Tag Archives: Shanghai

China Rapidly Changing International Gold Market  

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 join the 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).

SGE weekly gold volumes

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.

AIIB silk road

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.

Shanghai International Gold Exchange Comes To Life

In September 2014 the Shanghai Gold Exchange (SGE) launched its International Board, the Shanghai International Gold Exchange (SGEI). After a slow start, the volume of the physical SGEI kilobar contract (iAu99.99) has transcended all other SGE contracts in week 15 (April 6- 10).

The primary goals for the launch of the SGEI was to facilitate gold trading in renminbi, improve price discovery in renminbi and internationalize the renminbi. The Chinese consider gold as an indispensable component of China’s financial market and for the renminbi to internationalize the renminbi-gold market has to internationalize. It could be that the spike in trading volume of iA99.99 was an incidental burp, it could also be we’re witnessing the Chinese international gold exchange entering its adolescence.

In any case, the chairman of the SGE, Xu Luode, has been very clear about his intentions with the SGEI. A few snippets from Xu…

December 2013:

The Shanghai Gold Exchange chairman Xu Luode said he considers the construction of an offshore gold exchange international gold market in the Shanghai Free Trade Zone, for the cross-border use of renminbi, it will be launched for the international offshore investors… The industry comments that it will be a tool to promote the internationalization of the renminbi, …

…the goal is to build Shanghai into an international gold exchange trading market with global influence.

May 2014 (direct quote):

The Chinese gold market is an important force, a positive energy in the international gold market but its influence does not correspond to its mass and scale. Last year China’s domestic gold mines produced 428 tonnes; at the same time China imported 1540 tonnes of gold, adding up to nearly 2000 tonnes. China’s import volume is significant but China’s influence on the price of gold is very small. Real influence still lies in the West. Data such as Non-farm payroll, or even a speech could impact the gold market in a big way. In this sense, the mass and scale of China’s gold market and its influence in the international gold market does not match. Through the SGE international board Chinese pricing power will increase.

Foreign investors can directly use offshore yuan to trade gold on the SGE international board, which is promoting the internationalization of the renminbi. The international board will form a yuan-denominated gold price index system named “Shanghai Gold”. Shanghai Gold will change the current gold market “consumption in the East priced in the West” situation. When China will have a right to speak in the international gold market, pricing will get revealed. New York prices gold through bidding whereas in London the gold price is fixed by five banks. However the London gold fixing price is now being questioned since these five banks are price-fixers while at the same time they are also the market’s most important participants.

China is fully qualified and may become the world gold market’s very important first class player.

February 2015 (direct quote):

The Chinese government regards the gold market as an indispensable component of China’s financial market and attaches great importance to its growth and development.

… As national efforts to internationalize the renminbi reach their crescendo, China’s domestic gold market is facing an auspicious window and timing for pursuing its internationalization and greater openness. 

… China, India, Dubai and Singapore all enjoy vibrant trading scenes and comparative advantages; however, in the eyes of many investors, the influence wielded by the Asian markets is still very limited as a whole. Using the International Board as a launch pad, China’s gold market will embrace greater openness and foster stronger ties with its neighbors and, together, elevate the trading and pricing influence of Asia in the world’s gold market.

…All products listed on the Exchange are denominated in renminbi. As more market participants gather to trade on the Exchange, and onshore investors and domestic funds become more intertwined with offshore investors and offshore funds, the sphere of influence of trading prices on the Exchange will gradually expand from nearby regions to the whole world and, at the same time, renminbi-denominated gold benchmark price will emerge as another financial index of global significance.

As a reminder, from PBOC Governor Zhou Xiaochuan in 2004:

Despite the declining function of gold as currency in the world, the activeness and development of investment activities with gold as the target indicate that gold still has a strong financial nature and remains an indispensable investment tool. In major financial centre’s in the world, the gold market – together with the money market, securities market and FX market – constitutes the main part of the financial market.

In the chart below we can see the weekly trading volumes of the most traded SGE contracts – Au99.95, Au99.99, Au(T+D) – and the most traded SGEI contract – iAu99.99.

Weekly volume SGE SGEI contracts

The largest spike in volume was on April 8, when total iAu99.99 volume was 31 tonnes for the day (counted unilaterally). Which is still far below the COMEX, where 382 tonnes in gold futures were traded on April 8, though, COMEX gold is leveraged more than 20:1.

Note, the SGE contracts can be traded by international members of the SGEI, and domestic members of the SGE are allowed to trade SGEI contracts. Though, a limited number of members of the SGE can trade iAu99.99 and are allowed to import this gold from the Free Trade Zone into the mainland. No international SGEI member can export the gold from the SGE (mainland) to abroad. For more information read The Workings Of The Shanghai International Gold Exchange.

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SGE Withdrawals

Unfortunately we don’t know who is exactly trading the iAu99.99 contracts, international or domestic members. Nor do we know if the traded gold is withdrawn from the vaults, and if withdrawn, if it’s subsequently imported into the mainland or exported from the Shanghai Free Trade Zone. Based on data released in February and low iAu99.99 volume we could be fairly sure SGEI trading didn’t substantially distort our proxy of Chinese wholesale gold demand, SGE withdrawals. From SGE Withdrawals In Perspective:

For now, the SGE withdrawal distortion ratio is at most 0.0246 (3/122). Measuring Chinese wholesale gold demand conservatively would be

SGE withdrawals – (0.0246 X SGEI volume)

However, now SGEI volume is surging it’s hard to say if this “distortion ratio” is still usable. If the volume is surging the trading pattern can also be changing. We have to wait for new information on withdrawals to come out (believe me I’m trying to get it out) before we can continue to make accurate estimates of Chinese wholesale gold demand measured by SGE withdrawals. Until then, the significance of SGE withdrawals from week 14 is unsure.

The most recent SGE withdrawal data is from week 13 (March 30 – April 3), when SGEI volume hadn’t peaked. In week 13 withdrawals from the vault of the Chinese bourse accounted for 40 tonnes, year to date 647 tonnes have been withdrawn. 647 tonnes corrected by 0.0246 as distortion ratio is 641 tonnes, which is up 9 % from 2014. According to my estimates China has net imported over 450 tonnes year to date.

Shanghai Gold Exchange SGE withdrawals delivery only 2014 - 2015 week 13

Shanghai Gold Exchange SGE withdrawals delivery 2015 week 13 dips

So much for now on the Chinese gold market, keep you posted!