Au (T+D), and notable all these “spot contracts” may be leased (sometimes swapped) within the SGE system. Additionally, every Chinese gold ETF can invest 10% of its fund assets (5 % of net fund assets in case of Efund Gold ETF) in “other financial instruments” allowed by the China Securities Regulatory Commission (CSRC).

For example, the excerpt below is from the Efund Gold ETF’s prospectus [brackets added by me]:

The investment scope of the Fund [Efund Gold ETF] is liquid financial instruments, including gold physical contracts (including spot physical contracts, spot deferred contracts, etc), bonds, asset-backed securities, bond repos, bank deposits, money market instruments, and other financial instruments which laws, regulations or the CSRC allow the Fund to invest in the future (but these have to satisfy the relevant rules of the CSRC).

If laws, regulations or regulatory institutions allow the Fund to invest in other instruments (including but not restricted to gold derivatives like forwards, futures, options and swaps), after necessary procedures, the Fund Manager will include them into the investment scope.

The portfolio percentage: The fund asset invested in gold spot contracts is not lower than 95% of the net asset value of the Fund.

All the 4 gold ETFs in China can participate in gold leasing. Some can participate in gold swaps and some can pledge the gold to borrow money.

The excerpt below is from the Huaán Yifu Gold ETF Prospectus:

The Fund can do gold lease and pledge gold to borrow money.

Effectively the Fund Manager of the Huaán Yifu Gold ETF can make money by, for example, leasing the fund’s assets.

The excerpt below is From the Guotai Gold ETF Prospectus:

The Fund can do gold lease, gold swap and invest in gold spot deferred contracts, etc, in order to lower the operating expenses and lower tracking error. The Fund does margin trade only for the purpose of risk management and enhancement of the efficiency of the asset allocation.

As a result, the Fund Managers of Chinese gold ETFs have significant flexibility in handling the fund assets. Please remember that all gold leasing, swapping, etc. has to be done within the SGE system and the gold cannot leave the SGE designated vaults.

From the CSRC’s website [brackets added by me]:

Article 4. Gold ETFs may not deposit physical gold into the [SGE] vault or withdraw physical gold from the [SGE] vault. Margin trade is only for the purpose of risk management and enhancement of the efficiency of the asset allocation. 

Exhibit 5. The bottom row shows the minimum percentages the Gold ETFs must invest in “spot contracts”, though some of this gold can be involved in leasing.

3. NAV Per Share Recalculation

Since the inception of GLD in 2004 its share gold equivalent is steadily declining lower than 0.1 ounce of gold. That’s because the Sponsor, Trustee and Custodian don’t provide services for free. They need to earn money and their earnings must come from the Net Asset Value (NAV) of the ETF. In other words, the gold in the Trust is gradually sold to pay for operational expenses. From the GLD prospectus:

The amount of gold represented by the Shares will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust’s expenses irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold.

Each outstanding Share represents a fractional, undivided interest in the gold held by the Trust. The Trust does not generate any income and regularly sells gold to pay for its ongoing expenses. Therefore, the amount of gold represented by each Share has gradually declined over time. This is also true with respect to Shares that are issued in exchange for additional deposits of gold into the Trust, as the amount of gold required to create Shares proportionately reflects the amount of gold represented by the Shares outstanding at the time of creation. Assuming a constant gold price, the trading price of the Shares is expected to gradually decline relative to the price of gold as the amount of gold represented by the Shares gradually declines.

On November 18, 2004, 1 GLD share exactly equaled 0.1 ounces of gold, but by now (September 2016) 1 GLD share equals 0.09542 ounces of gold, a decline of almost 5 % over the course of 12 years. This explains why currently the amount of ounces needed by an AP to create a basket of shares has become less than 10,000 ounces, and continues to decline.

In China’s gold ETF market, although the gold represented by the ETF instruments also decline as with GLD, the share values are periodically re-adjusted to ensure the NAV per share remains (roughly) 0.01 gram of gold.

For example, from the Bosera Gold ETF prospectus:

Fund share re-calculation means the fund manager based on the necessity of the operation of the fund, under the premise that the total NAV is unchanged, adjusts the total fund shares outstanding and NAV per share. 

There is nothing complicated about the re-calculation. There are simply periodic adjustments when the Fund Manager sets the value of the shares (in yuan) higher because the gold content equivalent is elevated, from below 0.01 gram to 0.01 gram, whereby the Fund Manger “adjusts the total fund shares outstanding” downward.

4. Linked Funds

In China, every gold ETF is accompanied by a Linked Fund. The Linked Fund mainly invests in the Target Gold ETF as can be seen in the list below. The Linked Fund is usually a common open-ended mutual fund. While 90 % of the assets under management of the Linked Fund must be invested in its Target Gold ETF, the Fund Manager still has some room for managing the remaining 10%.

Exhibit 6.

For example, from the Bosera Gold ETF-linked Fund’s prospectus:

The Fund mainly invests in Bosera Gold Exchange Open-Ended Securities Investment Fund, gold contracts listed on the Shanghai Gold Exchange, gold futures contracts listed on the Shanghai Futures Exchange, bonds and other financial instruments which the CSRC allows the fund to invest, like securities lending and borrowing, gold lease, etc.

For more clarity I’ve drawn a graph to illustrate the ratios of investment allocation by the Guotai Gold ETF and the Guotai Gold ETF-linked Fund.

Exhibit 7.

Although, at this stage it’s not completely clear to me what would be the benefit for investors to invest in the Linked Fund, as opposed to the Target Gold ETF.

 5. Voting Rights

GLD holders only have limited voting rights. The excerpt below is from the GLD prospectus,

Under the Trust Indenture, Shareholders have no voting rights, except in the following limited circumstances: (i) shareholders holding at least 66.66% of the Shares outstanding may vote to remove the Trustee; (ii) the Trustee may terminate the Trust upon the agreement of Shareholders owning at least 66.66% of the outstanding Shares; and (iii) certain amendments to the Trust Indenture require 51% or unanimous consent of the Shareholders.

In China’s gold ETFs shareholders have more voting rights and can vote to decide on a lot of important issues. The excerpt below is from the prospectus of Bosera Gold ETF:

In one of the following circumstances, based on the consent of the fund manager, the fund custodian or the fund shareholders who hold 10% (including 10%) of the fund shares outstanding, it is mandatory to hold fund shareholders’ meeting:

1. Termination of the fund contract;

2. Change of the operation of the fund;

3. Increase of the remuneration of the fund manager or the fund custodian, but excluding the circumstances in which the increase of the remuneration is mandatory by the requirements of laws or regulations;

4. Replacement of the fund manager or fund custodian;

5. Amendment of the fund category;

6. Amendment of the fund investment target, scope or strategy (excluding the circumstances in which laws, regulations or the CSRC have other relevant requirements);

7. Amendment of fund share holders’ meeting proceedings, voting methods and voting procedures;

8. Termination of listing but excluding circumstances in which the fund no longer satisfies listing requirements and the listing is terminated by the Shenzhen Stock Exchange;

9. Merger of the fund with other fund(s);

10. Other items that have material influence on the rights and responsibilities of the parties to the fund contract and necessitate the fund share holders’ meeting to amend the fund contract;

11. Other items that are required by laws, regulations, the fund contract or the requirements of the CSRC to hold the fund share holders’ meeting.

Even the Linked Fund shareholders of China’s Gold ETFs can participate in voting:

The fund shareholders of the linked fund of this fund can attend or send representatives to attend the fund shareholders’ meeting and participate in voting, based on the share holding of the linked fund. The equivalent number of fund shares with voting rights and correspondent votes are: the product of the total shares of this fund held by the linked fund multiplied by the linked fund shares held by the respective link fund share holder as a percentage of the total linked fund shares outstanding. The result of the calculation is rounded to the nearest whole number.

Ironically, to me there seems to be more democracy and openness in China’s gold ETFs than in GLD. On the other hand, Chinese gold ETFs have a fundamentally different foundation, a hybrid design I would say.

China’s gold ETF market was erected in 2013 and is still evolving. In the future, there may be more complex gold ETF related financial structures that have a big impact on China’s overall gold market. I shall follow it closely.


The main sources used for this article are the prospectuses from the Bosera Gold ETF, Guotai Gold ETF, Huaán Yifu Gold ETF and Efund Gold ETF, and the prospectuses of the Linked Funds of these Gold ETFs, Bosera Gold ETF-linked fund, Guotai Gold ETF-linked fund, Huaán Yifu Gold ETF-linked fund and Efund Gold ETF-linked fund)

Spectacular Chinese Gold Demand 2015 Fully Denied By GFMS And Mainstream Media

Debunking the Thomson Reuters GFMS Gold Survey 2016 report. New information provides a more detailed perspective on the Chinese domestic gold market. 

In the Gold Survey 2016 report by GFMS that covers the global gold market for calendar year 2015 Chinese gold consumption was assessed at 867 tonnes. As Chinese wholesale demand, measured by withdrawals from Shanghai Gold Exchange designated vaults, accounted for 2,596 tonnes in 2015 the difference reached an extraordinary peak for the year. In an attempt to explain the 1,729 tonne gap GFMS presents three brand new (misleading) arguments in the Gold Survey 2016 and reused one old argument, while it abandoned five arguments previously put forward in Gold Survey reports and by GFMS employees at forums. Very few of all these arguments have ever proven to be valid, illustrated by the fact that GFMS perpetually keeps making up new ones, and thus gold investors around the world continue to be fooled about Chinese gold demand. For some reason GFMS is restrained in disclosing that any individual or institution in China can directly buy and withdraw gold at the Shanghai Gold Exchange, which is the most significant reason for the discrepancy in question.

According to my estimates true Chinese gold demand in 2015 must have been north of 2,250 tonnes.

The reason I keep writing about this subject (the discrepancy in question) is that it eventually will enable me to show that global physical gold supply and demand as presented by GFMS is just the tip of the iceberg. And, as stated in my previous post true physical supply and demand is far more relevant to the gold price than the numbers by GFMS.

New Information has enabled me to shine a fresh light on the Chinese domestic gold market, so we’ll zoom in once again to get the best assessment of the mechanics of this market. This post is part two of an overview of the Chinese gold market for 2015. In the first part we focused on the (paper) volumes traded on the Shanghai Gold Exchange (SGE) and Shanghai International Gold Exchange (SGEI). In this post we’ll focus on the size and mechanics of the Chinese physical gold market, while at the same time addressing the fallacious information in the Gold Survey 2016 (GS2016).

The Gold Surplus In China According to GFMS

First, let’s have a look at an overview of the key supply and demand data points for 2013, 2014 and 2015, as disclosed in Gold Survey reports by GFMS.

GFMS SD 2013-14-15
Exhibit 1.

Without GFMS mentioning the volume of SGE withdrawals for 2015 (2,596 tonnes) in the GS2016 they disclose apparent supply in the Chinese domestic gold market at 2,293 tonnes. Mine output accounted for 458 tonnes (page 22), scrap supply for 225 tonnes (page 36) and net import was 1,610 tonnes (page 54). The latter is incorrect because GFMS has double counted 63 tonnes Australia exported to China, as demonstrated in my post Australia Customs Department Confirms BullionStar’s Analysis On Gold Export To China, but the let’s not nitpick.

On other pages in the GS2016 we read total (consumer) demand for 2015 was 867 tonnes (page 52), consisting of retail bar demand at 199 tonnes (page 52) and gold fabrication at 668 tonnes (page 41). According to their own data there was a surplus of 1,426 tonnes (2,293 – 867) in the Chinese gold market. Whilst, in 2013 the surplus accounted for 826 tonnes and in 2014 for 917 tonnes, according to data disclosed in previous Gold Survey reports. Meaning, in the past three years GFMS has observed 3,169 tonnes (826 + 917 + 1,426) that were supplied to China not to meet demand, but for reasons that are constantly changing - wait till we get to the plea.

Remarkably, in the GS2016 report GFMS writes:

Hong Kong remained the primary conduit of Chinese gold imports, though its share has been contracting since 2013 … Gold import from this conduit was traditionally regarded as a simple proxy to estimate Chinese consumption … The declining dominance of Hong Kong and the increasing proportion directly routed into Beijing and Shanghai therefore points to the necessity of changes on methodology to calculate Chinese gold demand.

Exhibit 2.

GFMS states that when all Chinese imports came in through Hong Kong this inflow was “regarded as a simple proxy to estimate Chinese consumption”, but now gold is also being imported directly from countries like Australia, the UK and Switzerland, such inflow “points to the necessity of changes on methodology to calculate Chinese gold demand”. How can it be that a couple of years ago Chinese gold import from Hong Kong reflected demand, but a few years later direct massive additional import from the UK and Australia does not reflect demand?

As you probably know (otherwise you can read it here) most of the gold supply in China flows through the SGE. Consequently wholesale demand can be measured by the amount of gold withdrawn from SGE designated vaults. Comparable to the difference between apparent supply and consumer demand shown in exhibit 1, is the difference between SGE withdrawals and consumer demand – the latter being even wider.

Chinese domestic gold market S&D 2015
Exhibit 3.

In the GS2016 GFMS has written a chapter fully dedicated to the humongous difference between SGE withdrawals and their assessment of demand. The chapter is titled “A Review And Explanation Of How China’s SGE’s Withdraw Numbers Are Impacted By Other Trading Activities”. In this post we’ll only briefly discuss whether the arguments are valid, as one of them has to do with China’s highly complex VAT system and I like to expand on this subject in detail in a separated post. However, we’ll expose more of the mechanics of the Chinese domestic gold market in this post, which conveniently demonstrates why nearly all the arguments by GFMS that will be discussed later on are bogus.

This might surprise you, but I actually had fruitful correspondence in the past months with a Senior Precious Metals Analyst at GFMS and a Senior Analyst at Metals Focus (MF). Both gentlemen have been very helpful in sharing their methodology for computing (Chinese) physical supply and demand data. I have to say both of them have answered all my questions. This service is seldom provided by the the World Gold Council, the Bank Of England or the London Bullion Market Association. Based on the information shared by GFMS and MF I’ve refined my view on our on-going disagreement with respect to the Chinese gold demand.

The Mechanics Of The Chinese Domestic Gold Market And Estimating True Chinese gold demand.

Let us refresh our memory regarding the structure of this market. In the Chinese domestic gold market nearly all physical gold supply and demand flows through the SGE because all bullion import1 into the domestic market is required to be sold first through the SGE and there are rules and tax incentives that funnel nearly all domestic mine output and scrap supply through the central bourse. As gold in the Chinese domestic market is not allowed to be exported1, the amount of gold withdrawn from SGE designated vaults therefore serves as a decent indicator for wholesale demand.

However, there are a few possibilities through which SGE withdrawals can be distorted for measuring demand.

  • If metal is in some manner recycled2 through the central bourse. When gold is bought and withdrawn from the SGE vaults and promptly sold and deposited into SGE vaults (for example though process scrap), these flows would inflate SGE withdrawals while not having a net effect on the price of gold, hence the related supply and demand volumes would be deceiving. Although article 23 from the Detailed Rules for Physical Delivery Of the Shanghai Gold Exchange states that bars withdrawn from SGE designated vaults are not allowed to re-enter these vaults, this rule does not fully prevent gold from being recycled through the exchange. If bars withdrawn are re-melted and assayed by an SGE approved refinery they are allowed back into the vaults. And thus, some recycled gold can inflate SGE withdrawals as a measure for true demand.
  • Another example that could distort SGE withdrawals is when international members would withdraw gold from vaults of the SGEI in the Shanghai Free Trade Zone2 (SFTZ), these withdrawals are included in the total SGE withdrawal figure, to store elsewhere in the SFTZ or export abroad1.

For ease of reference we’ll label the amount of gold recycled through the SGE that has no net effect on the price, and gold withdrawn from SGEI vaults that is not imported into the Chinese domestic market as distortion2.

Therefor, in order for us to make the best estimate of true Chinese gold demand we should subtract the amount of distortion from SGE withdrawals. The crux of true Chinese gold demand is establishing the amount of distortion, that’s it.

Previously I assumed the scrap numbers by GFMS mainly reflected gold that was making it’s way back to the SGE and these flows included disinvestment. Both assumptions appeared to be false.

  1. Scrap numbers from GFMS and MF, although they’re certainly not equal, are collected from refiners that are not all SGE members. Implying not all refineries scrap is making its way to the SGE, but is sold through other channels.
  2. Scrap numbers from GFMS and MF include jewelry and industrial products sold back from consumers, they do not include disinvestment that flows directly through refineries to the SGE. GFMS does measure disinvestment at retail level, for example, when people sell bars back to banks these will get netted out to compute net retail bar demand. But if an affluent investor or institution wants to sell (disinvest) 500 Kg they’re likely to approach a refinery directly.

In my nomenclature “distortion2” is the part that inflates SGE withdrawals as a measure for demand, “scrap” is supply from sold fabricated products like old jewelry, and “disinvestment” is supply coming from investment bars sold directly to refineries making its way to the SGE.

As a consequence, these new insights regarding scrap and disinvestment supply have changed my perspective on the Chinese supply and demand balance.

To reach a more clear understanding of what was just described, I’ve conceived an exemplar graph to visually interpret the Chinese physical gold supply and demand balance. Have a look.

Example Chinese domestic gold market S&D
Exhibit 4.

As you can see in the graph above total supply and total demand are exactly equal, this is because one cannot sell gold without a buyer or buy gold without a seller. Consequently we can gauge demand by measuring supply. Please note, in the supply and demand balance shown above, and in our further investigation, two elements are left out. On the supply side I left out stock carry over in SGE vaults from previous years, as this information is not publicly available. On the demand side I left out gold bought at the SGE that was not withdrawn from the vaults, as this information is also unknown.

In all its simplicity the example chart shows that the difference between consumer demand and true Chinese gold demand is caused by direct purchases from individual and institutional clients at the SGE. While GFMS merely counts demand at retail level, by jewelry and bar sales at shops and banks, the real action is at wholesale level, at the SGE.

GFMS fully neglects direct purchases at the SGE (demand) and any corresponding disinvestment to the SGE (supply). Hence our disagreement.

Estimate of SGE withdrawals distribution
Exhibit 5. According to my analysis the PBOC does not buy its gold through the SGE. For more information read my post PBOC Gold Purchases: Separating Facts from Speculation.

At the moment the SGE has almost 10,000 institutional and over 8.3 million individual clients that are able to buy gold directly at the SGE. There is even an SGE smartphone application called “Yijintong” that allows anyone with an internet connection to open an SGE account and trade directly on the SGE wholesale platform enjoying the lowest spreads in China. Furthermore, the SGE counts 183 domestic members and 63 international members.

Exhibit 6. Screenshot Yijintong.

From the SGE (December 2015):

Yijintong is the first professional mobile terminal of state-level gold market jointly researched and developed by the Gold Exchange and all its members …

Yijintong has comprehensive functions and advanced systems, which are compatible with various Android and iOS operating systems. Right now, it possesses market, transaction, search and information functions, so investors can conduct transactions via mobile phones … In early 2016, Yijintong will support mobile phone online account opening. After that, new users will be able to establish Shanghai Gold Exchange’s “Gold Account” business on their mobile phones directly, and avoid the step of visiting stores. It has brought convenience for personal investors to participate in gold and silver transactions.

Investors can log into Yijintong through mobile phones to conduct daily and nightly market transactions and search, utilizing all-day mobile phone services for gold and silver transactions, allowing Yijintong to become a mobile phone gold and silver investment edge tool that integrates functions and practicability, which also helps investors to do well in both work and financial management.

Exhibit 7.

SGE app qr code

Exhibit 8. Download methods: iOS and Android mobile phone users can scan the QR code and open it in the browser to download and install directly.

The China Gold Association (CGA) makes yearly estimates of direct purchases at the SGE. In their Gold Yearbook 2013 direct purchases (net investment) were assessed at 1,022 tonnes, computed as SGE withdrawals minus consumer demand. The CGA neglects any distortion flowing through the SGE hence I stopped using their methodology. Have a look at the screenshot below.

CGA Gold Yearbook 2013 demand
Exhibit 9. CGA Yearbook 2013: framed in black is total demand 2013 in tonnes (Red = jewelry manufacturing, blue = small bar production (sold at ie banks) , purple = industrial material, turquoise = coin manufacturing, yellow = other, green = net investment)

Unfortunately me personally can’t exactly compute true Chinese gold demand, as I don’t have business relationships with all Chinese refineries to gauge disinvestment supply flowing to the SGE. In any case, these are the formulas:

True Chinese demand = net import into the Chinese domestic market1 + scrap + disinvestment + domestic mine output

Although a tad complex, the exact formula including SGE withdrawals is:

SGE withdrawals = net import into the Chinese domestic market1 + (domestic mine output – domestic mine output that not flows to the SGE) + (scrap – scrap that not flows to the SGE) + disinvestment + distortion + (an amount equal to “domestic mine output that not flows to the SGE + scrap that not flows to the SGE” being disinvestment or distortion)

Although not all scrap as disclosed by GFMS ends up at the SGE, it’s definitely all genuine supply and therefore useful in the first formula above. Same goes for domestic mine output.

The part of scrap and domestic mine output that doesn’t travel to the SGE (although being genuine supply) must be replaced by either disinvestment or distortion at the SGE (exhibit 4). Note, in the knowledge direct purchases from the SGE are immense in China (exhibit 9) we can safely assume that disinvestment flows to the SGE are sizable as well.

My new insights unfortunately do not imply that we can make a more precise estimate of true Chinese gold demand. However, I think the best approach is to set the lower bound of true Chinese gold demand at net import1 + mine output + scrap. While I think true demand is likely higher because disinvestment to the SGE can be significant.

Sadly because disinvestment is unknown, distortion is also unknown (exhibit 4)

Let’s return to our discussion with GFMS. The big question is of course, how can total Chinese gold demand by GFMS be 867 tonnes, in a market where mining output accounted for 450 tonnes (source), net imports by my calculations accounted for 1,575 tonnes1, and there is also scrap and disinvestment supply, but export is prohibited and the premium on gold in China was positive throughout the whole year?! This cannot be.

Shanghai Gold Exchange SGE gold premium 2015
Exhibit 10.

I would like to show a real life example to illustrate what’s going on the Chinese gold market: In 2015 the Chinese stock market (the Shanghai Composite Index) declined by 40 % from June till August. Seeking for a safe haven the Chinese bought physical gold en masse directly at the SGE; some weekly withdrawals in July, August and September transcended 70 tonnes. The gold was of course sourced by imports (look at the premium in exhibit 10), yet GFMS doesn’t consider this to be demand.

SCI vs SGE withdrawals
Exhibit 11. 

The Arguments

Although true Chinese demand cannot be less than SGE withdrawals minus distortion, GFMS pretends their arguments can explain the gigantic gap between SGE withdrawals and consumer demand. Illustrated in the chart below.

Chinese domestic gold market S&D 2013 - 2015
Exhibit 12.

All arguments presented can only explain the size of distortion (exhibit 4), not the difference between SGE withdrawals and consumer demand! Actually, I should stop writing here, but I won’t. Let’s briefly go through these arguments to see if they make any sense.

The chapter in question, “A Review And Explanation Of How China’s SGE’s Withdraw Numbers Are Impacted By Other Trading Activities” (Gold Survey 2016), surprisingly lists three new arguments…

  • Tax avoidance (page 56).
  • Financial statement window dressing (page 58).
  • Retailers selling unsold inventories directly to refiners (page 58)

…and one old argument:

  • Gold leasing activities and arbitrage opportunities (in China gold is money at lower cost) (Gold Survey 2016, page 57, Gold Survey 2015, page 78)

Given the fact GFMS has gone all out in this chapter one would assume it to be complete. But strangely, arguments presented in prior Gold Survey reports and at forums have been abandoned. The following arguments were presented by GFMS in recent years:

  • Wholesale stock inventory growth (Augustus 2013) (Gold Survey 2014, page 88)
  • Arbitrage refining (Gold Survey 2014, page 88) (Reuters Global Gold Forum 2015)
  • Round tripping (Gold Survey 2014, page 88) (Gold Survey 2015, page 78, 82)
  • Chinese commercial bank assets to back investment products. “The higher levels of imports, and withdrawals, are boosted by a number of factors, but notably by gold’s use as an asset class and the requirement for commercial banks to hold physical gold to support investment products.” (Gold Survey 2015, page 78).
  • Defaulting gold enterprises sent inventory directly to refiners and SGE (Gold Survey 2015 Q2, page 7)

What happened to arbitrage refining as described by GFMS Senior Precious Metals Analyst Samson Li at the Reuters Gold Forum in 2015? Has this arbitrage opportunity ever existed or did the market change and now the opportunity is closed? I never thought this argument was very compelling. Maybe GFMS changed its mind on arbitrage refining.

What happened to the round tripping of gold between Hong Kong and Shenzhen, put forward in the Gold Survey 2014 and 2015 as a reason that inflated SGE withdrawals? Did criminals stop using this scheme, or did GFMS find out it never inflated withdrawals because gold flows through Free Trade Zones are separated from the Chinese domestic gold market and the SGE system1? In several posts I’ve extensively shown round tripping does not inflate SGE withdrawals, for more information click here.

What happened to the argument Chinese commercial banks buy and withdraw gold at the SGE to back investment products they offer to customers, a practice which boosts import and withdrawals but was not considered demand by GFMS? Or is it demand now, as GFMS dropped this argument from the list? Ok, gotcha.

Now briefly about the new arguments listed by GFMS in the GS2016:

  • Tax avoidance.

The definition of tax avoidance is that it’s a legal way to pay as little tax as possible. However, the scheme GFMS describes in the GS2016 report is tax evasion, which is highly illegal, and worst case the perpetrator can suffer life imprisonment. This is not some legal loophole as GFMS purports (page 56).

We initially became aware of the scheme in 2013 when it first emerged, but based on information gathered from our contacts, the number of industry participants mushroomed in 2014 and 2015 as other traders became aware of the potential loophole.

By writing the scheme is a way of tax avoidance and a loophole GFSM is misleading their readers. In addition, this illegal scheme did not emerge in 2013. The tax rules are now the same as when the SGE was erected in 2002. In fact, if you click here, you can read an article about the same crimes in 2009. But as mentioned before, we’ll save the details for a forthcoming post, when we’ll also address “financial statement window dressing” and “retailers selling unsold inventories directly to refiners”.

About gold leasing that would inflate SGE withdrawals, I’ve written numerous blog posts about this in the past. Best you can read my post Chinese Commodity Financing Deals Explained. In all the posts I’ve written over the years on the subject I’ve stated that the gold leased is not likely to leave the SGE vaults except when the gold will be used for jewelry manufacturing (which is genuine demand). Effectively, all the gold leasing by enterprises, investors and speculators to acquire cheap funding happens within the SGE system and do not inflate withdrawals. Ironically, in the latest World Gold Council (WGC) report it’s written [brackets added by me]:

Over recent years we have observed a rising number of commercial banks participating in the gold leasing market. … It’s estimated that around 10% of the leased gold leaves the SGE’s vaults. The majority is for financing purposes and is sold at the SGE [and stays within the SGE vaults] for cash settlement.

So, I hope to have clarified why according to my estimates true Chinese gold demand in 2015 must have been north of 2,250 tonnes (import 1,575 tonnes, mine output 450 tonnes, scrap supply 225 tonnes). More details in the next post when we will discuss the tax scheme.


1. Estimating China’s net gold import is difficult. For one, because China’s customs department doesn’t publicly disclose its cross-border trade statistics for gold so we depend on bullion export data (HS code 7108) from the rest of the world. Data from Hong Kong, the UK, Switzerland, the US, Canada and Australia is publicly available, but for example data from South Africa is not. Therefor provisional data on China’s net import is not always fully accurate. Only when the CGA publishes the import amount in their Gold Yearbook can we know for sure. My estimate is 1,575 tonnes for 2015.

Net bullion exports to China in 2015: Hong Kong 861 tonnes, Switzerland 292 tonnes, the UK 285 tonnes, the US 6 tonnes, Japan 5 tonnes, Australia 124 tonnes, Canada 3 tonnes.

In China gold is not allowed to be exported from the domestic market (SGE Main Board). However, gold is allowed to be imported into / exported from China through processing trade, usually done in Free Trade Zones. This is the only way gold can be exported from China. Note, processing trade flows are completely separated from the Chinese domestic gold market. For detailed information read my post Chinese Cross-Border Gold Trade Rules.

In order to track how much gold China is net importing, it’s necessary to net out bullion export to China by foreign countries, with import from China by foreign countries (HS code 7108). Although, it’s also possible that bullion is imported into China through processing trade and exported as jewelry (China has a vast jewelry manufacturing industry), which falls under a separated trade category (HS code 7113). Suppose, a jewelry manufacturer in Shenzhen import 2 tonnes of gold from Hong Kong under HS code 7108 through processing trade, processes the gold into jewelry to subsequently export the finished products back to Hong Kong under HS code 7113. This would blur our view on net bullion import by China, however I neglect this phenomenon in my calculations.

The fine gold content in jewelry exported from China (HS code 7113) is very difficult to measure as the total value of the products shipped also contain other precious metals, gems and includes the fabrication costs. Hence, the value and weight of jewelry exported from China does not reveal the fine gold content. The reason why I do not adjust net bullion inflows into China by jewelry outflow is because the gold content in jewelry exported from China is roughly offset by imports of gold doré or gold as a by product in ores and concentrates.

For example, the most recent CGA Yearbook in my possession, covering calendar year 2014 (exhibit 13), states “Chinese domestic and overseas gold mining output” was 512.775 tonnes. In the same report it’s mentioned “domestic mining output” accounted for 451.799 tonnes, implying overseas mine supply accounted for 60.976 tonnes. And thus, I net out overseas mining imported into China (60.976 tonnes) against jewelry exported from China. If I find more information on Chinese cross-border gold trade flows I will adjust my methodology accordingly.

Exhibit 13. Screenshot taken from my hard copy of the CGA Yearbook 2014. We can see framed in blue is “domestic and overseas mine supply”, framed in red is “gold import” and framed in green is “total supply”. Total supply, as disclosed by the CGA, equals SGE withdrawals for 2014, likewise it did for the years 2007, 2008, 2009, 2010, 2011, 2012 and 2013. 

Last but not least, gold can be imported through processing trade into the Shanghai Free Trade Zone (SFTZ) where the Shanghai International God Exchange (SGEI) vaults are located. Potentially, this gold in SGEI vaults, once sold to foreigners is withdrawn and exported abroad (inflating SGE withdrawals). However, a source at ICBC has indicated to me that regarding physical flows the SGEI is mainly used by Chinese domestic banks to import gold into the Chinese domestic market, at least this was the case until December 2015. So I don’t see a possibility there were exorbitant large volumes of gold in SGEI vaults in 2015, or have been withdrawn and exported.

The only noteworthy imports from China (the SGEI) I have observed are by India, which has taken in 370 Kg during 2015 (source Zauba), and by Thailand that presumably bought 7 tonnes (source COMTRADE).

Screen Shot 2016-08-13 at 11.20.26 am Screen Shot 2016-08-13 at 11.21.56 am Screen Shot 2016-08-13 at 11.22.20 am Screen Shot 2016-08-13 at 12.11.32 pmExhibit 14.

iAu9999 & iAu9999 OTC SGE
Exhibit 15. Weekly trading volume of the most popular SGEI contract iAu99.99, traded on-exchange and in the OTC market.

For more information on the SGEI read my posts, Workings Of The Shanghai International Gold Exchange and What Happened To The Shanghai International Gold Exchange?

2. For the sake of simplicity I have categorized under “distortion” everything that is not true demand, namely: process scrap, stock inventory change, arbitrage refining (if it exists), the VAT scheme, smuggling and SGEI withdrawals.

Chinese Gold Demand 973t In H1 2016, Nomura SGE Withdrawals Chart False

Chinese wholesale gold demand, as measured by withdrawals from the vaults of the Shanghai Gold Exchange (SGE), reached a sizable 973 metric tonnes in the first half of 2016, down 7 % compared to last year.

Although Chinese gold demand year to date at 973 tonnes is slightly down from its record year in 2015 – when China in total net imported over 1,550 tonnes and an astonishing 2,596 tonnes were withdrawn from SGE designated vaults – appetite from the mainland is still the greatest of all single nations worldwide. At the same time the mainstream consultancy firms (World Gold Council, GFMS, Metals Focus) continue portraying Chinese gold demand to be roughly half of SGE withdrawals, as these firms measure “gold demand” merely at retail level which excludes any direct purchases at the SGE by institutional and individual investors. But to reassure you, Chinese wholesale gold demand still equals SGE withdrawals. 

In the month of June (2016) SGE withdrawals accounted for a robust 139 tonnes, although this was down 29 % from June last year. The reason being for “somewhat subdued” Chinese gold demand in recent months is that the price of gold has risen strongly over this time horizon and the Chinese tend to buy gold when its price goes down, in contrast to Western investors that buy gold when the price goes up. From 1 June until 30 June 2016 the price of gold in US dollars jumped by 9 % from $1,214.70 to $1,325.76. Over the first six months of 2016 the price of gold exploded by 25 % (from $1,061.5 on 1 January 2016). So, since January this year when the price of gold started to rise, the Chinese actually stepped down their gold purchases while Western demand, which can be roughly measured by the net flow in/out of the UK, went up impressively.

Let us have a look at a few charts to come to grips with what’s going on in the Chinese (and international) gold market. Below, we can see a chart showing monthly SGE withdrawals plotted against the end of month price of gold in yuan per gram. In recent years, whenever the price of gold goes down the Chinese step up their purchases (buying the physical supply coming from the West) and whenever the price of gold goes up the Chinese slow their purchases. 

Shanghai Gold Exchange SGE withdrawals June 2016
Since January 2016 when the gold price started rising, SGE withdrawals started declining. Note, for spotting trends, gold bought at the SGE does not have to be withdrawn immediately.

By looking at a weekly SGE withdrawals chart (from before January 2016) we can see the trend just described – “the Chinese tend to buy more gold when the price goes down” – in a more granular fashion. Have a look below.

Shanghai Gold Exchange SGE weekly withdrawals
The SGE published weekly withdrawal data until January 2016.

In contrast to Chinese gold buying behaviour, let us have a look at gold demand from the West. Our proxy for Western demand is the net flow in/out of the UK where the London Bullion Market (LBMA) and the world’s largest ETF’s such as GLD store physical gold. At the beginning of 2016 (when the price of gold started to rise) the direction of the flow has reversed sharply, from the UK being a net exporter to being a net importer.

UK Gold Trade 2012 - June 2016

From being a large net gold exporter in 2013, 2014 and 2015, the UK is now one of the largest net importers. In April 2016 the UK net imported 195 tonnes of gold – while export to China was nil.

If we look at a chart that reflects the net flow of gold into the UK versus the gold price, we can clearly see the correlation. A declining gold price (blue line) coincides with the UK net exporting gold (black line) and vice versa. 

UK Gold Trade 2012 - June 2016 vs goldprice

The impressive gold rally year to date, and the accompanied massive growth in GLD inventory in London, predicts sustaining net gold imports by the UK in May and June. In a forthcoming post we’ll discuss more thoroughly how above ground gold stock is moving between which nations and how this correlates to the price of gold.

International merchandise trade statistics always lag a few months, so I don’t know exactly the total amount of gold China has net imported in H1 2016. That I know of, China has net imported 368 tonnes year to date, according to trade data from Hong Kong covering January-April, the UK covering January-April and Switzerland covering January- May. Australia’s export data is not clear yet. If we project the pace of imports to to six months, China has “at least” imported 512 tonnes of gold in H1 2016.

Supply to the SGE can only come from import, domestic mine output or scrap/disinvestment. As, import accounted for 512 tonnes and domestic mine supply for 225 tonnes, consequently scrap/disinvestment through the SGE must have been approximately 236 tonnes in H1 2016.

Import + mine output + scrap/disinvestment = SGE withdrawals

SGE withdrawals – import – mine output = scrap/disinvestment

973 – 512 – 225 = 236

By using our preliminary estimate of 512 tonnes for China’s net import in H1 2016 and mine output at 225 tonnes, there are currently an estimated 18,444 tonnes of gold within China. Assuming the PBOC has accumulated about 4,000 tonnes by now which has not been supplied through the SGE, that is. For a detailed explanation how I conceived this estimate please read my post “PBOC Gold Purchases: Separating Facts from Speculation”.

Total Chinese gold reserves june 2016

If my speculative estimate of PBOC holdings would be incorrect, and China’s central bank holds what is officially disclosed at roughly 1,800 tonnes, there are currently an estimated 16,244 tonnes of gold within China.

Nomura’s SGE Withdrawal Data Is False

Since I’ve been publishing SGE withdrawals and its relation to Chinese gold demand many others have jumped the bandwagon, though some more successful than others. A few days ago I stumbled upon a “SGE withdrawals chart” from Nomura research with false data.

Courtesy Nomura.

In Nomura’s chart it’s shown that withdrawals from the vaults of the SGE in the first five months of 2016 accounted for 4,425 tonnes. Which of course is false. If that would be true, China should have imported about 3,800 tonnes in five months. No, that did not happen.

What Nomura did is grab the “cumulative delivery amount” from the Chinese Market Data Monthly Reports, instead of the “cumulative load-out volume”. The latter is how the SGE refers to “withdrawals” in English. As I’ve written previously the “delivery amount” is not the same as “load out volume”. The “delivery amount” reflects the volume of gold that changes ownership inside the vaults, computed as the sum of the trading volumes in physical products and the contract delivery volumes of deferred products, whereas “load out volume” tells to the amount of gold that is withdrawn from the vaults.

Let’s have a look at the Chinese Market Data Monthly Report from May, which Nomura used for its withdrawal data for January-May 2016 (“5M16” in their chart).

Screen Shot 2016-07-06 at 1.57.34 pm
Courtesy SGE. Red numbers added by Koos Jansen.

We can see that at number 4 the “cumulative delivery amount” notes 4,425,035.28 Kg, which is exactly what Nomura shows in its chart as “withdrawn”.

By and by, the “cumulative delivery amount” is counted bilaterally. Effectively, half of this amount (2,212,517.64 Kg) is how much physical gold changed ownership inside SGE designated vaults from January until May 2016.

At number 8, we see the actual amount of gold withdrawn from the vaults over this period (counted unilaterally). In the first five months of 2016 SGE withdrawals accounted for 835 tonnes.

Below is the full explanation of the Chinese trade table.

1Delivery amount this month, the sum of the trading volumes in physical products and the contract delivery volumes of deferred products for the reported month, counted bilaterally in Kg.

2) Trading volume this month, the sum of all trading volumes in physical and deferred products for the reported month, counted bilaterally in Kg.

3Delivery ratio this month, the proportion of the delivery amount to the total trading volume of both physical and deferred products for the reported month (1 divided by 2).

4Cumulative delivery amount, the sum of all monthly delivery amounts from the beginning of the year to the statistical time point, counted bilaterally in Kg.

5Cumulative trading volume, the sum of all trading volumes in physical and deferred products from the beginning of the year to the statistical time point, counted bilaterally in Kg.

6Cumulative delivery ratio, the proportion of the cumulative delivery amount to the cumulative trading volume of both physical and deferred products from the beginning of the year to the statistical time point (4 divided by 5).

7Load-out volume this month, the amount of gold withdrawn from the vaults for the reported month, counted unilaterally in Kg.

8Cumulative load-out volume, the amount of gold withdrawn from the vaults from the beginning of the year to the statistical time point, counted unilaterally in Kg.

SGE Gold Trading Volume 2015 Up 84 % Y/Y Due To International Board

In two parts I will present an overview of the Chinese gold market for calendar year 2015. In this part we’ll focus on Shanghai Gold Exchange trading volumes. In the next post we’ll focus on physical supply and demand flows in Chinese gold market in 2015.

First, let us quickly assess the core volume data of the largest precious metals exchanges in China and the US. Physical and derivative gold trading at the Shanghai Gold Exchange (SGE) in 2015 reached 17,033 tonnes, up by 84 % from 9,243 tonnes in 2014. Gold futures trading at the Shanghai Futures Exchange (SHFE) in 2015 accounted for 25,421 tonnes, up 7 % from 23,750 tonnes in 2014. Consequently, total wholesale trading volume in China (SGE + SHFE) was 42,454 in 2015, up 29 % year on year. In New York at the COMEX total gold futures volume reached 128,844 tonnes for the year 2015, up 3 % from a year earlier. COMEX trading volume was three times as large as the total volume in China.

COMEX vs SGE & SHFE gold volume 2015 pie chart

It’s unknown how much gold is traded in the Over-The-Counter London Bullion Market. However, a survey conducted by the LBMA in 2011 pointed out approximately 680,783 tonnes of gold per year change hands through the London based market.

All tonnages mentioned in this post are counted single-sided.

The Shanghai Gold Exchange

There are a few more interesting data points to be found in SGE trading for 2015 when examining the developments of the specific contracts.

At the SGE two types of gold products (/contracts) can be traded: physical products and deferred products. The physical contracts traded on the Main Board (SGE / domestic market) are:

  • Au50g (50 gram gold bar, 9999 fine)
  • Au100g (100 gram gold bar, 9999 fine)
  • Au99.99 (1 Kg gold ingot, 9999 fine)
  • Au99.95 (3 Kg gold ingot, 9995 fine)
  • Au99.5 (12.5 Kg gold ingot, 995 fine)

The physical contracts traded on the International Board (SGEI / international market) are:

  • iAu100g (100 gram gold bar, 9999 fine)
  • iAu99.99 (1 Kg gold ingot, 9999 fine)
  • iAu99.5 (12.5 Kg gold ingot, 995 fine)

The contracts above cannot be traded on margin and are settled (/delivered inside SGE(I) designated vaults) immediately (T+0), therefor they embody pure physical trading.

The deferred contracts (only traded on the Main Board) are:

  • Au(T+D) (1 Kg per lot, delivery in 3 Kg or 1 Kg ingots)
  • Au(T+N1) (100 gram per lot, delivery in 1 Kg ingots)
  • Au(T+N2) (100 gram per lot, delivery in 1 Kg ingots)
  • mAu(T+D) (100 gram per lot, delivery in 1 Kg ingots)

Because the deferred contracts are traded on margin and there is no fixed delivery date, these derivative products embody paper trading.

All SGE contracts can be traded competitively over the Exchange, but the physical contracts can also be negotiated bilaterally in the Over-The-Counter (OTC) market and then settled through the SGE system. The SGE publishes the volume of these OTC trades.

The most traded contract on the Exchange in 2015 was the deferred product Au(T+D). In total Au(T+D) volume accounted for 5,648 tonnes, up 30 % from the previous year. The second most traded contract was the physical product Au99.99, of which 3,465 tonnes changed hands, up 65 % from 2014 - although, if we include OTC trading total Au99.99 volume for 2015 reached 6,998 tonnes, which would make it the number one contract.

Shanghai Gold Exchange Trading Volume 2015
The contracts Au99.5 and iA99.5 are not included in the chart, as the products have not been traded. This underlines the PBOC, that would prefer to buy 12.5 Kg bars, is not buying gold through the SGE.

Shanghai Gold Exchange Yearly Trading Volume 2002 - 2015

Physical trading (including OTC activity) at the SGE in 2015 accounted for 9,745 tonnes (57%), versus 7,288 tonnes in paper trading (43 %).

The growth in total gold trading at the SGE in 2015 was the strongest since the financial crisis erupted in 2008. According to my analysis one reason for this has been the opening of the Shanghai International Gold Exchange (SGEI) in September 2014.

The SGE system services gold trading for the domestic Chinese gold market. This gold traded over the SGE system is prohibited from being exported. The SGEI is a subsidiary of the SGE located in the Shanghai Free Trade Zone, where international members of the Exchange can import, trade and export gold. In terms of physical gold flows the SGE and SGEI are separated venues. For more information please read my previous post, “Workings Of The Shanghai International Gold Exchange”.

On the surface it looks as if the SGEI has been a failure. The most traded contract at the International Board is iAu99.99. At the start of 2015 iAu99.99 trading was weak and after a short peak in April, volume came down to practically nil throughout the middle and the end of the year. Hence, most analysts stated the SGEI was dead. There are two important points that undermine this statement.

The first point is that iAu99.99 can be traded in the OTC market. When it appeared that trading of iAu99.99 was dying out at the Exchange, in the OTC market activity continued. There is no constant trading in iAu99.99 in the OTC market, but the volumes are significantly higher than iAu99.99 trading over the Exchange (see the chart below).

iAu99.99 SGEI volume

Tellingly, the iAu99.99 trades in the OTC market are all performed in giant batches of 100 or 1000 Kg. Have a look at the data labels in the chart below. We can see that all weekly OTC iAu99.99 volumes are in sizes one hundred (blue bars) or one thousand (red bars) 1 Kg bars. For example, look at the week that ended 3 July 2015, when exactly 73,000 Kg’s were traded. In theory 20,855 Kg’s were traded on Monday and 52,145 Kg’s on Thursday, aggregating to 73,000 Kg’s in total for the week. Though, this coincidence cannot have occurred each and every week. More likely the iAu99.99 traders in the OTC market always buy and sell per 100 or 1000 Kg’s. No other SGE or SGEI contract shows this bulky trading pattern.

Weekly iAu9999 OTC Trading Volume

The second point is that international members of the Exchange are not only allowed to trade the contracts on the International Board, they’re also allowed to trade the domestic contracts, they’re just not allowed to withdraw the metal from domestic vaults. The international members that focus on arbitraging any price differentials between the US and China will prefer the most liquid contracts on the Exchange. So, for this purpose the international members would trade Au99.99 and Au(T+D). Sources at the SGE confirmed to me that indeed international members are trading Main Board contracts.

If we look at the next chart, we can see that since the inception of the SGEI in September 2014 total SGE volume (including domestic, international, physical and deferred contracts) increased significantly. My conclusion is that the gateway of the SGEI has increased liquidity at the Exchange in Shanghai and enhanced the connection between the Chinese and Western gold markets.

Total Weekly SGE Trading Volume

I realize the system of the SGE and SGEI, how trading and physical gold flows are divided, is not easy to understand. The best I can do to clarify this is to present the diagram furnished by the SGE showing how trading in all contracts by all customers is organized (see below). In the next post we’ll examine the physical gold flows going through China and the Shanghai Free Trade Zone.

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Courtesy SGE.

Note, domestic members/customers are allowed to use onshore renminbi to trade all products on the Main Board, but are also allowed to use onshore renminbi to trade all products on the International Board (although load-in and load-out metal from the vaults is prohibited). In turn, international members are allowed to use offshore renminbi to trade all contracts on the International Board, but are also allowed to use offshore renminbi to trade most contracts on the Main Board (although load-in and load-out metal from the vaults is prohibited).

Kazakhstan & China Join Forces In Gold Market

Silk Road Gold Trading Kicks Off

The other day I bumped into a small but potentially important news item on the website of the Shanghai Gold Exchange. The article was published in Mandarin, of course, as the Chinese (authorities) hardly ever publish valuable information in English – most articles published in English have been intentionally written to communicate what the State Council wants the West to hear. In the article it’s described a financial delegation from Kazakhstan visited the Shanghai Gold Exchange (SGE) to discuss cooperation in gold trading along One Belt One Road (OBOR), also referred to as the new Silk Road, that reaches over the whole Eurasian continent. From the SGE (exclusively translated by BullionStar):

A group led by Kairat Kelimbetov, the Chairman of the Board of Directors of the Kazakhstan International Financial Center, visited the Exchange

At noon on 26 February 2016 a group led by Kairat Kelimbetov, President of the Astana International Financial Center and former President of the National Bank of Kazakhstan, visited the Shanghai Gold Exchange and held talks with President Jiao Jinpu. Both parties reached consensus on strengthening cooperation and seeking development in the gold market under the “One Belt One Road” project. Zuo Qihan, Kazakhstan consulate general in Shanghai, Shen Gang, Vice General Manager of the Exchange and Zhuang Xiao, CTO, attended the meeting.

Although the article lacks any detail, we can discover its potential impact if we study the financial and political backdrop.

Kelimbetov has an impressive track record. Previously he served as the Minister of the National Economy, Deputy Prime Minister and Governor of the National Bank of Kazakhstan. Currently, he’s the head of the brand new Astana International Financial Center (AIFC) that was officially launched in January 2016, aimed to become one of the top 10 financial centers in Asia and one of the top 30 financial centers in the world by 2020. The government of Kazakhstan contributes full support to the AIFC .

Kairat Kelimbetov and Jiao Jinpu at the SGE
26 February 2016, on the left SGE President Jiao Jinpu, in the middle AIFC President Kairat Kelimbetov. Courtesy SGE.

The main language spoken at the AIFC is English and the center includes an independent court for financial and investment disputes using English law. Kenneth Rogoff, Professor at Harvard University and former chief economist at the IMF, has said with English law at the basis the AIFC will be a game changer.

The AIFC decree signed in May 2015 at the Astana Economic Forum (AEF) by the President of Kazakhstan, Nursultan Nazarbayev, commands the National Bank of Kazakhstan and the Kazakhstan Stock Exchange to relocate from the city of Almaty to Astana. The AIFC will be installed on the premises of the EXPO 2017 starting from 1 January 2018.

At the AEF Nazarbayev stated the financial crisis that broke out in 2008 is systemic and will only end when the key cause is eliminated: the profound accumulated imbalances in the currency markets. He added that these hidden, latent roots of the crisis have spawned currency wars and economic wars in the form of sanctions hurting many countries. Nazarbayev said, “This is what generates an increase in confrontation between East and West, the U.S. and NATO against Russia and China, … deep reforms are needed for sustained economic growth.”

Nazarbayev may 2015 AEF
Nazarbayev speaking at the AEF 22 May 2015.

Nazarbayev has always been a vocal critic of US supremacy and an advocate of gold. Under his guidance, in 2011 the National Bank of Kazakhstan has taken the pre-emptive right to buy all domestic gold mine output to strengthen its international reserves and develop the local gold industry. In 2012 a (third) large gold refinery, Tau-Ken Altyn, was erected as one of the key projects of the Astana Industrial Park, to ensure all domestic mine output can be refined in Kazakhstan.

President Nazarbayev paid a visit to the Tau-Ken Altyn refinery in December 2013, as can be seen in the video below starting at 1:13. Tau-Ken Altyn can produce 12.5 Kg investment bars for the central bank, as well as 100 gram and 1 Kg bars for personal investment.

Although official documentation is lacking, from the news item at the SGE website I assume the AIFC has included the Shanghai International Gold Exchange (SGEI) for servicing gold trading in renminbi – supporting the internationalization of the renminbi.

It’s unclear if the AIFC has exclusively attracted the SGEI platform for gold trading. On 11 March 2016 Kelimbetov visited London where he held a meeting with the heads of UK government institutions, large investment banks (Goldman Sachs, Morgan Stanley, UBS) and international financial organizations to discuss the AIFC’s progress. Though, Kazakhstan is likely to prefer cooperating with its Chinese partner in gold business, as both nations share a common interests of making a fist against US dollar domination.

The central banks of Kazakhstan and China are among the most aggressive gold buyers in the world. Since 2010 the official gold reserves of Kazakhstan have grown from 67 metric to 222 tonnes. In turn, over the same time horizon China has increased its official gold reserves from 1,054 tonnes to 1,762 tonnes, according to official statistics – it’s thought China’s central bank has significantly more gold than it publicly discloses.

Kazakhstan & China Gold Reserves 2011 2015

The central banks of numerous other countries in (central) Asia are buying gold as well, in example Russia, Belarus, Tajikistan, and Kyrgyzstan, sharing an objective to diversify foreign exchange reserves and unwind the US dollar hegemony.

But increasing their official gold reserves is not all these countries do, it’s part of something bigger. In recent years a vast movement of economic collaborations between countries in Eurasia has unfolded. One of these collaborations is the Silk Road economic project (/OBOR) that was launched in 2013. Partially funded by China’s foreign exchange reserves the project focuses on connectivity and cooperation among countries in Asia, Europe and Africa. Aside from its independent activities OBOR also provides the structure to connect other collaborations, of which the most relevant ones are:

  • The Shanghai Corporation Organization (SCO). The SCO is a political, economic and military alliance, comprising the member states Russia, China, Kazakhstan, Tajikistan, Uzbekistan and Kyrgyzstan, that was launched in 1996.
  • The Eurasian Economic Union (EEU). Launched in 2014 the EEU members Russia, Belarus, Kazakhstan, Armenia and Kyrgyzstan now form a space that is modeled on the European Economic Community.
  • The Asian Infrastructure Investment Bank (AIIB). The AIIB is an international financial institution, erected to support the building of infrastructure in the Asia-Pacific region, launched in 2015 counting 57 prospective founding members. Most Asian (except Japan) and European countries participate in the AIIB.

If we look closely we can observe that China is slowly pushing for more integration of the clubs mentioned above with OBOR. For example, in May 2015 Xi Jinping and Vladimir Putin signed a decree on cooperation in tying the development of the EEU with OBOR and in December 2015 the first discussions were held to integrate the SCO with OBOR. (Chinese state press agency Xinhua has a dedicated Silk Road web page that covers developments regarding OBOR and the SCO, EEU and AIIB.)

Kazakhstan recently opened a logistics terminal in Lianyungang, China, and completed the construction of its Zhezkazgan-Beineu railway to create a better connection for China through Kazakhstan to the Caspian seaports. “All these projects are aimed at increasing the transit potential of both our country and the whole of the Eurasian Economic Union,” said Nazarbayev at the AEF on 22 May 2015. “This is the new Silk Road. Forty countries have showed an interest in free trade with the Eurasian Economic Union. But we must not stop there. I propose to create a new … Eurasian transcontinental corridor.”

Screen Shot 2016-03-15 at 11.23.11 pm
Kazakhstan has a strategic position in Eurasia.

Coincidentally, also on 22 May 2015 the Silk Road Gold Fund was launched at a conference in Xi’an, China, with the subject of “Serve the New Strategy of the Silk Road, Lead the New Development of Gold”. From iFeng we can read (exclusively translated by BullionStar):

Representatives from gold and financial institutions talked freely about bringing gold’s superiority into full play, seizing the historic and strategic opportunity of One Belt One Road [OBOR], strengthening bank-enterprise cooperation and financial-industrial combination, and leading the transformation and upgrading of the gold industry under the economic background of the new normal.

Time will tell to what extent the cooperation between the SGEI and the AIFC will execute what this quote describes. Namely, increasing gold business in the economies along the Silk Road.

A few days later in May 2015 China unveiled the Silk Road Gold Fund to the English-speaking world. From Xinhua:

The fund, led by Shanghai Gold Exchange, is expected to raise an estimated 100 billion yuan in three phases.

…Among the 65 countries along the routes of the Silk Road economic belt … there are numerous Asian countries identified as important reserve bases and consumers of gold.

…About 60 countries have invested in the fund, which will in turn facilitate gold purchase for the central banks of member states to increase their holdings of the precious metal, …

I’m not sure if the National Bank of Kazakhstan will buy its gold through the SGEI anytime soon, more likely some of Kazakhstan’s gold production will be sold through the Chinese exchange.

From all information presented above the intensions of China and numerous Asian countries with respect to gold and the Silk Road are clear. Through OBOR China will not only use its foreign exchange reserves for infrastructure in Eurasia to boost growth and strengthen economic ties and in the region, additionally, gold business is developed and gold is promoted as a key reserve currency.