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.
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 withoil 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.
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:
As shown above China hasn’t announced anything but an oil-yuan futures contract. Gold has nothing to do with it.
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.
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.)
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.
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:
Industrial demand (August 2013)
Stock movement change (August 2013)
Round tripping (April 2014)
Leasing (April 2014)
Official purchases (April 2014)
Recycled distortion (November 2014, February 2015, March 2016)
Export (May 2015)
Chinese commercial banks’ balance sheets
Financial statement window dressing (March 2016)
Retailers selling unsold inventories directly to refiners (March 2016)
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.
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…
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.
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).
Some people see withdrawals on the Shanghai Gold Exchange as a proxy for Chinese demand. Do you think this is valid?
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 thevalue-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” inthis 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.
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(andSGE 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.
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.
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 12,183tonnes 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.
Last week the Shanghai Gold Exchange (SGE) launched a new English website to offer international customers more information and tools on trading gold in renminbi through its subsidiary in the Shanghai Free Trade Zone the Shanghai International Gold Exchange (SGEI). BullionStar took the opportunity to translate a speech by a Teng Wei, Deputy General Manager of the SGEI, named “How China’s Gold Market Can Help The RMB Achieve International Status” that was held at the Renminbi World summit in Beijing on the 29th and 30th of November 2016. In the speech Teng Wei outlined his vision for the SGEI going forward regarding renmibi (RMB) internationalization, connecting the onshore and offshore renminbi market and increasing gold market share.
My comment before you read the translation:
1) In the financial blogosphere the general perception is that the SGEI has been a failure since it was launched in September 2014. This analysis is based on the assumption that the trading volume of the most popular SGEI contract (1 Kg 9999 – iAu99.99) has been tepid for two years now. But this analysis neglects two important elements.
First, iA99.99 can be traded competitively “on Exchange”, but also in the OTC market. The OTC possibility is hardly known by commentators in the English world, though the related volumes are significant. Have a look at the next chart in which I’ve plotted iAu99.99’s weekly trading volume “on Exchange” and in the OTC market. Clearly iAu99.999 is traded mainly in the OTC market.
Second, international customers of the SGEI can not only trade the SGEI gold contracts, but they can also trade SGE (domestic) gold contracts. Logically, as at present liquidity on the SGE is much higher than on the SGEI, many international customer that seek to trade gold in renminbi, and don’t need to export the metal, will choose to trade SGE gold contracts.
When observing total trading of all SGE(I) gold contracts, there is a clear rise in volume since the SGEI was launched.
Up till now international customers are mainly trading SGE contracts. The significant rise in trading volume of all SGE(I) contracts since September 2014 is due to the inception of the International Board (SGEI). In the second week of November 806 tonnes was traded on the SGE(I), the highest amount ever.
So the launch of the SGEI has not been a failure in my opinion – it has elevated gold trading in (offshore) renminbi.
2) Teng Wei mentions that in 2015 gold demand in China and India was 985 and 849 tonnes respectively. In the case of China this refers only to consumer demand, not institutional demand. Chinese consumer and institutional demand in 2015 combined was well north of 2,000 tonnes.
3) A gold exchange doesn’t flourish overnight. The SGE was launched in 2002; in that year its total trading volume was 22 tonnes and withdrawals accounted for 16 tonnes. Ten years later total trading volume was 3,175 tonnes and withdrawals accounted for 1,138 tonnes. In 2015 total trading volume was 17,033 tonnes and withdrawals accounted for 2,582 tonnes. The development of the SGE, becoming the largest physical gold exchange globally, took time and it can be no different for the SGEI.
Document Translation [brackets added]:
Teng Wei: China’s Gold Market Opens Up To Boost RMB Internationalization
The 2016 RMB summit was held in Beijing on the 29th and 30th of November. Deputy General Manager of the Shanghai International Gold Exchange Center Teng Wei participated in the forum and discussion on “How China’s Gold Market Can Help the RMB Achieve International Status”. He expressed that using Shanghai’s free trade zone status, investors can open trading accounts denominated in RMB and participate in trading directly through the Exchange’s international board [SGEI] that allows access to most of the precious metal products that are traded in China. The international board has developed relatively well since establishment with active participation from international members and steadily increasing trading volume.
Gold on the international board is quoted and settled in RMB, which effectively connects the RMB onshore market and offshore market. This will extend the scope of RMB usage across borders and provide a new channel for inward capital flows. It is a move that is beneficial to expand the RMB usage to steadily promote internationalization of the RMB.
The actual speech:
Ladies and gentlemen, good afternoon, I am Teng Wei from the Shanghai International Gold Exchange. I am delighted to participate in this forum organized by the Asian Bankers Association to have a chance to speak and interact with everyone about opening China’s gold market to the world and how that can help the internationalization of the RMB.
This afternoon, I would like to touch upon on three topics. The first topic is the new pattern of the internationalization of the RMB and the global gold market. China’s gold market was established in 2002 with the launch of the Shanghai Gold Exchange. If anyone is familiar with the history of China’s gold market, you will know that before the year 2002 the Chinese gold market was entirely ran by the People’s Bank of China, including the process of purchasing, allocating and storing of gold. There wasn’t a single unified market where all participants could trade at the same time. Since the year 2002, with approval of the State Council, the People’s Bank Of China developed gold spot trading on the Shanghai Gold Exchange, as well as gold futures trading and over-the-counter trading via commercial banks, etc, which formed the basis for a multi-level diversified gold market system. While the Chinese gold market was developing rapidly, the pattern of the global gold market was also having a dramatic change. As time passed, the international gold spot market was heavily concentrated in London and the international gold futures market has been concentrated in New York. However, in recent years, with the rise of gold demand in China, India and other Eastern nations, and with the exit of European and American banks from the precious metals market, it’s clear that Western gold is moving to the East. In 2015 gold demand in China and India was at 985 tons and 849 tons respectively. These figures alone account for 45% of global [consumer] gold demand. With gold demand from other markets dipping to various levels, China is not only the world’s largest gold producer and importer of gold, but has also become the world’s largest gold consumer.
Just now, I mentioned that the two main centers for gold trading are London and New York, and the current situation is Western gold flowing to the East. Everyone, have a look at some statistics that I have here, showing that just China and India alone make up over 45% of global gold demand. This was last year’s data.
Since the year 2005, when the RMB exchange rate was reformed, international investors’ willingness to trade in RMB denominated assets has also increased. This has objectively enhanced the Chinese gold market’s international status and garnered attention. In recent years, the RMB exchange rate is expected to have some changes.
The Shanghai Gold Exchange provides the important infrastructure for China’s gold market. ECB officials have mentioned that an important part of promoting the internationalization of the RMB is having a good financial market infrastructure. The exchange is also an important “all-in-one” foundation for gold transactions, clearing, delivery and storage. It serves with the commitment to provide gold investors with efficient and convenient market services. It has been 14 years since establishment of the exchange in the year 2002 and development has been rapid with annual trading volumes increasing 40% on average.
At the end of 2015 there were over 8.6 million individual accounts, over 10,000 institutional accounts and the total gold trading volume for the year reached 17,000 tonnes. The exchange was ranked as one of the largest and we firmly grasped an important opportunity for the internationalization of the RMB with the profound changes happening in the gold market. At the same time, we want to build a harmonious ecological gold market that sets a new path for the global gold market and achieve the status of being a global gold power from a large gold holding nation.
For the second point, I would like to explain how opening up China’s gold market externally to the world can help the internationalization of the RMB. To further promote and innovate China’s gold market, on 18th September 2014, the Shanghai Gold Exchange set up an international board [SGEI], open directly to foreign investors. This move has effectively connected China’s domestic gold market and the international gold market. Using Shanghai’s free trade zone, investors can open trading accounts denominated in RMB and participate in trading directly through the exchange’s international board that allows access to most of the precious metal products that are traded in China. The international board has developed relatively well since establishment with active participation from international members and steadily increasing trading volume.
As of now, the exchange has 67 international members, including most of the world-renowned gold suppliers and traders like Mr Thomas McMahon, who is also our Exchange’s member. At the end of the third quarter of 2016, the international board had recorded a total of 7,837 tonnes of gold traded, with a turnover valued at nearly 200 billion RMB. The Shanghai International Gold Exchange is the test pilot and pioneer for opening up China’s gold market to the world. It is significantly important for further increasing the capacity, expansion and international influence of China’s gold market. In addition, the international board uses RMB for settlements, producing an effective convergence of the RMB offshore and onshore markets, expanding the cross-border use of the RMB and providing a new channel for return of funds. All these points steadily promote the internationalization of the RMB and serve as a useful exploration.
For RMB denominated gold products to gain popularity outside of China, we think the prerequisite is to provide a fair offering for global gold market transactions, with reliable gold benchmark pricing in RMB, using the Shanghai Gold Exchange benchmark pricing mechanism [Shanghai Fix] for our trading platforms. The weight of the gold traded is 1 kilogram, with a fineness of no less than 99.99%. Using a price inquiry method and market volume, a balance is reached to form the benchmark price of gold measured in RMB. The price announcements will be released externally each trading day at 10:15 and 14:15.
At present, the Shanghai gold benchmark price is being used by domestic gold producers and suppliers for hedging and settlements. More and more commercial banks are also using the Shanghai gold benchmark price for gold leasing and financing as the standard. More and more products linked to the Shanghai gold benchmark will be made available.
Other than domestic usage, the Shanghai gold benchmark price is also being actively studied more and more by external markets regarding its application. In October, the exchange signed an agreement with Dubai for the right to use the Shanghai gold benchmark price and authorization was given for the Dubai gold exchange to use the Shanghai gold benchmark price as the standard for offshore RMB denominated futures. The signing of this agreement marks the use of the Shanghai gold benchmark price in international financial markets for the first time. This greatly helps to elevate the international influence of the exchange in global markets and improves the image and reputation of the RMB abroad.
For the third point, I would like to share with everyone how the Shanghai Gold Exchange acts as an important infrastructure for internationalization in three steps. As the forerunner for opening domestic markets and innovation, the Shanghai Gold Exchange cannot forget its historical mission. We are determined to take the international and market-oriented strategy.
Overall, for the internationalization process, we have three steps to take. The first step is to be open and inclusive, actively inviting foreign investors to come in. Just now, we have introduced our international board after the establishment of the Exchange and we will continue to increase publicity efforts. In accordance to high standards and multifaceted principles, we will continue to increase and expand international membership of the Exchange. Accordingly, we have carried out a variety of promotional activities in major financial hubs and countries and regions along the new Silk Road to allow more international market participants to hear the sound coming from the Chinese gold market. The exchange also takes the opportunity to actively learn from the experience of advanced international markets in the optimization of various trading systems and innovation of all kinds of trading products.
For the second step, since we have invited guests inwards, we also have to step outwards. Through cooperation and win-win situations, the gold Exchange can be promoted and step out of China. The Shanghai gold benchmark price has now taken a first step with the Dubai Gold Exchange agreement. This can be considered an ice-breaking move and serve as a cooperation model for other overseas markets and improve the recognition, branding and acceptance of the Shanghai gold benchmark price. Taking this as an opportunity, the Shanghai Exchange, together with the Chicago Mercantile Exchange (CME, COMEX), the Hong Kong Stock Exchange, the Malaysian Stock Exchange and a number of foreign exchange markets explored on long-term cooperation mechanisms that will allow foreign investors to directly participate in our gold market, in RMB denominated gold trading, standard gold settlement, and many other aspects and modes of cooperation that will increase the Shanghai Gold Exchange’s international market influence.
The third step is to realize RMB internationalization and increase global transaction on the exchange through integration and upgrades. As the international financial markets continue to merge and develop, market boundaries are increasingly blurred and we believe that market fragmentation will be removed gradually. In recent years, we can all notice that there are more and more mergers and acquisitions among major exchanges in the world. We hope to learn from the experiences of such joint stock mergers and acquisitions between global exchanges and explore the different modes of industry integration with overseas exchanges. By offering a wide range of local and overseas products through an open platform [SGEI], we hope to create a world class exchange group. The journey of the internationalization of the Shanghai Gold Exchange will epitomize the opening of China’s financial markets to the outside world and play an important part in the internationalization of the RMB. With Shanghai becoming the third most important market in the world after London and New York, the Chinese gold market will make a great contribution to the internationalization of the RMB. Thank you everyone.
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.
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.
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.
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.
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.
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.
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.
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.
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 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.
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.
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.
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.
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:
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:
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 code7108) 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.
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).
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.
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.
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:
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.
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).
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.
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.
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.
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).
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.
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 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 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.”
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.
Everything there is to know about the Chinese gold market and the true size of Chinese private and official gold demand. Start here. This post was updated in late 2017.
This post will guide you through all relevant articles that have been published on BullionStar Blogs over the years that elucidate the mechanics of the Chinese (domestic) gold market and true Chinese gold demand. If you are new to the Chinese gold market or like to refresh your memory, this post provides a staring point from where to navigate through all segments of the market you like to study. For example, Chinese gold demand metrics, the Shanghai Gold Exchange (SGE) system, Chinese cross-border gold trade rules, the “precious metals” on Chinese commercial banks’ balance sheets, the Chinese gold lease market and official gold reserves held by China’s central bank the People’s Bank Of China (PBOC).
The BullionStar blog posts that collectively clarify all facets of the Chinese gold market are titled the Chinese Gold Market Essentials. If there is anything unclear, if you have additional information or if you have a suggestion to improve the Chinese Gold Market Essentials, please send me an email at email@example.com.
Understanding The Chinese Gold Market Step By Step
The unique structure of the Chinese domestic gold market, the SGE system, and why the amount of physical gold withdrawn from the vaults of the SGE (published on a monthly basis) can be used as a measure for Chinese wholesale gold demand is explained in part one:The Mechanics Of The Chinese Domestic Gold Market. It also provides a basic understanding of contrasting metrics applied to measure Chinese gold demand, and the difference between SGE withdrawals and Chinese consumer gold demand as disclosed by the Thomson Reuters GFMS, which has aggregated to 6,000 tonnes from 2007 until 2016. GFMS and its affiliates have continuously presented feeble arguments that should explain the difference. The Chinese Gold Market Essentials debunks these arguments where necessary, back up by facts, in order to make our best estimate of true Chinese gold demand.
More detailed rules regarding cross-border gold trade in and out of the Chinese domestic gold market and Free Trade Zones in China are discussed in part two: Chinese Cross-Border Gold Trade Rules. When fully comprehending the mechanics of the Chinese domestic gold market and Chinese cross-border gold trade rules you can continue reading Workings Of The Shanghai International Gold Exchange about the international subsidiary exchange of the SGE set up to become the major physical gold trading hub in Asia.
Finally, please read PBOC Gold Purchases: Separating Facts from Speculationfor studying the amount of gold accumulated by China’s central bank in recent years in addition to private reserves. At the end of the post you can find an overview of the estimated amounts of above ground gold in China (privately owned gold and official holdings), updated in July 2017.
Withdrawals from the vaults of the largest physical gold bourse globally, the Shanghai Gold Exchange (SGE), accounted for 54 tonnes (in week 45 / 16 until 20 November), up 10 % from last week. Year to date SGE withdrawals have reached 2,313 tonnes, which is an all time record.
Given elevated SGE withdrawals and continued weakness in the gold price it looks like the Chinese population is buying the dips. The Chinese central bank (PBOC) is likely doing the same, but not through the SGE. The PBOC does its monetary gold purchases in the international OTC gold market – for example, in London or Hong Kong.
According to Reuters China has imported 72 tonnes of (non-monetary) gold from Hong Kong in October – this gold is required to be sold first through the SGE, it’s not directed to the PBOC. Data from the Hong Kong Census & Statistics Department has not been released, but Reuters has a contract with the Department in order to obtain data a few days before the public release.
Known gold exports to China year to date: From January until October Hong Kong has exported 653 tonnes to China mainland, which is 784 tonnes annualized. Switzerland has exported 217 tonnes to China from January until October, annualized 260 tonnes. The UK shipped 210 tonnes to China in the first nine months of this year, annualized 280 tonnes. Australia net exported 49 tonnes in seven months, which is 84 tonnes annualized. So, without counting shipments from exporters such as South Africa and Singapore, China has imported 1,129 tonnes of gold year to date and is on track to import 1,408 tonnes of (non-monetary) gold in total this year. In addition, Chinese domestic mining output is set to reach 476 tonnes. Chinese apparent gold supply – without counting scrap – in 2015 will be 1,884 tonnes.
Using SGE withdrawals as a measure for Chinese gold demand canbe slightly deceiving for a number of reasons. For example, Chinese citizens can buy gold on the SGE but prefer not to withdraw this metal from the vault, or chose to withdraw next month/year. This way, wholesale demand would actually be higher than the amount of gold being withdrawn. On the other hand, since the inception of the Shanghai International Gold Exchange (SGEI) gold can be withdrawn from SGEI (IB) Certified Vaults in the Shanghai Free Trade Zone (SFTZ) and exported abroad. According to the accounting rules from the SGE, any SGEI withdrawal is included in SGE withdrawals. An export from the SFTZ would be included in SGE withdrawals. I’m always occupied with the details regarding SGE withdrawals, why we can use it as a measure for Chinese wholesale gold demand and why not. I think SGEI withdrawals can have been a cause for inflated SGE withdrawals this year.
Late 2014 and early 2015 I’ve written SGE withdrawals could have been distorted by withdrawals from the SGEI. For a while I corrected SGE withdrawals by SGEI trading volume to be conservative about Chinese wholesale gold demand. We simply didn’t know what happened to the SGEI gold that was traded – was it withdrawn from the vaults or not withdrawn. Then, in February 2015 SGE chairman Xu Luode published some figures in an article for Bullion Bulletin that pointed outmost of the SGEI trades that were withdrawn from the vault was imported into the Chinese domestic mainland. Meaning, SGEI trading volume could only have slightly distorted our measure of Chinese wholesale gold demand (SGE withdrawals).
After a run up in SGEI trading volume this year, from January until March, it appeared trading of iAu9999 (the most commonly traded SGEI contract – 1 Kg 9999) severely declined in recent months and I stopped subtracting SGEI trading volume from SGE withdrawals to measure Chinese wholesale gold demand. But, the other day I studied the Chinese SGE weekly reports. What I failed to see in recent months was that iAu9999 has been trading in the Chinese OTC market. Mea culpa. In the Chinese OTC market SGE contracts can be negotiated off-SGE, while settlement is done on-SGE.
In the Chinese weekly SGE reports we can see OTC trades on the first page. Below is a screen shot of the report, the OTC settlements are framed in red. Framed in blue is ‘this weeks’ trading, which was in week 45 (framed in green).
Some analysts, including myself, thought the SGEI was dead. But it isn’t.
First of all, the iAu9999 contract is traded increasingly in the OTC market. In the chart above the black line resembles OTC iAu9999 trading volume. In the OTC market volume has declined from a peak in May, but I wouldn’t say trading has ceased.
It certainly is possible the gold of these OTC iAu9999 trades can have been withdrawn from the vaults in the SFTZ and exported abroad and thus inflated SGE withdrawals. When acontract (iAu9999) at the SGEI is exchanged, four things can happen (in the context of this investigation):
The gold stays in the vault.
The gold is withdrawn and stored elsewhere in the SFTZ.
The gold is withdrawn and imported into the Chinese domestic gold market.
The gold is withdrawn and exported to, for example, India.
Option 2 and 4 would increase SGE withdrawals without increasing Chinese wholesale gold demand.
When looking at the numbers from the OTC iAu9999 trading we can see an interesting pattern.
Have a look at the data labels in the chart above. We can see that all weekly OTC iAu9999 volumes end on two zeros (blue bars) or three zeros (red bars). These volumes are the sum of all trades executed during the week. It’s safe to conclude these volumes are exchanged by large traders, as iAu9999 is changing hands in batches of one hundred (blue bars) or in some weeks one thousand (red bars) 1 Kg 9999 bars. For example, in the week that ended 3 July 2015 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 at 73,000 Kg’s in total for the week. Though, this coincidence cannot have occurred each and every week. More likely the OTC iAu9999 traders buy and sell per 100 or 1000 Kg’s. No other SGE or SGEI contracts show this bulky trading pattern.
Did any foreign nations buy gold through the SGEI OTC market and export it from the SFTZ? Hard to say. The most obvious gold trading partner for China is India. Early this year the SGE chairman wrote about the SGEI [brackets added by me]:
… Using the International Board [SGEI] as a launch pad, China’s gold market will embrace greater openness and foster stronger ties with its neighbours and, together, elevate the trading and pricing influence of Asia in the world’s gold market.
As a perennial major consumer of gold and a close neighbor of China, India will undoubtedly become one of SGE’s most important partners in the coming years. SGE looks forward to forming close partnerships with the Indian market.
Imaginably, the iAu9999 purchases were withdrawn from the SGEI vaults in the SFTZ and exported to India. Though, India’s trade statistics can be tracked very precisely and only a small amount of gold has been exported from China to India since the SGEI was erected in September 2014.
In the table above we can see India imported 1.205 tonnes from China Since September last year. These imports into India can be processing trade from any Free Trade Zone in China (no SGEI involvement required), but can also be from purchases at the SGEI in the Shanghai Free Trade Zone. In the latter scenario these exports would have been captured in SGE withdrawals (the metal is bought at the SGEI, withdrawn from the IB Certified Vault and exported).
In any case India imported very little gold from China in the past year. The only other gold importer from China I could find was Thailand at 1.488 tonnes, which makes me think foreigners have not yet been very active on the SGEI. More likely, at this stage, is that SGEI withdrawals are imported into the Chinese domestic gold market. Another option, given the large round number volumes, is that OTC iAu9999 is trading in China’s foreign exchange market.
I should add, the customs departments from Switzerland and Hong Kong confirmed that when gold is exported from local soil to the Shanghai Free Trade Zone it’s disclosed in their data as an ‘export to China’. It is irrelevant if that gold is ever imported into the Chinese domestic gold market. No matter what happens to the gold in the SFTZ it is initially disclosed as an export to China.
In short, trading at the SGEI can have blurred SGE withdrawals this year. More research should point to what extent.
Much to my surprise speakers at the LBMA conference in Vienna (held from 18 until 20 October 2015) have been discussing how gold round tripping and gold leasing in China inflates withdrawals from the vaults of the Shanghai Gold Exchange (SGE). These Chinese Commodity Financing Deals(CCFDs), which gold round tripping and gold leasing can be labeled as, were presented at the conference as the explanation for the hugedifferencebetweenSGE withdrawalsandChinese consumer gold demandas disclosed by the World Gold Council (WGC).
By any measure the aggregated difference has transcended 2,500 tonnes of gold, which is more than the official gold reserves of Russia, India, Singapore, South Africa and Mexico combined. If CCFDs could inflate SGE withdrawals it would be a legitimate argument to lodge with, butgoldround tripping cannot inflate SGE withdrawals and gold leasing can only inflate SGE withdrawals to a limited extent (not 2,500 tonnes).
Regular readers of this blog know I’ve written numerous articles about CCFDs and that I have clearly exposed round tripping and gold leasing cannot explain thedifference the gold space is apparently still ignorant about. Once more we’ll thoroughly set out all the gossip that is making rounds about CCFDs and elucidate the true workings of the Chinese gold market. This post is focused on round tripping, or actually about the rules on the import and export of gold in and out of China, in a succeeding post we’ll extensively discuss gold leasing.
Back to the LBMA conference, this is what I think has happened. On 20 October at 12:15 pm the following BullionVault tweet was published live from the LBMA conference in Vienna:
Numbers complex, but huge gap between SGE withdrawals and demand data is simple – leasing + round tripping #LBMA
From looking at the programme of sessions and speakers on 20 October (click here to view the schedule and slides presented) I assume the message in the tweets was supplied by a panel that was on stage halfway the conference day. As, the moment this panel was talking could very well have coincided with the moment the tweets were published, 12:15 pm and 12:33 pm. The panel on stage consisted of:
Raymond Key, Senior Partner & Head of Metals & Mining, TrailStone Australia Pty Ltd
Albert Cheng, Advisor to World Gold Council
Anne Dennison, Consultant, LPPM
Jeremy East, Managing Director, Head, Metals Trading & Commodities, Northeast Asia and Greater China, Financial Markets, Standard Chartered Bank
Philip Klapwijk, Managing Director, Precious Metals Insights Limited
The members of the panel Cheng, East and Klapwijk are known for having an interest in the Chinese gold market, so it would make sense for them to come up with the statements the tweets referred to.
In addition, in the morning of 20 October the second speaker on the programme was Jiang Shu, Chief Analyst of Shandong Group (click here to view the slides from Jiang). Let’s have a look at his slides, here is number three:
The header of the slide says, “China’s Demand Is Thought To Be Inflated: Two Possible Sources”. Obviously, Jiang’s keynote speech is about the difference between SGE withdrawals and Chinese consumer gold demand, for which Jiang mentions two possible causes, (i) commodity financing deals “which use the import and export of gold”, here Jiang refers to round tripping, and (ii) gold leasing.
So, likely in the morning of 20 October Jiang talked about the difference in the Chinese gold market and CCFDs, a few hours later the panel chatted along the same lines, which (again) seduced a big chunk of the international gold community to think the difference in the Chinese gold market is simply caused by Chinese Commodity Financing Deals.
Attendants of the LBMA conference must have reasoned, “if a gold analyst from China (Jiang) is saying CCFDs cause SGE withdrawals to inflate and experts like Cheng, East and Klapwijk agree with him it must be true”. On 23 October Sharps Pixley published an article that quoted Jiang and stated gold leasing is to blame for the +2,500 tonnes difference. The same day Dundee Capital Markets (Martin Murenbeeld) published a newsletter:
…These totals leave some unanswered questions. Where do the extra 500 tonnes of gold end up (the 500 tonne difference between domestic production plus net imports minus domestic consumption)? And what does the 1000-tonne difference between total SGE deliveries and the 1600 tonnes of domestic production and imports imply?
The first answer is that the extra 500 tonnes are likely to end up 1) in PBoC reserves and 2) in commercial bank stocks to support gold leasing transactions, and such. (Lawrie Williams,writing on the Sharps Pixley website, alluded to a presentation at this year’s LBMA meeting in Vienna, in which an analyst from the Shandong Group suggested some 1,370 tonnes of gold are now tied up in leasing arrangements…).
This is how information spreads through the gold space.
When I read Jiang’s slides I sensed a feeling of familiarity with the words. Reading some of my own posts on CCFDs confirmed my hunch; Jiang had copied my writings. Below is slide number seven from Jiang:
For general trade fifteen banks enjoy a PBOC license to import gold.
All bullion imported through general trade is required to be sold first through the SGE, and consequently all gold flowing through the SGE is prohibited from being exported. Detail: a few jewelry companies also have a gold trade license for general trade, but this is insignificant.
We can also see that Jiang’s first point is a composition of my writings, the second sentence being an exact copy. Apparently Jiang reads my blog and uses the content for his own analysis. This is noteworthy as it influences our qualification of Jiang’s independent expertise.
Since I have not attended the LBMA conference I don’t know if Jiang gave me verbal attribution, but me thinks chances are slim. I don’t have a problem with colleague gold analysts consulting my writings and using it for their own reports or presentations, but attribution is a requisite, especially when writings are copied one on one. Unfortunately, this is not a single occurrence. Frequently I come across writings from colleagues that resemble my work remarkably close – you know who you are. I would kindly suggest everyone adds full and proper attribution.
Round Tripping Does Not Inflate SGE Withdrawals
To understand why round tripping cannot inflate SGE withdrawals, we need to get more familiar with how goods can be imported into and exported from China. There are two types of cross-border trade with China: general trade and processing trade.
Only through general trade gold can be imported into the Chinese domestic gold market where it’s required to be sold first through the SGE. Gold imported through processing trade must be used for manufacturing or assembling purposes after which the finished goods are required to be exported.
Processing trade is meant for China’s manufacturing industry to efficiently connect with the rest of the world. The Chinese and foreign companies engaging in processing trade are exempt from, in example, import duties and value added tax.
In this post I will demonstrate round tripping can only be done through processing trade in which it cannot enter the Chinese domestic gold market or interfere with the SGE system. Consequently, round tripping cannot inflate SGE withdrawals and thus has nothing to do with the difference we’re after.
Customs Specially Supervised Areas
CSSA is a collective noun for free trade zones, export processing zones, bonded logistics parks, bonded ports, comprehensive bonded zones, etc. Without going into detail what the differences are between various types of CSSAs, all such areas must be seen as regions in China mainland where rules for taxes, customs and foreign exchange administration can be different from the rest of the mainland.
Through CSSAs cross-border trade between China mainland and foreign countries can be established without China having to fully open up its borders. By slowly increasing the number of CSSAs and easing cross-border trade rules between these areas and the rest of the world, the State Council gradually allows China to open up. Hong Kong is not a CSSA, but a Special Administrative Region of the People’s Republic of China. In terms of trade Hong Kong must be treated as a separate country from China mainland, having its own customs department and currency.
Some CSSAs are physically open to the rest of the mainland, people are free to go in and out without being asked to show documentation by Chinese customs, others are restricted, surrounded by a fence and goods moved in or out can be subject to checks.
“Processing trade” shall refer to the business activity of import of operating enterprises of all or some raw and auxiliary materials, components, parts, mechanical components and packing materials (Materials and Parts) and the re-export thereof as finished products after processing or assembling. It includes processing of supplied materials and processing of purchased materials.
Let’s examine the two types of processing trade to get a better understanding of the wider concept. There is the Processing Of Purchased Materials Model (or Contract Manufacturing model) and the Processing Of Supplied MaterialsModel (or Toll Manufacturing model).
The Processing Of Purchased Materials Model involves a Chinese manufacturer to import raw materials and parts from abroad into China (a CSSA) to assemble or process into finished goods. Upon completion the finished goods will be exported and sold in an overseas market by the Chinese manufacturer.
The Processing Of Supplied MaterialsModel involves a foreign company to export raw materials and parts to China (a CSSA) to be processed by a Chinese manufacturer into finished goods. Upon completion the finished goods are exported to an overseas market to be sold at the discretion of the foreign company. This foreign company will pay the Chinese manufacturer a processing fee for its services provided.
Example given of a processing trade with gold:
Bullion from Hong Kong is exported to the CSSA in Shenzhen where 4,000 Chinese gold manufacturers are located. Subsequently, the gold is fabricated into jewelry and upon completion imported back into Hong Kong to be sold in jewelry shops. This trade can be either conducted through the Processing Of Purchased Materials Model or the Processing Of Supplied MaterialsModel.
Essential to understand is that the flow of gold in processing trade is completely separated from the Chinese domestic gold market, though this gold crossing the Chinese border is included in customs statistics. From the PRC Customs Supervision and Administration of Processing Trade Goods Procedureswe can read:
Article 21. Goods imported and exported by operating enterprises in the form of processing trade shall be included in customs statistics.
Processing trade – and the rules just mentioned – explains how gold can be imported into China from Hong Kong and exported back from China to Hong Kong.
As you can see in the chart above there is a difference between gross gold trade and net gold trade, which is caused by processing trade.
Now we understand processing trade, let us move on to study trade between the Chinese domestic market and foreign countries.
If goods are imported into/ exported from the Chinese domestic market this is referred to asgeneral trade. Regarding general trade the rules for gold diverge from the rules for all other commodities.The agency that controls allformsof gold in general trade is China’s central bank, the People’s Bank Of China (PBOC). Only financial institutions and gold enterprises that carry theImport and Export License of the People’s Bank of China for Gold and Gold Products(The License hereafter) can get gold to pass customs into the Chinese domestic gold market.Recently BullionStar published the translation of the officialMeasures for the Import and Export of Gold and Gold Products(The Measures hereafter) drafted by the PBOC in March 2015. For the first time these rules are now publicly available in English. From The Measures we can read:
The Catalogue for the Regulation of the Import and Export of Gold and Gold Products (click here to view) describes all forms of gold (powder, coins, bullion, unwrought, scraps, jewelry) that can cross the Chinese border. For gold to be imported into the Chinese domestic gold market the material is required to be accompanied by The License.
Currently there are fifteen commercial banks that can apply for The License to import standard gold, which in the Chinese system is bullion in bar form weighing 50g, 100g, 1Kg, 3Kg or 12.5Kg, having a fineness of 9999, 9995, 999 or 995. The fifteen commercial banks are:
Shenzhen Development Bank / Ping An Bank
Industrial and Commercial Bank of China
Shanghai Pudong Development Bank
Agricultural Bank of China
China Construction Bank
Bank of Communications
China Merchants Bank
China Minsheng Bank
Bank of Shanghai
Bank of China
Allstandard goldimported through general trade into the Chinese domestic gold marketis required to be sold first through the SGE (the core of the Chinese domestic gold market).From The Measures we can read [brackets added by me]:
… An applicant for the import and export 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 and export 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.
Next to standard gold there is non-standard gold in the Chinese system, for example bullion bars weighing 1,040 gram, jewelry, coins, ore and doré. Non-standard gold is not required (and not allowed) to be sold through the SGE when imported into the Chinese domestic gold market. Only a very limited number of gold enterprises can apply for The License to import non-standard gold under general trade. Although, The Measures released in March 2015 by the PBOC loosened the requirements for The License.
Example given of a gold enterprise that can import non-standard gold into the Chinese domestic gold market:
On 26 May 2015 Zijin Mining Group bought a 50 % stake in Barrick Gold Corp’s Porgera mine in Papua New Guinea for $298 million. On 9 October 2015 China Gold Network wrote that Zijin Mining was one of the first mining companies to be granted the qualification by the PBOC to import gold under general trade, allowing Zijin to import doré from Papua New Guinea into the Chinese domestic gold market. Note, if the dore is imported and refined into standard gold, the bars are required to be sold through the SGE.
On Sept 25, Zijin Mining was granted by the People’s Bank of China the permission to do gold import business [under general trade], which broke the common practice that in China only financial institutions do this business, and became the first case that a big domestic gold miner does gold import business [under general trade].
By loosening the rules for enterprises to import non-standard gold into the Chinese domestic gold market the PBOC has helped Chinese mining companies to strive for more overseas acquisitions.
Above we can see The License form that commercial banks have to fill in for every gold import. Being able to apply for The License does not grant unlimited permission to import gold into the Chinese domestic gold market – from abroad or CSSAs – as for every shipment a stamp from the PBOC is needed. From the Measures we can read:
There shall be one Import and Export License of the People’s Bank of China for Gold and Gold Products for each batch of product and the License shall be used within 40 work days since the issuing date.
Gold export from the Chinese domestic market is prohibited by the PBOC(except for golden Panda coins). The reason The Measures mention export is because if the PBOC would ever change its policy in allowing gold export from the Chinese domestic gold market it doesn’t need to rewrite all the rules. Currently, if one of the fifteen banks (or Zijin) will submit a request at the PBOC for an export license it will be rejected.
Has anybody ever seen an SGE bar outside China mainland? Likely not. This is because the SGE system operates in the Chinese domestic gold market and thus bars withdrawn from the SGE vaults are prohibited form being exported.
1. 上海黄金交易所标准金条 SGE Standard Gold Bar. 2. 上海黄金交易所标志 SGE Logo. 3. 品牌标志 Brand Logo. 4. 金条品牌 Bar Brand (泰山 is Mount Tai, which is produced by Shandong Gold). 5. 成色 Fineness. 6. 重量 Weight. 7. 金条编号 Bar Number.
However, there is one possibility to export an SGE bar from the Chinese domestic gold market. Individuals can bring 50 grams of gold when traveling abroad. Though this rule is not very stringent on the import side, on the export side one individual would be allowed to bring a 50g SGE bar across the border, two individuals would be allowed to bring a 100g SGE bar with them, etc.
More important, through processing trade enterprises not carrying The License can import and export gold. From The Measures we can read:
…, gold and gold products imported and exported by the following means shall exempted from handling Import and Export License of the People’s Bank of China for Gold and Gold Products and shall be supervised by the customs instead:
… Imported or exported by processing trade…
There you have it. Enterprises can import gold into and export from China through processing trade without The License from the PBOC – because CSSAs are separated from the Chinese domestic gold market. These enterprises are required to be engaged in gold business, for example, as jewelers or refiners.
Gold trade between a CSSA and the Chinese domestic market is considered as general trade. Meaning, for gold to be imported from the Shanghai Free Trade Zone into the Chinese domestic gold market The License must be provided.
From slide number six of Jiang we can read his description of round tripping:
The way Jiang explains round tripping is exactly what Goldman Sachs wrote in 2014 (what a coincidence), though I agree this is how the scheme is executed. In Jiang’s slide we can clearly see round tripping is done through processing trade. The reason being, gold trade rules in China dictate enterprises can only import and export gold without The License through processing trade. The only possibility to round trip gold in China is through processing trade, which requires the gold to be physically imported and exported. Goldman Sachs correctly pointed out in 2014 [brackets added by me]:
…Chinese gold financing deals [round tripping] are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals [round tripping] involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals.
By and by, not every enterprise is approved by Chinese customs to conduct processing trade. If speculators wish to illegally engage in gold round tripping they must erect a shell gold company (like a jewelry company). Under this disguise the gold can be imported into/ exported from China through processing trade in order to round trip.
I wish to abstain from expanding on the fiat gains accrued by speculators in round tripping, as this is beyond the scope of this post. The key takeaway is that the physical gold flows involved in round tripping are separated from the Chinese domestic gold market and thus cannot interfere with the SGE system, let alone inflate SGE withdrawals. Because gold round tripping requires the metal to be imported and exported through processing trade it cannot possibly interfere with the SGE system.
Readers can download the original Chinese Measures for the Import and Export of Gold and Gold Products from the People’s Bank Of China (PBOC) here. Be advised the Measures for the Import and Export of Gold and Gold Products can be confusing if not connected to Chinese trade rules in general.
In the translation below reference is being made to:
Annex 1, Import and Export License of the People’s Bank of China for Gold and Gold Products, ofwhich is a translation can be viewed here.
Annex 2, Application Form for Import and Export of Gold and Gold Product, of which a translation can be viewed here.
Catalogue for the Regulation of the Import and Export of Gold and Gold Products, of which a translation can be viewed here.
Measures for the Import and Export of Gold and Gold Products
Order of General Administration of Customs and People’s Bank of China
Order No. 1〔2015〕
Measures for the Import and Export of Gold and Gold Products is prepared by People’s Bank of China and General Administration of Customs based on Law of the People’s Republic of China on the People’s Bank of China, Customs Law of the People’s Republic of China and Decision of the State Council on Establishing Administrative License for the Administrative Examination and Approval Items Really Necessary to be Retained.
The Measured is issued hereby and shall take effect since April 1, 2015.
Measures for the Import and Export of Gold and Gold Products
Article 1 The Measure is prepared to regulate the imports and exports of gold and gold product and to enhance the import and export management of gold and gold product based on laws like Law of the People’s Republic of China on the People’s Bank of China, Customs Law of the People’s Republic of China and Decision of the State Council on Establishing Administrative License for the Administrative Examination and Approval Items Really Necessary to be Retained etc.
Article 2 For the purpose of these Measures, gold means gold unwrought and gold products mean semi-finished gold and finished products of gold.
Article 3 The People’s Bank of China, as the authority in charge of the import and export of gold and gold products, implements a permit system for the import and export of gold and gold products.
The People’s Bank of China, based on the needs of national macroeconomic regulation and control, may conduct restrictive approval for the import and export volume of gold and gold products.
For the import and export customs clearance of gold and gold products as included in the Catalogue for the Regulation of the Import and Export of Gold and Gold Products, the Import and Export License of the People’s Bank of China for Gold and Gold Products (Annex 1) issued by the People’s Bank of China or a People’s Bank of China branch shall be submitted to the Customs.
The People’s Bank of China shall, in conjunction with the General Administration of Customs, formulate, adjust, and issue the Catalogue for the Regulation of the Import and Export of Gold and Gold Products.
Article 4 A legal person or another organization importing and exporting gold and gold products by the following trade modes shall obtain an Import and Export License of the People’s Bank of China for Gold and Gold Products in accordance with these Measures:
(I) General trade;
(II) Processing trade for the domestic market and gold products exported under processing trade with gold raw materials purchased within the territory of China; and
(III) Import and export between areas under special customs supervision or supervised bonded places and overseas areas.
An individual, a legal person or any other organization donating imported gold and gold products for public interest undertakings shall obtain an Import and Export License of the People’s Bank of China for Gold and Gold Products in accordance with these Measures.
The provisions on the administration of individuals entering and leaving China with gold and gold products shall be formulated by the People’s Bank of China in conjunction with the General Administration of Customs.
Article 5 The import and export of the state gold reserves shall be handled by the People’s Bank of China.
The import and export of gold coins (including gold precious metal commemorative coins) shall be handled by institutions designated by the People’s Bank of China.
Article 6 The main market players with the qualifications for the import and export of gold shall assume the liability of balancing the supply and demand of material objects on the domestic gold market. Gold to be imported and exported shall be registered at a spot gold exchange approved by the State Council where the first trade shall be completed.
Article 7 Applications for the import and export of gold and the import of gold products donated for public interest undertakings shall be accepted and approved by the People’s Bank of China.
Applications for the import and export of gold products shall be accepted by the branches of the People’s Bank of China at or above the prefecture level and approved by the Shanghai Head Office of the People’s Bank of China, the branches and business management departments of the People’s Bank of China, or the central sub-branches of the People’s Bank of China in the capital cities of the provinces (autonomous regions), and the central sub-branch of the People’s Bank of China in Shenzhen.
Article 8 An applicant for the import and export of gold (except the import of gold for donation to public interest undertakings) shall have corporate status, have no record of violating laws and regulations within the recent two years, and satisfy one of the following conditions:
(I) It is a financial institution member or a market maker on a gold exchange approved by the State Council, with professionals of the gold business, a perfect gold business risk control system, and stable gold import and export channels, whose business carried out on the gold market complies with relevant policies or regulatory provisions, and whose spot trading of gold is active and the volume of transactions for its own account is among the highest in the two years before the application is filed;
(II) It is a comprehensive member of a gold exchange approved by the State Council, and a mining enterprise with annual gold production of 10 tons or more, pollutant emissions during the production process satisfying the environmental protection standards of the state, overseas gold mineral products investment scale exceeding USD 50 million, which has obtained mining rights of overseas gold mines or paragenetic and associated gold mines, which has formed mineral gold production capacity, whose business carried out complies with relevant policies or administration provisions, and whose spot trading of gold is active and volume of transactions for its own account is among the highest in the two years before the application is filed;
(III) It is a mining enterprise, with three consecutive years of domestic taxation records no less than RMB 200 million yuan and investment in overseas nonferrous metals exceeding USD 100 million, which has obtained mining rights of an overseas gold mine or paragenetic and associated gold mine and is ready to produce gold, and whose business carried out complies with the relevant policies or regulatory provisions;
(IV) It is a manufacturing enterprise that assumes the task of producing precious metal commemorative coins for the state;
(V) It is a gold importing and exporting refining enterprise which has become a certified brand on the international gold market.
Article 9 An applicant for the import and export of gold products (except the import of gold products for donation for public interest undertakings) shall have corporate status or the status of other organization, have no violation of laws and regulations within the recent two years, and satisfy one of the following conditions:
(I) For enterprise which produces, processes or uses relevant gold products, it shall possesses necessary production sites, equipment and facilities, discharge pollutant made in the production process based on national environment protection standards and keep a tax payment record that no less than RMB 1 million yuan has been paid each year for a successive 3 years;
(II) For foreign trade operation enterprise which applies to customs certification on enterprise management, it shall keep a tax payment record that no less than RMB 3 million yuan has been paid each year for a successive 3 years;
(III) Educational organizations, science study organizations and so on which need to use gold product for national research project and key subjects.
Article 10 Those which apply for import and export of gold shall submit the following materials to People’s Bank of China:
(I) Descriptions on business conditions including name, address (office place), enterprise profile, using of the imported and exported gold and planned amount etc. shall be noted on the written application;
(II) Application Form for Import and Export of Gold and Gold Product (Annex 2);
(III) Copies of officially sealed business certification of the enterprise legal person;
(IV) Gold import and export contracts and their copies;
(V) Officially sealed copies of Organization Code Certificate of the People’s Republic of China;
(VI) Explanatory materials on whether the applicant has illegal conducts in the past 2 years;
(VII) Financial organization of banking industry shall also offer relevant materials on internal gold business control system; those which apply for gold export shall submit real gold inventory amount certification of gold and commodities exchange approved by State Council;
(VIII) Gold mining enterprises shall also submit pollutant discharge permit certification and copies of annual qualification inspection report issued by provincial environment protection department, copies of relevant foreign investment approval document by the business department, copies of bank out-remittance certification, relevant certifications on exploiting gold in foreign countries or regions and tax payment record of the enterprise in the past 3 years; those which apply for exporting gold shall submit gold production capacity issued by the industry command department or self-discipline organization and registration certification of gold and commodities exchange approved by State Council.
Those which apply for gold import and export again and of which no materials of the aforesaid terms are changed shall only need to submit materials in Item II and Item IV; or shall apply and handle as the first application in case the other materials in the aforesaid terms are changed.
Article 11 Those which apply for import and export of gold product shall submit the following materials to the branch of People’s Bank of China above municipal level where the applicant lives:
(I) Descriptions on business conditions including name, address (office place), enterprise profile, using of the imported and exported gold and planned amount etc. of the applicant shall be noted on the written application;
(II) Application Form for Import and Export of Gold and Gold Product;
(III) Copies of officially sealed legal registration certificate including business certification of the enterprise legal person and legal certificate of public institutions;
(IV) Gold import and export contracts and their copies;
(V) Registration Form for the Archival Filing and Registration of Foreign Trade Operator or Certificate of Approval for Establishment of Enterprises with Foreign Investment in PRC which is sealed with archive filing seal.
(VI) Description materials on whether the applicant has illegal conducts in the past 2 years;
(VII) Enterprises which produce, process or use gold product shall also submit the enterprise tax payment record of the past 3 years, pollutant discharge permit certificate issued by municipal environment protection department and annual qualification inspection report as well as their copies;
(VIII) Enterprise of foreign trade operation shall also submit relevant enterprise management proving materials apply to customs certification and enterprise tax payment record of the past 3 years;
(IX) Education organizations and science research institutes shall also submit proving materials on conducting national research projects or key subjects;
(X) Enterprises which export gold products shall also submit proving materials including added-value tax invoice of gold raw materials obtained within China.
Those which apply for gold import and export again and of which no materials of the aforesaid terms are changed shall only need to submit materials in Item II and Item IV; besides, education organizations and science research institutes shall also submit materials in Item IX and enterprise which export gold products shall also submit relevant materials specified in Item X; or shall apply and handle as the first application in case the other materials in the aforesaid terms are changed.
Article 12 The application conditions specified in Item I, Article 9 of the Measure applies to gold product from processing trade for the domestic market, imported materials of products for domestic market within products listed in Catalogue for the Regulation of the Import and Export of Gold and Gold Products and gold products exported under processing trade with gold raw materials purchased within the territory of China.
For processing trade for the domestic market, the application materials shall be submitted and delivered in accordance with provisions in Article XI of the Measure; besides, materials explaining fair reasons for turning to domestic market, copies of processing trade business approval certificate and processing trade contracts and their copies etc.
For gold products exported under processing trade with gold raw materials purchased within the territory of China, the enterprise shall report the conditions of gold purchase within the territory of China when the processing trade manual is established (changed) and submit Import and Export License of the People’s Bank of China for Gold and Gold Products.
Article 13 As for imported gold and gold product donation made by individual, legal person or other organization for public welfare establishments, the following materials shall be submitted by the Donee to People’s Bank of China:
(I) Donation agreement that conforms to provision of Law of the People’s Republic of China on Donations for Public Welfare;
(II) Legal registration certificate and their copies including public institute legal person certificate or social group legal person registration certificate;
(III) Application Form for Import and Export of Gold and Gold Product
Article 14 People’s Bank of China shall make the administration permit decision within 20 work days since accepting the application for import and export of gold and gold products.
Article 15 Municipal branches of People’s Bank of China shall directly report the primary review opinions and all the application materials to the upper organization within 20 work days since accepting the application for import and export of gold and gold products. And the upper organization shall make the administration permit decision within 20 work days since receiving the primary review opinions and all the application materials.
Shanghai head office, all branches, business management department, central branches of provincial capitals (metropolis) and Shenzhen central branch of People’s Bank of China which directly handle application for import and export of gold products shall make the administration permit decision within 20 work days since acceptance.
Article 16 People’s Bank of China or its branches may review the applicant in case it is necessary to verify the real content of the application materials; the review shall be conducted by more than 2 working staff.
Article 17 The approved applicant shall handle relevant procedures at the customs by Import and Export License of the People’s Bank of China for Gold and Gold Products when handling cargo import and export of gold and gold products.
There shall be one Import and Export License of the People’s Bank of China for Gold and Gold Products for each batch of product and the License shall be used within 40 work days since the issuing date. The licensed party which need a postpone for reasonable reasons may apply for handling a delay procedure to the issuing organization with the original license 5 work days after the expiring of the license.
Article 18 People’s Bank of China and its branches are entitled to supervise and inspect the activities of administration permit items conducted by the Licensee shall be cooperative.
Article 19 The Licensee shall promptly report the implementation conditions of import and export of gold and gold products and provide relevant materials based on the provision of People’s Bank of China and its branches.
Article 20 Despite of the provisions in Article 4 of the Measure, gold and gold products imported and exported by the following means shall exempted from handling Import and Export License of the People’s Bank of China for Gold and Gold Products and shall be supervised by the customs instead:
(I) Imported or exported by processing trade;
(II) Imported or exported between customs special supervision region, tax-free supervision area and foreign territories;
(III) Imported or exported between customs special supervision region and tax-free supervision area;
(IV) Imported or exported by maintenance, shipment return and temporary in-and-out methods.
Article 21 Except for provisions in Article 4, 5 and 20 of the Measure, any individual, legal person or other organization shall not import and export gold and gold products by any other means. Except otherwise specified by the state.
Article 22 Individual, legal person or other organization shall abide by relevant national regulations on anti-money laundering and anti-terrorist financing when importing and exporting gold and gold products.
Article 23 Foreign exchange receipts and payments incurred when importing and exporting gold and gold products shall be handled in accordance to foreign exchange management rules.
Article 24 The Licensee shall not make the following conducts:
(I) Transfer or lend the import and export license for gold and gold products;
(II) Use fake or intentionally made import and export license for gold and gold products;
(III) Acquire the import and export license for gold and gold products by lying or other dishonest conducts;
(IV) Exceed the class, specification and amount scale permitted by the import and export administration;
(V) Make fake donations on imported and exported gold and gold products;
(VI) Fail to register and exchange the imported and exported gold at the gold and commodities exchange based on the provisions;
(VII) Maliciously manipulate gold exchange price by means like hoarding and profiteering, or other conducts which violate the rights and interests of the other investors like cheating;
(VIII) Violate relevant policies or management provision on gold market and gold derivatives exchange;
(IX) Refuse the supervision and inspection by People’s Bank of China and its branches or hide relevant conditions and provide fake materials during the supervision and inspection process.
In case the Licensee makes any of the conducts listed in former terms, People’s Bank of China and its branches is entitled to suspend the handling of its import and export application; those with vital situations shall be punished in accordance to Article 46 of Law of the People’s Republic of China on the People’s Bank of China.
Article 25 People’s Bank of China and its branches is entitled to withdraw the import and export license for gold and gold products of the Licensee by law.
Article 26 Illegal conducts including smuggling or violating customs supervision provisions resulting from importing and exporting gold and gold products by violating the Measure shall be disposed in accordance to laws and regulations including Customs Law of the People’s Republic of China and Regulation of the People’s Republic of China on the Implementation of Customs Administrative Punishment by the customs; or shall be investigated for its criminal liabilities by being transferred by the justice organization in case of crime.
Article 27 People’s Bank of China and General Administration of Customs are responsible for explaining the Measure.
Article 28 The Measure shall be implemented since April 1, 2015.
1. Import and Export License of the People’s Bank of China for Gold and Gold Products
2. Application Form for Import and Export of Gold and Gold Products
Since 2007 China has the largest domestic gold mining output, since 2011 the Shanghai Gold Exchange has been the largest physical gold exchange and in 2013 and 2014 China was the largest importer. Now the Chinese seek to escalate pricing power.
From the beginning of the liberalization of China’s gold market in 2002, the governor of the People’s Bank Of China has been strikingly honest – compared to his Western colleagues – regarding his view on gold. At the LBMA conference in 2004 governor Zhou Xiaochuan stated gold is a currency, an indispensable investment tool and the gold market – together with the securities and foreign exchange market – constitute the main part of the financial market.
As of today, China has fully developed its domestic gold market and is aiming to further integrate with the international gold market – inter alia to support the internationalization of the renminbi – as was planned more than a decade ago. From Zhou in 2004:
China’s gold market must integrate into the global market. Therefore China will further open up the market and quicken its steps toward integrating into the international market.
China’s aim is … to establish a safe and effective system for gold trading and to give full play to the gold market’s function of investment and risk warding, thus promoting the development of China’s gold market. We will strive for this aim with members from the international financial industry, and in particular, the global gold fraternity.
The Chinese gold market has come a long way since the launch of the Shanghai Gold Exchange (SGE) in 2002 to the launch of the Shanghai International Gold Exchange (SGEI) in 2014. From no gold market whatsoever before 2002 to an international gold market has been a meaningful accomplishment. When Zhou attended the opening ceremony of the SGEI in 2014 he said:
This event [the launch of the SGEI] is a major milestone in China’s opening of its financial market to foreign investors. The Shanghai International Gold Exchange will bolster China’s gold market toward greater trading volume and further highlight the price discovery function of the gold market.
In order to move the center of gravity of the international gold market towards Shanghai, the Chinese are pursuing to increase (paper) trading volume in renminbi – through the Shanghai International Gold Exchange (SGEI), attract global supply to be sold through the Shanghai Free Trade Zone, have a renminbi denominated gold fix and improve the connection between the Chinese gold market with the international gold market.
Recurrently, China likes to play multiple hands at the same time: on June 16, 2015, the Bank Of China became the first Chinese bank to participate in the LBMA Gold Price auction process, formerly know as the London Gold Fix. Industrial & Commercial Bank Of China (ICBC) is considering to jointhe fix as well. By joining the LBMA Gold Price auction the Chinese aim to influence the Western side of the international gold market to a larger extent, most notably the London Bullion Market which has much weight in setting the international gold price. Concurrently, China is said to be launching its own gold fix in renminbi this year; the PBOC is expected to give approval for a renminbi denominated gold fix anytime now. The multiple hands strategy can also be detected as China is pushing to increase power within Western dominated multilateral institutions such as the International Monetary Fund, while at the same time establishing new multilateral institutions such as the the Asian Infrastructure Investment Bank.
Along the lines of spreading engrossment the SGE has disclosed on June 25, 2015, at the LBMA forum in Shanghai to be in discussions with CME Group (COMEX) about listing each other’s contracts. Allegedly, an agreement will be signed this August and trading may start in the first quarter of 2016. Shen Gang, Vice President of the SGE, has stated her exchange will open a trade link with the Chinese Gold & Silver Exchange Society in Hong Kong and the Dubai Gold & Commodities Exchange as well.
Trading volume on the SGE for the first half of 2015 reached a record of 8,778 tonnes, up 200 % year on year, up 55 % from the second half of 2014 (including OTC trading that was settled through the SGE).
Perhaps the most intriguing recent development is the new Silk Road Gold Fund, a 100 billion yuan fund to be led by the SGE – including a Gold ETF Fund, Gold Resource Merger and Acquisition Fund and Gold Investment Fund, which will facilitate gold purchases for the central banks of Silk Road member states to “serve the strategy of the Silk Road and lead the new development of gold”. Official information on the Gold Fund is hard to come by, the best intelligence I could find was an English piece on Xinhua and a Chinese report of the Gold Fund launch event on iFeng (exclusively translated by BullionStar). IFeng wrote:
Representatives from gold and financial institutions talked freely about bringing gold’s superiority into full play, seizing the historic and strategic opportunity of the One Belt And One Road [Silk Road], strengthening the 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.
The holding of the conference enhanced the communication and cooperation between the western gold industry and countries along the line of the One Belt And One Road, clarified the development direction of the gold industry under the economic background of the new normal … and unlocked a new chapter of the gold industry development.
This can be a paradigm shift as one of the institutions that are identified with the Silk Road initiative is the Asian Infrastructure Investment Bank, that has been allied by 57 nations (of which many are Western but with the United States and Japan absent). The Gold Fund is likely to drive gold business through the Shanghai International Gold Exchange.
Gold business developments not yet directly related to the Gold Fund, but at this stage said to be part of the Silk Road initiative, are mining collaborations in the Asian region. On May 11, 2015, Chinese gold miner, China National Gold Group Corporation, has announced it has signed an agreement with Russian gold miner Polyus Gold to deepen ties in gold exploration. The cooperation will include mineral resource exploration, technical exchanges and materials supply.
In addition, Chinese mining companies are on a buying spread acquiring other companies: Zijin Mining Group has bought a 50 % stake in Barrick Gold Corp’s Porgera mine in Papua New Guinea for $298 million on May 26, 2015. In Australia, the world’s second largest mining country, Zijin Mining Group already owns Norton Gold Fields and has recently launched a bid for Phoenix Gold next door. Zijin has announced to issue shares worth 10 billion yuan ($1.61 billion) for future acquisitions. From George Fang, Zijin Mining Group Executive Director and Vice President:
Gold is our game. The company is open to opportunities around the world.
Furthermore, on July 1, 2015, the LBMA and the SGE mutually recognized the specifications of 9999 kilobars, the preferred gold bar in China, which will enhance connectivity between the Shanghai gold market and the rest of the world. I wouldn’t be surprised if eventually 9999 kilobars become London Good Delivery. Specifications for Good Delivery have been changed before; in 1954 coin bars (either 899 – 901 or 915.5 – 917 fine) were removed from the Good Delivery list. Currently, only 995+ fine bars weighing 350 – 430 ounces can be subjected to Good Delivery status, but there is no reason why this can’t change.
From June 8 – 12 withdrawals from SGE certified vaults in China mainland and CME Kilobar vaults in Hong Kong accounted 76 for tonnes.
Withdrawals from the vaults of the Shanghai Gold Exchange (SGE) and Shanghai International Gold Exchange (SGEI) came in elevated for this time a year at 46 tonnes in week 23 (June 8 – 12), up 41 % from the previous week.
Year to date a staggering 1,061 tonnes have been withdrawn, up 20 % y/y (2014), up 7 % y/y from 2013.
SGE withdrawals have lost their accuracy since the launch of the SGEI in September 2014 – withdrawals in the Shanghai Free Trade Zone (SGEI) can distort Chinese wholesale demand measured by SGE withdrawals (SGE withdrawals disclosed in the weekly reports capture both SGE and SGEI withdrawals). From numbers available in 2014 we knew that not much of SGEI trading was withdrawn by foreign SGEI members; most of the withdrawals in the Shanghai Free Trade Zone were imported into the mainland by SGE members.
At this stage total SGE withdrawals, as disclosed by the weekly SGE reports, are difficult to analyze as we didn’t get any hints lately from the Chinese as to what is composition of the demand side of withdrawals, how much are SGEI withdrawals that are not imported into the mainland, and what is the composition of the supply side, how much gold is imported into the mainland and/or recycled to supply SGE withdrawals. Technically, all trades (volume) on the SGEI can be withdrawn and exported to, for example, India. This is not likely, but we don’t know. Attempts from my side to obtain the latest data regarding SGEI withdrawals have resulted in little intelligence.
In week 23 (June 8 -12) total SGEI volume was 35 tonnes; international gold trading in renminbi slowly comes to life.
The iAu99.99 contract is traded on the SGEI; Au99.95, Au99.99 and Au(T+D) are traded on the SGE.
Hong Kong Kilobar Withdrawals
In March 2015 the Chicago Mercantile Exchange (CME) launched a gold kilobar futures contract, which can be physically delivered in Hong Kong. The contract can be traded over exchanges (CME Globex, CME ClearPort, CME Direct, New York open outcry) and in the Over The Counter (OTC) market.
The kilobar volume over exchanges is insignificant and I’m not aware if any delivery is made from these trades. However, if we look at the physical gold throughput of the Hong Kong vaults, we must conclude this contract is a popular trade in the OTC market. This has been confirmed to me by a CME representative. Note, withdrawals from the Hong Kong vaults transcend the volume disclosed by the Merc, so the physical settlements must happen in the OTC market.
I would like to emphasize kilobar withdrawals do not have the same significance as SGE withdrawals. The mechanics of the gold market in Hong Kong are completely different from the market in the mainland. Hong Kong has been a trade hub for centuries; gold is imported and exported in vast amounts. Kilobar withdrawals do not reflect gold demand; it does illustrate how much is going through the Chinese Special Administrative Region (Hong Kong).
In week 23 kilobar withdrawals in Hong Kong accounted for 30 tonnes. On June 8 a record 16.61 tonnes in 9999 kilobar gold was withdrawn from the Brink’s vault in Hong Kong.
I’ve found more detailed rules on the workings of the Chinese gold market regarding, (i) the use of onshore renminbi for contracts traded on the Shanghai International Gold Exchange (SGEI), (ii) gold sales of Chinese domestic gold mines. Previously I’ve written posts on these subjects that contained inaccurate information that I would like to correct. (My previous posts are already corrected.)
First, let’s have a quick look at the latest Shanghai Gold Exchange (SGE) withdrawal numbers. In week 22 (June 1 – 5) withdrawals came down 12 % from the week before at 32 metric tonnes. Year to date 1,015 tonnes have been withdrawn. The current downtrend is completely normal as seasonally the summer months are quiet in the Chinese gold market, as opposed to the months around new year.
SGE Customers Can Use Onshore Renminbi For SGEI Contracts
Chinese citizens in the mainland that have an SGE account are allowed to use onshore renminbi to buy physical gold contracts on the Shanghai International Gold Exchange (also referred to as the International Board or SGEI). On May 30, 2015, I published a post on the current status of trading rules at the SGEI regarding the use of onshore renminbi by domestic traders. From a source at the SGE I was told domestic SGE members (banks, refineries, etc) can trade SGEI contracts using onshore renminbi, but domestic SGE customers (citizens, corporations) cannot. Afterwards I came in contact with an employee of the SGEI who told me this is incorrect, in reality both SGE members and SGE customers can use onshore renminbi to trade International Board contracts. I checked with a source at ICBC and he confirmed SGE customers can use onshore renminbi to trade SGEI contracts.
Important to understand is that if SGE customers buy SGEI contracts they own gold stored in the Shanghai Free Trade Zone (offshore), but they’re not allowed to withdraw this gold and/or transport. Likewise if SGEI members purchase SGE contracts (in the mainland) they’re not allowed to withdrawal and/or transport.
This is the corrected segment from my post May 30, 2015:
Since September 2014 international traders can use offshore renminbi to trade all contracts on the International Board and most contracts on the Main Board (they can only withdraw gold from International Board contracts stored in the Shanghai FTZ). Domestic traders can trade all Main Board contracts and International Board contracts. Although, only a few Chinese banks – to my knowledge ICBC and China Industrial Bank – offer domestic clients SGEI brokerage to use onshore renminbi to trade International Board contracts.
Have a look at the next table for an overview. Kindly note, delivery is not the same as withdrawals (/load-out).
In my previous post I quoted Wang Lixing (also known as Roland Wang, Managing Director China for the World Gold Council) saying:
China’s domestic investors still cannot conveniently participate in trading on the International Board. Key reason is control on foreign exchange, which the International Board requires the use of the offshore renminbi.
Now I know SGE customers can also use onshore renminbi on the International Board I disagree with Wang even more.
Not All Chinese Domestic Mining Ouput Is Required To Be Sold Through The SGE
A few years ago I’ve written, “all output from Chinese mines is required to be sold though the SGE”, based on the rule:
All PRC [People’s Republic of China] gold producers are … required to sell their standard gold bullion through the Shanghai Gold Exchange…
Later I found out what standard gold bullion encompasses in the Chinese gold market; gold bars of 50g, 100g, 1Kg, 3Kg or 12.5Kg, with a purity of Au9999, Au9995, Au999 or Au995. Meaning, not all output from Chinese mines is required to be sold through the SGE, only when doré/ore is refined into standard gold bullion it’s required to be sold through the SGE.
In my opinion this rectification is not a game changer. Because the SGE has the best liquidity in the Chinese domestic gold market miners want to sell through the SGE, so they mostly cast standard gold bars to sell.
Mining output and scrap supply can be refined into standard gold bullion or non-standard god bullion, if standard gold is traded over the SGE or SHFE it’s exempt from VAT. Standard gold traded off-SGE is not exempt from VAT. Non-standard gold (for example jewelry) traded off-SGE is exempt from VAT (if there is value added, the value added would enjoy VAT), but many buyers and sellers like to trade standard gold bullion over the SGE for the liquidity and because this gold is granted of the highest quality.
Imported gold can be standard gold bullion or non-standard gold bullion (like doré). Imported standard gold is required to be sold though the SGE. I’m not sure at this stage what the rules are for imported doré/ore, though I know much of it is refined into standard gold and sold through the SGE. (It’s likely the rules for imported gold are the same for domestically mined gold.)
In short, there are many incentives that drive supply in the Chinese domestic gold market to be sold through the SGE. Hence, SGE withdrawals (the demand side) is such significant data.
The author of this post would like to have lunch some time with the architect of the Chinese domestic gold market, but doesn’t yet know who this person(s) is.
Every year the gold in Fort Knox is ‘audited’ by checking the official joint seals that were placed on all vault compartments during the continuing audits of U.S.-owned gold from 1974 until 1986, when allegedly 97 % of the (Deep Storage) gold was inspected. However, a Freedom Of Information Act request I’ve submitted in order to obtain all audit reports could not be honored. Seven reports are missing.
From at least 1944 the world reserve currency is the US dollar, which was backed by gold until 1971 and supported by gold ever since. There can be no world reserve currency without appropriate gold reserves supporting it, providing essential confidence and credibility. The US official gold reserves are the world’s greatest by far at 8,134 metric tonnes. The fact that 7 audit reports that should grant the existence of these reserves appear to be missing is problematic.
At the congressional hearing of the Gold Transparency Act (H.R. 1495, not enacted) in 2011 the Inspector General (IG) of the Treasury presented a case ‘all is fine’, but all is not fine. And the problem goes far beyond missing audit reports. In a series of posts we’ll continue to examine all there is to find regarding the audits of US official gold reserves.
Let’s recap what we’ve studied in the previous posts. The US Treasury currently owns 8,134 tonnes of gold of which 7,716 tonnes is stored by the US Mint (4,583 tonnes at Fort Knox, 1,364 tonnes in Denver, 1,682 at West Point) and 418 tonnes at the Federal Reserve Bank Of New York. We’ve focused on the first audits of the gold stored by the US Mint. A Fort Knox physical gold audit in 1953 was anything but full, neither was the famous audit in 1974.
The Continuing Audits Of U.S.-Owned Gold 1974-1986
Currently the Office Inspector General of the Treasury is responsible for the audits of the gold reserves at the US Mint. At the congressional hearing of the Gold Transparency Act in 2011 Inspector General (IG) Eric Thorson stated:
Before I discuss the details of the audits that are the topic of this hearing, I want to make one point very clear: 100 percent of the U.S. Government’s gold reserves in the custody of the Mint has been inventoried and audited. Furthermore, these audits found no exceptions of any consequence. I also want to assure you that the physical security over the gold reserves is absolute. I can say that without any hesitation, because I have observed the gold and the security of the gold reserves myself.
He said this, but there is no proof. His statement “100 percent of the U.S. Government’s gold reserves in the custody of the Mint has been inventoried and audited“ is impossible to confirm, as we’ll see later on.
More from Thorson:
In June 1975, the Treasury Secretary authorized and directed a continuing audit of U.S. Government-owned gold for which Treasury is accountable. Pursuant to that order, the Committee for Continuing Audit of the U.S. Government-owned Gold performed annual audits of Treasury’s gold reserves from 1975 to 1986, placing all inventoried gold that it observed and tested under an official joint seal.
The committee was made up of staff from the Treasury, the Mint, and the Federal Reserve Bank of New York. The annual audits by the committee ended in 1986 after 97 per cent of the Government owned gold held by the Mint had been audited and placed under official joint seal.
Ron Paul asked:
…It seems that a portion of the Mint and the U.S. gold reserves were audited in an assay between 1993 and 2008, as you acknowledged. The Mint estimated that as much as one-third of the gold reserves were examined during this period. The other two-thirds, however, have not been inventoried–that is according to my understanding–or assayed since somewhere between 1975 and 1986. Do you think it would be worthwhile, at least, to inventory and assay this portion of the Mint-held gold?
Eric Thorson replied:
By–I forget which date it was, I believe by 1986, we–hold on just one second here, I got it. It basically covered–by 1986, 97 percent of the Government-owned gold held by the Mint had been audited and placed under joint seal. So once you have done that, and that seal remains unbroken, then I am not sure what other benefit there would be to going back into it at that point. But by 1986, you had 97 percent was audited–
Connecting thereto, from Thorson’s opening statement:
My office began conducting annual audits of the gold reserves in Fiscal Year 1993.
Since 1993, when we assumed responsibility for the audit, my office has continued to directly observe the inventory and test the gold.
…At the end of Fiscal Year of 2008, all 42 compartments had been audited by either the GAO, the Committee for Continuing Audit of the U.S. Government-owned Gold, or my office, and placed under official joint seals. There has not been any movement of inventoried gold since that time.
From 1993 to 2008 the remaining 3 % of the gold reserves stored at the US Mint has been audited – I assume. For this post we’ll focus on the continuing audits of U.S.-owned gold, as these audits should proof there is gold in Fort Knox. By gathering information from audit reports from 1974 – 1986 (the ones I could get my hands on) and statements made at the congressional hearing in 2011 we’ll analyze our way through this. I have copied as much quotes in this post as I can to minimize the possibility of an erroneous interpretation of the official text in the audit reports.
At the hearing Thorson presented exhibits to support his case 100 % of the gold held at the US Mint has been audited. Next, we can see Thorson’s list he presented of physical gold audit reports of the continuing audit program from 1974 to 1986.
On this sheet 5 physical gold audit reports are listed, framed in red. The reports from 1974 and 1977 we’ve extensively analyzed in my previous post Second Thoughts On US Official Gold Reserves Audits, published on February 9, 2015. After writing it I’ve been trying to collect all audit reports dating from 1974 – 1986. The 1974 Fort Knox audit by the GAO has been acknowledged and adopted by the continuing audits committee, so this it became part of the continuing audits.
In total there should be 13 reports (1974 – 1986), 2 already were in my possession (1974 and 1977). With regard to my quest for all reports, let’s have a look what US government departments could not deliver what I was looking for:
First was the Counsel to the Inspector General Department of the Treasury. Because this is the department currently responsible for the audits I was surprised my request to obtain all audit reports wasn’t honored. They could only find 2 reports I didn’t posses previously, of the audits conducted in 1985 and 1986. They wrote me by email:
Mr. Nieuwenhuijs – our Office of Audit found:
as well as GAO’s 1974/1975 and 1978 reports.
That’s everything we have, or are aware of.
Counsel to the Inspector General
Department of the Treasury
The “1974/1975 and 1978” reports refer to the audits conducted in 1974 and 1977.
The Counsel to the Inspector General Department of the Treasury told me his department only had 4 of the 13 reports I was looking for. His advice to me was to try at the General Accounting Office (GAO) and National Archives for more reports. I would like to stress the importance of this failure to deliver the audit reports of 97 % of the official US gold reserves by the department directly responsible at this point in time. At the congressional hearing in 2011 the IG stated to be 100 % certain all gold stored by the Mint was inventoried and audited, yet his department had access to only a fraction (4) of all audit reports (13).How can the IG be positive if he did not have access to the most basic documentation? The answer is, he can’t.
Meanwhile I was fortunate to find the 1981 audit report at the website The Golden Sextant from Reg Howe. This document also contains a summary of the 1980 audit – which, by the way, isn’t less detailed than the full 1981 report. For the sake of simplicity, let’s say I have both audit reports, 1980 and 1981. That’s 6 down, 7 more to go.
Next was the GAO; unfortunately they couldn’t deliver anything I was looking for. Instead, I was advised to contact the Treasury. Same story at the US Mint and US National Archives. There was nothing left to do but submit a Freedom Of Information Act (FOIA) request.
On February 25, 2015, I submitted a FOIA request in order to obtain the audit reports drafted by the Continuing Audits Of U.S.-Owned Gold committee in 1975, 1976, 1978, 1979, 1982, 1983 and 1984. Shortly after I got an email that stated my request had been received and was being processed.
Two months later I still got no response. When I logged in at my account at the FOIA website, I saw my request had disappeared. I decided to send an email to the FOIA online Help Desk to ask what happened to my request. The next screen shot is from the reply by the FOIA help desk on May 6, 2015.
My FOIA request had disappeared, or did it? After some correspondence back and forth I finally got an email saying my FOIA was exported out of FOIAonline because my request was for access to historical records. Then, the official response from the offline department to my request I received on May 13 as a PDF attachment (click here to view) – oddly enough it’s dated ‘March 25, 2015’ but not sent to me at the time. This is what it said:
This is in response to your March 2, 2015 Freedom of Information Act (FOIA) request for records in the custody of the National Archives and Records Administration (NARA). Your request was received in this office on March 3, 2015 and assigned FOIA case number RD 45578.
You requested access to audit reports of the United States Department of the Treasury’s official gold reserves published by the “Committee for Continuing Audit of the U.S. Government-owned Gold” for the years 1975, 1976, 1978, 1979, and 1981-1984.
Using the terms:
GOLD, RESERVES, REPORT(S), AUDIT, COMMITTEE FOR THE CONTINUING AUDIT, COMMITTEE, INSPECTOR GENERAL, ASSISTANT SECRETARY OF THE TREASURY FOR INTERNATIONAL AFFAIRS, BUREAU OF FISCAL SERVICE, and BUREAU OF GOVERNMENT FINANCIAL OPERATION.
Our staff conducted a search using the National Archives Holdings Management System under the following records group numbers: RG 50 Treasurer of the United States, RG 56 General Records of the Department of the Treasury, RG 82 Federal Reserve System, RG 101 Office of the Comptroller of the Currency, RG 104 U.S. Mint, and RG 425 Financial Management Service. However, we were unable to locate records responsive to reports similarly titled or closely related to the subject annual gold audit 1975-1984.
For your information, we contacted a librarian at the Treasury Department who informed us that “reports from ‘Committee for Continuing Audit of the U.S. Government-owned Gold’…are not in our collection.” And we attempted to contact a records management officer at the Treasury Department, but did not receive a reply as of the date of this letter. Given the date range of your request 1975-1984, the nature of the report —an annual audit of gold, and the fact that reports of similar type have been periodically published on the Internet, it is likely that copies and drafts of these reports are in the legal and physical custody of the Department of the Treasury. You may consider submitting a FOIA request directly to the Treasury Department.
In short, the US National Archives could not extradite the 7 audit reports I requested.The reports were not present at the National Archives, the OIG or at the Treasury Department. I doubt an attempt to “submitting a FOIA request directly to the Treasury Department” will bring me anything; likely it will be a waste of time as I had already contacted all possible government departments separately, which could not deliver me the reports I was looking for despite none of them was unwilling to help me. I will, however, submit a couple of new FOIA’s at the US government regarding gold audits.
The reports I did find, and are now publicly available, are:
Coincidentally, or not, these reports are exactly the same ones as listed by Thorson at the congressional hearing in 2011 (exhibit 1, framed in red). It seems these 6 reports (5 documents) are the only ones “currently in existence” and the remaining 7 have mysteriously disappeared.
1980, 1981, 1985 & 1986 Audit Reports Anomalies
Remember, we’re investigating the audits of the greatest gold hoard on earth, which underpins the world reserve currency the US dollar.
We will discuss the remaining 4 audit reports at once, as they are very similar. I’ve found many anomalies that we’ll discuss. These could be better understood, or clarified, if we could obtain all audit reports from 1974 – 1986. However, until the missing audit reports show up we can only look at this case as it’s presented by the US government through the documents that are ‘publicly available’.
Federal Reserve Bank Of New York Stopped Auditing Gold During Continuing Audits Program
In June 1975 the Secretary of the Treasury authorized the continuing audits of the US owned “gold stock”. While the order is not very detailed, in the years that followed the committee started auditing gold stored at the US Mint and at the Federal Reserve Bank of New York (FRBNY).
In the 1980 report we can read the audit procedures and a few other snippets (we’ll quickly jump through) that help us understand how and where the audits were conducted:
Audit procedures included (1) inspecting the joint audit committee seals used to control compartments containing previously audited gold;(2)comparing the records for each compartment inventoried to the identifying information on the gold bars;(3) weighing, from each compartment inventoried, at least one randomly selected melt in each fifty melts (a melt, averages about 20 bars cast from one crucible of molten gold); (4) removing samples from a bar in each of the melts weighed and having the samples assayed; (5) verifying the mathematical accuracy of all inventory records; (6) verifying the inventoried gold to the institutions’ records; (7) verifying the quantities shown by the institutions’ records to the control accounts for gold maintained by the Bureau of the Mint and to the central accounts maintained by BGFO; (8) placing audited gold bars in compartments under Official Joint Seal and audit committee control; and (9) reviewing and evaluating internal controls and security procedures.
Committee for Continued Audits of
United States Government-owned Gold
Joseph F. Ruffley, sr Chairman
Bureau of Government Financial Operations [BGFO]
Thomas E. Diarforli
Bureau of the Mint
William M. Schultz
Federal Reserve Bank of New York
Schultz from the New York Fed was part of the continuing audits committee and therefor the FRBNY was supposed to be audited. Quoting from the 1981 report:
Gold at the Federal Reserve Bank of New York is audited periodically by examiners of the Board of Governors of the Federal Reserve System, Members of the Committee for Continuing Audits of United States Government-owned Gold representing the Mint and BGFO observed the audits at the invitation of the Board and the Federal Reserve Bank.
The initial intention is clear to us, the FRBNY was supposed to be audited; the gold to be counted, weighed, assayed and the compartments to be sealed (these were the audit procedures of the continuing audits committee). More from 1981 report:
The continuing audit is being conducted on a cyclical basis because of the enormous quantity of gold to be handled and the related costs. In performing the audit, the gold bars are physically moved from one vault compartment to another. During this operations, the melt numbers and the number of bars in each melt are verified with an inventory listing, and one in fifty melts is randomly selected for weighing and test assay.
…Compartments audited at Mint institutions and depositories are kept under official joint seal by representatives of the audit committee.
The compartments at the Mint were placed under official joint seal, whereas the FRBNY compartments were never placed under official joint seal (as we can read on page 11 of the 1980 audit report).
This suggests the gold at the FRBNY was stored so it could be easily transported in and out of the vaults, possibly through a corridor to the adjacent private vault at 1 Chase Manhattan Plaza – read this post by BullionStar gold researcher Ronan Manly for more information on the construction of the FRBNY vault and the connection to the vault across the street that was owned by JP Morgan, but recently bought by Fosun (October 2013), a Chinese investment conglomerate.
Let’s read more about the audits at the FRBNY conducted under the continuing audits program, a quote from the 1981 report:
The audit procedures followed [at the FRBNY] are essentially the same as those followed at Bureau of the Mint depositories, except that assay samples are not taken to verify the purity of the gold.
A quote from the 1985 report:
Although the quality of the gold in the custody of the Federal Reserve Bank of New York cannot be readily assayed, …
Not only were the vault compartments at the FRBNY exempt from being sealed, in addition, for an unknown reason assay tests were never performed at the FRBNY! More from the 1985 report:
The audit procedures followed [at the FRBNY] were essentially the same as those followed at Mint institutions except that assay samples were not taken to verify the purity of the gold and the audited gold was not under committee control after the audit. As a result, the gold at the Bank [FRBNY] is considered unaudited.
According to the reports available to us, in 1985 the committee had to conclude the gold at the FRBNY was never audited! The intention in 1975 was to audit the gold at the FRBNY, but then, a few years down the road the gold at the New York Fed was mysteriously exempt from the continuing audits program.
Assay Tests For US Official Gold Reserves Have Never Been Credible
Moving on to the assay tests conducted at the US Mint. An overview starting from 1953:
*In the 1953 report we could read 26 bars (0.00002 % of the total stash at that time) were assayed from bore samples. The assay tests found no irregularities. The assayer is unknown and there was no assay report included in the audit report.
*In 1974 the New York assay office tested 95 bars. Two tetrahedron-shaped chips were removed form the top and bottom of each bar assayed. The assay tests found no irregularities. There was no assay report included in the audit report.
*For all other ‘publicly available’ audit reports (1980, 1981, 1985, 1986) it’s very briefly mentioned assay tests were conducted, presumably for one in every fiftieth melt. No irregularities were found. The assayer is unknown and no assay reports have been included in the audit reports.
*For the audits performed in 1975, 1976, 1978, 1979, 1982, 1983 and 1984 under the continuing audits program allegedly 1 in 50 melts has been assayed, although there are no audit reports, nor assay reports, nor do we know who the assayer was.
*It’s likely 97 % of the audited gold by the continuing audits committee has not been assayed by an independent assayer. In 1977 the New York assay office, which is a subsidiary of the US Mint, conducted the assays. For the other years we don’t know what office performed the checks.
At this stage I haven’t been able to get my hands on any assay report from 1974 – 1986. But, the OIG disclosed assay reports – of the audits of 3 % of the US official gold reserves stored by the Mint – at the congressional hearing in 2011 (exhibit 3 and 4).
Let’s have a look. in 2004 the assayer was Ledoux & Company, a private contractor (read their homepage). Ledoux & Company found no irregularities in 2004. Then, from 2005 to 2008 the assay tests were conducted by White Sands Missile Range, which is a subsidiary of the US army. This fits right into how the US government imposes audits on their official gold reserves; the audits are performed by the US government itself. We’ve barely come across any independent auditor that saw, counted, weighed or assayed the US official gold reserves. In 2011 it was portrayed as if KPMG currently is the third party auditor (next to the owner and custodian), but this is not true. A separate post will be dedicated to KPMG.
The results of the assays by Ledoux & Company and White Sands Missile Range presented by the OIG at the congressional hearing show nearly all 9999 fine gold (see exhibit 3, or read page 62 to 124 from this document). This is remarkable. My assumption is, these assays from 2004 – 2008 are all assays authorized by the OIG from 1993 – 2008 and therefor cover 3 % of the gold stored at the US Mint.
In the excel sheet with the bar list of gold stored by the US Mint, published a few years ago, we can see nearly all the gold is “low purity” – roughly 90 % pure – very little was 9999 fine. Coincidentally almost all the gold assayed by the OIG from 2004 – 2008 was 9999 fine.
According to the excel sheet the US Mint stores 312 tonnes in 9999 fine gold, spread over 3 depositories; Fort Knox 15 tonnes, Denver 100 tonnes, West Point 197 tonnes. 312 tonnes of the total is 4 %. The OIG audited 3 % from 1993 – 2008. Technically it’s possible the OIG assayed exactly the remaining stash of 9999 gold, though chances are slim given the fact the 9999 gold was spread over multiple compartments at multiple depositories.
Why haven’t we ever seen any assays of “coin bars”? Coin bars are “assaying 899 to 901 per mille or 915 1/2 to 917 per mille”, roughly 90 % pure, and these types of bars allegedly form the bulk of the US official gold reserves. Former US Mint director Edmund Moy has stated in 2013 US reserves contain mainly coin bars because of the great confiscation in 1933 by President Roosevelt, when US citizens were forced to hand in all physical gold. All the golden coins that were handed in supposedly accumulated to the greatest gold pile on earth. However, as I’ve written in my post Where Did The Gold In Fort Knox Come From? Part One, all golden coins that circulated in the US before 1933 could not have supplied the US official gold reserves to the extent Mr Moy has stated.
The “coin bars” topic, which ties together with the existence of the US official gold, deserves a thorough study to be expanded upon in a separate post.
1,700 Tonnes At For Knox Was Re-Audited In Between 1983-1986
As we’ve seen thus far there are many problems with the official story ‘everything is fine, all the US official gold reserves all audited’. The missing audit reports and assay reports feed into our skepticism. And there is more, a lot more.
By the end of 1982 the continuing audits committee, which consisted of BGFO and US Mint staff, was “reorganized under the Department of the Treasury, Office of the Inspector General”. This was the first time the OIG was responsible for the audits of the gold at the Mint (note, this same OIG is still responsible for the audits). Then, something very strange happened in 1983.
If we carefully read the scarce audit reports available to us, we notice the audit procedures were revised in 1983. As a result more than 1,700 tonnes at the Fort Knox and the Denver depository, that were both fully audited and sealed at that time, needed to be re-audited. From the 1985 report:
In fiscal year 1985 audits of Government-owned gold were conducted at the United States Mint in Denver and the United States Bullion Depository in Fort Knox, Kentucky. The audits were conducted in accordance with the revised audit guidelines that required a statistical sample of gold melts within randomly selected compartments at the facilities.
…In October 1984, 4,136,046.924 fine troy ounces of gold were reaudited at the United States Mint, Denver. In July 1985, 11,912,458.207 fine troy ounces of gold were reaudited at the Fort Knox Depository.
…2/ As of September 30, 1982, 100 percent of the gold stored at the depository [Fort Knox] was audited under the initial continuing audit program. Between July 1983 and July 1985 the gold was audited in accordance with the plan approved by the Treasurer, as follows.
July 1983 15,248,015.541
July 1984 14,817,180.740
July 1985 11,912,458.207
July 1986 12,477,777.638 [this number I copied from the 1986 report]
…12/ As of September 30, 1984, 99.9 percent of the gold stored at the United States Denver Mint had been audited under the initial continuing audit program. In October 1984, 4,136,046.924 fine ounces gold was reaudited.
When thinking about these re-audits, three scenarios pop to mind:
In 1983 the OIG found out something was amiss with the audits performed 1974 – 1982. It was decided to destroy several audit and assay reports and no less than 1,700 tonnes needed to be re-audited.
The US government wished to open the vaults of audited gold to lease or sell the metal on the open market. An excuse was needed to break the seals. The BGFO and Mint staff was replaced by the OIG and the “revised audit procedures” were invented as a reason to open several compartments.
The auditors were bored and decided to re-audit 1,700 tonnes.
Why else would so much gold have been re-audited?
I shall rest here. More anomalies with regard to the audits of the US official gold reserves will be discussed in forthcoming posts. As will conclusions and speculation. In the meantime I will fire several new FOIA’s at the Office of the Inspector General and others. If official documents come to surface I will report accordingly.
Let us begin by looking at withdrawals from the Shanghai Gold Exchange (SGE), as this is the best indicator for demand in the Chinese wholesale market – read this post for the mechanics of the Chinese gold market. In week 20 (May 18 – 22) withdrawals accounted for 43 tonnes, down 6.57 % week on week, but still a robust amount.
Year to date a whopping 946 tonnes have been withdrawn. That’s 20 % more than withdrawals year to date at May 23, 2014, and 8 % more than withdrawals in 2013 at May 24.
As I’ve written numerous times on these pages, SGE withdrawals can be supplied by either mine, import or scrap. To get to the best estimate of each category, we first have to look at trading activity on the Shanghai International Gold Exchange (SGEI) to define what was demand in the mainland – read this post for the workings of the SGEI. In week 20 the volume traded on the SGEI, which is mainly done in the iAu99.99 contract, accounted for 24.8 tonnes, year to date 523 tonnes has changed hands on the International Board. If we calculate by how much this volume could have distorted SGE withdrawals we get 13 tonnes – read this post on how I calculated the distortion ratio.
My best estimate is, China mainland wholesale gold demand was 933 tonnes (945.7 tonnes minus 12.9 tonnes) on May 22, 2015. How was this supplied? In 2013 the SGE was supplied by 11 % scrap (recycled gold) and in 2014 by 19 % scrap (2014 percentage is an estimate). Let’s use 15 % for 2015. If we subtract 15 % (scrap year to date) from 934 tonnes, and then another 174 tonnes (mining year to date), we get 620 tonnes that have been imported into the mainland.
Speculation: as these estimated imports are relatively high to what we see being exported to the mainland from places like Hong Kong and Switzerland, my guess is Chinese import was actually a little less, and SGEI withdrawals – that were not imported into the mainland – have actually been a little more. I hope to finally get confirmation from the SGE anytime soon.
When the renminbi is said to be “fully convertible” it means that China has opened up its capital account. This would, for example, allow Chinese citizens to invest their capital overseas in stocks and bonds and alike. This is what the Chinese government is slowly achieving. The Shanghai International Gold Exchange can, inter alia, be seen as a tool to gradually allow onshore renminbi to be traded abroad and offshore renminbi in the mainland.
Friday morning I called the SGE to ask about the current status regarding the use of onshore renminbi for SGEI (/International Board) contracts. Since September 2014 international traders can use offshore renminbi to trade all contracts on the International Board and most contracts on the Main Board (they can only withdraw gold from International Board contracts stored in the Shanghai FTZ). Domestic traders can trade all Main Board contracts and International Board contracts. Although, only a few banks – to my knowledge ICBC and China Industrial Bank – offer domestic clients SGEI brokerage to use onshore renminbi to trade International Board contracts.
Have a look at the next table for an overview. Kindly note, delivery is not the same as withdrawals (/load-out).
Rumors are spreading China is to open up its capital account this year to internationalize the renminbi and aiming the Chinese currency to be included into the SDR. From MarketWatch:
HONG KONG (MarketWatch) — China is expected to launch a slate of major policies “very soon” to open its capital account and make the yuan … a fully convertible currency by the end of this year, the country’s largest state-controlled investment bank said in a report Tuesday. China International Capital Corp. (CICC) said that “2015 is no ordinary year for the internationalization” of the yuan, also known as the renminbi or “people’s currency.”The CICC report cited China’s wish to have the currency become one of those used by the International Monetary Fund to value its Special Drawing Rights, the accounting unit used by the Fund. Since the vote to add new currencies to the SDR basket — held once every five years — is scheduled to take place in October, CICC said they expected China to quickly carry out its plans to further open its financial sector, including easing controls over the yuan. “We forecast the renminbi to be called a fully convertible currency by the end of this year,” it said.
As I’ve stated before it’s likely the PBOC will revise its official gold holdings to accomplish renminbi inclusion into the SDR – for more information read this post about the renminbi, the SDR and gold. According to Wang Lixing (known as Roland Wang in the west), Managing Director China for the World Gold Council, the power to price gold will shift to the Middle Kingdom when China has opened its capital account. Wang told Reuters on May 14, 2015(published only in Chinese that I’m aware of) . The next quotes from Wang are translated by Soh Tiong Hum!
Reuters, Beijing 14 May (author: Li Wenke) –
Wang Lixing, Managing Director China WGC, says on Thursday that despite China’s economic slowdown and a red hot stock market that are a drag on gold consumption, China’s gold consumption this year is expected to reach 900-1000 tons due to the ‘One Belt and One Road’ strategy as well as the liberalization of gold market. China’s influence on the gold price is expected to rise.
Market liberalization will raise China’s influence on price
Wang says that China’s gold market continues to be liberalized. This includes opening up circulation channels, cancelling the use of permits and developing the International Board. Add loosening of import and export controls, demand is set to grow quickly which will add to China’s influence on the international gold price.
“Relatively speaking, how fast the renminbi capital account can be opened will determine the extent of further liberalization of the gold market”,he said.
In his opinion, gold retains strong features of a currency. As long as the renminbi capital account cannot be fully liberalized, gold will continue to be controlled.
For example, China’s domestic investors still cannot conveniently participate in trading on the International Board. Key reason is control on foreign exchange, which the International Board requires the use of the offshore renminbi.
According to the SGEDomestic traders (members and customers) can use onshore renminbi to trade on the International Board (see above).
He emphasizes that the SGE international board and internationalization of the renminbi walk hand in hand. Gold trading using offshore renminbi is the first step of integration. As transaction volume grows and the market continues to attract offshore investors, in conjunction with internationalization of Chinese enterprises, China’s market will elevate its influence on the international market.
Wang opines that the Chinese government’s encouragement to mining and finance companies to internationalize with policies like ‘One Belt and One Road’ will benefit these companies’ development.
He states ‘One Belt and One Road’ covers 70 countries including 16 major gold producers. This huge growth strategy helps nations to development their gold resources together. In addition, ‘One Belt and One Road’ also includes nations that have high demand for gold. Coming together will boost sales and consumption of jewelry.
Although China is a major gold consumer and producer,China can only achieve pricing influence if there are more participants engaging in an international effort.
“If our mining companies do not internationalize, if our financial enterprises participating in gold leasing and precious metals do not cover the globe, there is no point to talk about global influence”he says.
At the forefront of an effort to secure gold pricing influence is the Shanghai Gold Exchange’s international board, established in September 2014, which for the first time allows foreign investors to trade contracts in renminbi. Insiders reveal that China plans to launch a gold price fixing in renminbi this year. Price fixing will be done at SGE.
To be continued…
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