Tag Archives: Peoples Republic of China

Russia, China and BRICS: A New Gold Trading Network

One of the most notable events in Russia’s precious metals market calendar is the annual “Russian Bullion Market” conference. Formerly known as the Russian Bullion Awards, this conference, now in its 10th year, took place this year on Friday 24 November in Moscow. Among the speakers lined up, the most notable inclusion was probably Sergey Shvetsov, First Deputy Chairman of Russia’s central bank, the Bank of Russia.

In his speech, Shvetsov provided an update on an important development involving the Russian central bank in the worldwide gold market, and gave further insight into the continued importance of physical gold to the long term economic and strategic interests of the Russian Federation.

Firstly, in his speech Shvetsov confirmed that the BRICS group of countries are now in discussions to establish their own gold trading system. As a reminder, the 5 BRICS countries comprise the Russian Federation, China, India, South Africa and Brazil.

Four of these nations are among the world’s major gold producers, namely, China, Russia, South Africa and Brazil. Furthermore, two of these nations are the world’s two largest importers and consumers of physical gold, namely, China and Russia. So what these economies have in common is that they all major players in the global physical gold market.

Shvetsov envisages the new gold trading system evolving via bilateral connections between the BRICS member countries, and as a first step Shvetsov reaffirmed that the Bank of Russia has now signed a Memorandum of Understanding with China (see below) on developing a joint trading system for gold, and that the first implementation steps in this project will begin in 2018.

Interestingly, the Bank of Russia first deputy chairman also discounted the traditional dominance of London and Switzerland in the gold market, saying that London and the Swiss trading operations are becoming less relevant in today’s world. He also alluded to new gold pricing benchmarks arising out of this BRICS gold trading cooperation.

BRICS cooperation in the gold market, especially between Russia and China, is not exactly a surprise, because it was first announced in April 2016 by Shvetsov himself when he was on a visit to China.

At the time Shvetsov, as reported by TASS in Russian, and translated here, said:

“We (the Central Bank of the Russian Federation and the People’s Bank of China) discussed gold trading. The BRICS countries (Brazil, Russia, India, China and South Africa) are major economies with large reserves of gold and an impressive volume of production and consumption of the precious metal. In China, gold is traded in Shanghai, and in Russia in Moscow. Our idea is to create a link between these cities so as to intensify gold trading between our markets.”

Also as a reminder, earlier this year in March, the Bank of Russia opened its first foreign representative office, choosing the location as Beijing in China. At the time, the Bank of Russia portrayed the move as a step towards greater cooperation between Russia and China on all manner of financial issues, as well as being a strategic partnership between the Bank of Russia and the People’s bank of China.

The Memorandum of Understanding on gold trading between the Bank of Russia and the People’s Bank of China that Shvetsov referred to was actually signed in September of this year when deputy governors of the two central banks jointly chaired an inter-country meeting on financial cooperation in the Russian city of Sochi, location of the 2014 Winter Olympics.

Deputy Governors of the People’s Bank of China and Bank of Russia sign Memorandum on Gold Trading, Sochi, September 2017. Photo: Bank of Russia

National Security and Financial Terrorism

At the Moscow bullion market conference last week, Shvetsov also explained that the Russian State’s continued accumulation of official gold reserves fulfills the goal of boosting the Russian Federation’s national security. Given this statement, there should really be no doubt that the Russian State views gold as both as an important monetary asset and as a strategic geopolitical asset which provides a source of wealth and monetary power to the Russian Federation independent of external financial markets and systems.

And in what could either be a complete coincidence, or a coordinated update from another branch of the Russian monetary authorities, Russian Finance Minister Anton Siluanov also appeared in public last weekend, this time on Sunday night on a discussion program on Russian TV channel “Russia 1”.

Siluanov’s discussion covered the Russian government budget and sanctions against the Russian Federation, but he also pronounced on what would happen in a situation where a foreign power attempted to seize Russian gold and foreign exchange reserves. According to Interfax, and translated here into English, Siluanov said that:

“If our gold and foreign currency reserves were ever seized, even if it was just an intention to do so, that would amount to financial terrorism. It would amount to a declaration of financial war between Russia and the party attempting to seize the assets.”

As to whether the Bank of Russia holds any of its gold abroad is debatable, because officially two-thirds of Russia’s gold is stored in a vault in Moscow, with the remaining one third stored in St Petersburg. But Silanov’s comment underlines the importance of the official gold reserves to the Russian State, and underscores why the Russian central bank is in the midst of one of the world’s largest gold accumulation exercises.

1800 Tonnes and Counting

From 2000 until the middle of 2007, the Bank of Russia held around 400 tonnes of gold in its official reserves and these holdings were relatively constant. But beginning in the third quarter 2007, the bank’s gold policy shifted to one of aggressive accumulation. By early 2011, Russian gold reserves had reached over 800 tonnes, by the end of 2014 the central bank held over 1200 tonnes, and by the end of 2016 the Russians claimed to have more than 1600 tonnes of gold.

Although the Russian Federation’s gold reserves are managed by the Bank of Russia, the central bank is under federal ownership, so the gold reserves can be viewed as belonging to the Russian Federation. It can therefore be viewed as strategic policy of the Russian Federation to have  embarked on this gold accumulation strategy from late 2007, a period that coincides with the advent of the global financial market crisis.

According to latest figures, during October 2017 the Bank of Russia added 21.8 tonnes to its official gold reserves, bringing its current total gold holdings to 1801 tonnes. For the year to date, the Russian Federation, through the Bank of Russia, has now announced additions of 186 tonnes of gold to its official reserves, which is close to its target of adding 200 tonnes of gold to the reserves this year.

With the Chinese central bank still officially claiming to hold 1842 tonnes of gold in its national gold reserves, its looks like the Bank of Russia, as soon as the first quarter 2018, will have the distinction of holding more gold than the Chinese. That is of course if the Chinese sit back and don’t announce any additions to their gold reserves themselves.

The Bank of Russia now has 1801 tonnes of gold in its official reserves

A threat to the London Gold Market

The new gold pricing benchmarks that the Bank of Russia’s Shvetsov signalled may evolve as part of a BRICS gold trading system are particularly interesting. Given that the BRICS members are all either large producers or consumers of gold, or both, it would seem likely that the gold trading system itself will be one of trading physical gold. Therefore the gold pricing benchmarks from such a system would be based on physical gold transactions, which is a departure from how the international gold price is currently discovered.

Currently the international gold price is established (discovered) by a combination of the London Over-the-Counter (OTC) gold market trading and US-centric COMEX gold futures exchange.

However, ‘gold’ trading in London and on COMEX is really trading of very large quantities of synthetic derivatives on gold, which are completely detached from the physical gold market. In London, the derivative is fractionally-backed unallocated gold positions which are predominantly cash-settled, in New York the derivative is exchange-traded gold future contracts which are predominantly cash-settled and again are backed by very little real gold.

While the London and New York gold markets together trade virtually 24 hours, they interplay with the current status quo gold reference rate in the form of the LBMA Gold Price benchmark. This benchmark is derived twice daily during auctions held in London at 10:30 am and 3:00 pm between a handful of London-based bullion banks. These auctions are also for unallocated gold positions which are only fractionally-backed by real physical gold. Therefore, the de facto world-wide gold price benchmark generated by the LBMA Gold Price auctions has very little to do with physical gold trading.

Conclusion

It seems that slowly and surely, the major gold producing nations of Russia, China and other BRICS nations are becoming tired of the dominance of an international gold price which is determined in a synthetic trading environment which has very little to do with the physical gold market.

The Shanghai Gold Exchange’s Shanghai Gold Price Benchmark which was launched in April 2016 is already a move towards physical gold price discovery, and while it does not yet influence prices in the international market, it has the infrastructure in place to do so.

When the First Deputy Chairman of the Bank of Russia points to London and Switzerland as having less relevance, while spearheading a new BRICS cross-border gold trading system involving China and Russia and other “major economies with large reserves of gold and an impressive volume of production and consumption of the precious metal”, it becomes clear that moves are afoot by Russia, China and other nations to bring gold price discovery back to the realm of the physical gold markets. The icing on the cake in all this may be gold price benchmarks based on international physical gold trading.

Neck and Neck: Russian and Chinese Official Gold Reserves

Note: This article has now been updated to reflect the fact that during September 2017, the Bank of Russia added a further 1.1 million ounces of gold (34 tonnes) to its gold reserves. This information was released by the Bank of Russia on Friday 20 October.

Official gold reserve updates from the Russian and Chinese central banks are probably one of the more closely watched metrics in the gold world. After the US, Germany, Italy and France, the sovereign gold holdings of China and Russia are the world’s 5th and 6th largest. And with the gold reserves ‘official figures’ of the US, Germany, Italy and France being essentially static, the only numbers worth watching are those of China and Russia.

The Russian Federation’s central bank, the Bank of Russia, releases data on its official gold holdings in the Bank’s monthly “International Reserves and Foreign Currency Liquidity” report which is published towards the end of the third week of each month, and which confirms gold reserve changes as of the previous month-end.

The Chinese State releases data on its official gold holdings via a monthly “Official Reserve Assets” report published by the State Administration of Foreign Reserves (SAFE) that is uploaded within the Forex Reserves pages of the SAFE website. This gold is classified as held by the Chinese central bank, the People’s Bank of China (PBoC). The SAFE report is published during the 2nd week of each month, reporting on the previous month-end.

In both reports, official gold reserves (i.e. monetary gold) are specified in both US Dollars and fine troy ounces. Monetary gold is gold that is held by a central bank or other monetary authority as a reserve asset on a central bank’s balance sheet.

Delta: 63 Tonnes

For the Bank of Russia, its latest report, published on 19 September 2017 addressing August month-end, shows the Bank holding 57.2 million fine troy ounces of gold (1779 tonnes). For the Chinese State, the latest SAFE release is reporting Chinese official gold reserves of 59.24 million ounces (1842 tonnes).

Russian gold reserves, as officially reported, now total 1779 tonnes, and are now just 63 tonnes shy of the ‘official’ gold reserves of the Chinese central bank. Given that the Bank of Russia is expected to add about another 36 tonnes of gold to its official reserves during the remainder of 2017,  then if the Chinese State does not reveal any increase in its ‘official’ gold reserves between now and the first quarter of 2018, Russia will most likely surpass China in terms of official gold reserves by April 2018.

While its possible and probable that the Chinese State / PBoC really holds more gold than it claims to hold, any upcoming scenario in which the Bank of Russia surpasses the People’s Bank of China in terms of gold holdings would at least be symbolic in terms of international monetary developments, and would be sure to generate some chatter in the financial press.

Although the official gold reserves of these two key nations are now nearly neck and neck, there are still some interesting contrasts between them, not least the way in which the Bank of Russia’s reported gold holdings have been steadily increasing month on month, while the reported gold holdings of the People’s Bank of China have remained totally unchanged for nearly a year now, since the end of October 2016.

Therefore the situation which is now emerging, i.e. the distinct possibility that Russian official gold reserves will surpass those of China something in early 2018, is a situation which is emerging precisely because the Russian Federation keeps adding to its gold reserves, while the Chinese State seemingly does not.

Differing Styles of Communication

The routes via which these two strategically important nations have amassed their official gold reserves are also quite different, at least at a public reporting level.

Bank of Russia
Bank of Russia Gold Reserves: 2006 – September 2017

It wasn’t so long ago (2007) that the gold reserves of the Russian Federation were still in the region of 400 tonnes. However, beginning in about the third quarter of 2007, the Bank of Russia began a concerted campaign to rapidly expand its official gold holdings, a trend which never subsided and which has been ongoing now for exactly 10 years. By early 2011, official Russian gold reserves had exceeded 800 tonnes. By the end of 2014, the Bank of Russia was reporting holding more than 1200 tonnes of gold. And by the end of 2016, Russian official gold were more than 1600 tonnes. For full details on the Bank of Russia’s gold holdings, including gold storage, gold reserve management, gold purchases and Russian government views on gold, see “Bank of Russia, Central Bank Gold Policies” at BullionStar’s Gold University.

From the above chart, it can be seen that during 2014, 2015 and 2016, respectively, the Bank of Russia added 171 tonnes, 208 tonnes, and 199 tonnes to its gold reserves, or in total 578 tonnes over a 3 year period. In 2017, with the Bank of Russia having added another 164 tonnes of gold for the year to end of August, its official gold reserves now stand at 1779 tonnes.

The route to the Chinese State accumulating 1842 tonnes of gold is a different one to that of the Russians, again at least from a publicly reported angle. While the Bank of Russia has historically published changes to its gold reserves on a monthly basis, the Chinese central bank has chosen to remain very secretive, and between 2001 and mid 2015 had only issued four public updates addressing the size and growth of its gold reserves. These 4 updates were as follows:

  • 4th Quarter 2001: From 394 to 500 tonnes: A 106 tonne increase
  • 4th Quarter 2002: From 500 to 600 tonnes: A 100 tonne increase
  • April 2009: From 600 to 1,054 tonnes: A 454 tonne increase
  • July 2015: From 1,054 to 1,658 tonnes: A 604 tonne increase

Beginning in July 2015, however, the Chinese State started to report changes in its official gold reserves on a monthly basis, and by July 2016 was reporting 1823 tonnes of official gold holdings. The following graphic, taken from a BullionStar infographic on the Chinese gold market, illustrates the sporadic reporting of Chinese official gold reserves between the early 2000s and July 2015. Note that between July 2016 and October 2016, the Chinese State through SAFE reported that the PBoC had acquired another 19 tonnes of gold, taking its total reported gold reserves to 1942 tonnes as of the end of October 2016.

Chinese Official Gold
Chinese Official Gold Reserves, 2003 – 2016 Source: Chinese Gold Market Infographic, BullionStar

The sparse official reporting by the Chinese is also clear in the below chart from the GoldChartsRUS website, which shows cumulative holdings of monetary gold by the People’s Bank of China (PBoC) between 2000 and 2017. Looking at the top panel of the chart, it can be seen that between 2001 and 2015, there were only 4 distinct jumps in the quantity of gold held by the PBoC.

This was followed by a period of about 15 months from July 2015 during which SAFE reported small monthly accumulations in PBoC’s gold holdings, as can be seen from the gradual increases in the bars in the top panel from July 2015 to October 2016, and the corresponding presence of frequent activity in the monthly changes in the lower panel of the chart.

China
Official Gold Reserves of the Chinese central bank: Divulged Holdings 2000 – 2017. Source:www.GoldChartsRUs.com

By September 2016, Chinese State gold reserve holdings had reached 59.11 million ounces. In October 2016, the SAFE report announced that Chinese official gold holdings had reached 59.24 million ounces, a 0.13 million ounce increase from the previous month. However, then something unusual happened, at least in terms of monthly updates. Since October 2016, Chinese official gold reserves have not changed at all. The SAFE updates are still published each month, but the gold holdings figure has remained unchanged at 59.24 million ounces (1842 tonnes).

Therefore, for nearly a year now, the Chinese authorities are signalling that they have not acquired any new gold. At least that is what they want the public to believe. Hence the constantly recurring headlines from the financial media, such as this one from Reuters a week ago, “China gold reserves steady at 59.24 mln ounces at end-September – central bank”.

But is it true that China only holds 1842 tonnes of gold and that it has not been active during the last year in continuing to accumulate monetary gold as part of its reserve assets? And for that matter, is it the case that the Bank of Russia and Russian Federation only hold 1779 tonnes of monetary gold?

While its difficult to know for sure, it is possible that the People’s Republic of China and the Russian Federation both hold additional gold that is not reported by their monetary authorities. This is so for multiple reasons, including the opaque ways in which these monetary gold reserves are accumulated, the traditional secrecy of both governments, and the fact that both countries have access to other investment pools that might hold gold that can be transferred at short notice into the respective central banks’ official gold holdings.

How Much Gold could the Chinese State really have?

The historical track record of the Chinese State in sporadically communicating the size of its monetary gold holdings shows that there has often been a large gulf between the true size of its gold reserves and what the Chinese claimed to have via its piecemeal and rare updates. For example, even based on its official numbers, the PBoC accumulated over 600 tonnes of gold between April 2009 and July 2015 but did not reveal this until July 2015.

The nearly year-long hiatus between October 2016 and the present, during which the Chinese authorities, via SAFE, claim that the PBoC’s gold holdings have remained at 1842 tonnes, could be true, but only in so far as the Chinese State does not wish to inform the world about its sovereign gold reserves. Beyond this, the true gold holdings of the Chinese central bank may be significantly higher than even official published figures suggest.

There is very little transparency into how the Chinese authorities accumulate monetary gold. In July 2015, when SAFE announced the first update to its gold holdings since 2009, it stated that the “major channels of accumulation” of gold were from purchases in foreign markets, domestic gold production, domestic scrap sources, and other transacting in the domestic market. But beyond this, the Chinese authorities never comment on where they source gold from.

There is lots of evidence that the Chinese State purchases significant quantities of gold in the international market, including in the London Gold Market, and then monetises this gold (i.e. classifies it as monetary gold) , before transporting it back to Beijing. See “PBoC Gold Purchases: Secretive Accumulation on the International Market”, at BullionStar Gold University for further details.

The Chinese State is also a possible candidate for having purchased a tranche of the IMF’s gold during IMF gold sales in 2010. See BullionStar blog  “IMF Gold Sales – Where ‘Transparency’ means ‘Secrecy’” for further details.

There are also plenty of other State entities and state controlled entities in addition to the Chinese central bank that could conceivably be holding gold reserves that could in time be reclassified as PBoC gold, and brought into the sphere of reporting. See section “Gold Transfers from other Chinese State entities” in BullionStar Gold University article “Gold Policies of the People’s Bank of China” for further details.

There is also evidence to suggest the Chinese State is really buying about 500 tonnes of gold per year, and that it has a first step target of holding at least 4000 tonnes of gold. This evidence, which is from 3-5 years ago, comes from senior people in the China Gold Association (CGA). See section “How much gold might the PBoC be buying each year?” in article PBoC Gold Purchases.

A gold reserves-to-FX reserves ratio of 5% would currently put Chinese state gold holdings at nearly 4000 tonnes. A gold-to-GDP ratio of about 1.77%, which is the equivalent of the gold-to-GDP ratio of the US, would currently put Chinese state gold holdings at nearly 5000 tonnes of gold.

Russia: Golden Pipelines and Stockpiles

In its “Methodological Notes to International Reserves of the Russian Federation“, the  Bank of Russia defines “monetary gold”  as:

“standard gold bars and coins with a purity of at least 995/1,000 held by the Bank of Russia and the Government of the Russian Federation. It comprises gold in vault, en route and in allocated accounts, including that which is held abroad. The item monetary gold includes unallocated gold accounts with non-residents.”

The primary source of gold flowing to the Bank of Russia comes from Russian gold mining production, with the Russian Federation acquiring a large percentage of domestic gold mining production each year. In practice, a small group of state influenced Russian banks are authorised to intermediate between the gold mining companies and the State, acting as a gold pipeline between the mines and the Bank of Russia / Government. These banks finance the mining companies, purchase their gold output , have it refined into gold bars by Russian gold refineries, and then offer this gold to the Russian State.

Some of these banks include Sberbank, VTB, Gazprombank and Otkritie. For details see section “Russian Banks as bulk buyers of Russian Gold” in the Russian gold market article in BullionStar’s Gold University.

But its possible that some of this gold ends up not with the Bank of Russia, but with other Russian State entities, one of which is the “Gosfund” or “Precious Metals and Gems fund” operated by “The Gokhran”.

This Gosfund could be buying a portion of Russian gold mining output, stockpiling it, and intermittently releasing some of its stockpile to the Bank of Russia. When I asked the Gokhran last year could it reveal its gold holdings, the Gokhran replied to me that “it does not publish information about the amount of gold reserves in the Russian Gosfund nor any data about its precious metal operations.” See letter reply from Gokhran below (for those who can read Russian).

Gok
Gokhran reply January 2016 to query on whether it could publish its Gold Holdings.

Conclusion

Given the high degree of opacity with which both the Russian State and Chinese State accumulate monetary gold, and the fact that they both can probably tap additional gold stockpiles for boosting their official gold reserves, it will be interesting to see whether China, through SAFE, announces any increase in the PBoC’s gold holdings between now and the end of Q1 2018.

Because if China does not do so, the Russian Federation will soon have the distinction of being the world’s 5th largest gold holder, pushing China into 6th place. Will China update its gold holdings before the end of 2017, or at least by early 2018? Nothing is certain, but with an ‘official’ difference of only 63 tonnes of gold between them, the race is on.

Shanghai Gold Benchmark Price – New Kid on the Block

Exactly 19 months to the day after the International Board of the Shanghai Gold Exchange (SGE) held its first full trading session on 19 September 2014, the Shanghai Gold Exchange launched the Shanghai Gold Benchmark Price auction on 19 April 2016. In China, the number 19 is very auspicious since it consists of lucky number 1, which means origin or beginning, and lucky number 9 meaning everlasting, eternity, or longevity.

In another example of calculated Chinese planning, the SGE first announced plans to launch its own gold fixing auction on 11 March 2015. This was the week immediately prior to the launch of the LBMA Gold Price auction on 20 March 2015, an event which occurred without any Chinese banks being present in the initial participant list. This lack of Chinese banks as initial participants in the LBMA Gold Price auctions was despite the Chinese banks having made it clear in October 2014 that they wanted to be present in the London auction on launch day:

“It’s been very welcome to see that quite a few banks in China are very interested in taking part. They said they definitely wanted to be there on day one for gold” [Ruth Crowell, LBMA CEO, October 2014 interview with MetalBulletin quoted here]

Two Chinese banks eventually joined the LBMA Gold Price auction, Bank of China on 22 June 2015, and China Construction Bank on 30 October 2015, with Industrial and Commercial Bank of China(ICBC) tee’d up to join the LBMA Gold Price auction next month on 16 May 2016. However, sources in the gold market have indicated that the Chinese banks, and others, had difficulty establishing the necessary credit lines with the incumbent bullion banks that are a LBMA perquisite for being a direct participant in the LBMA auction. This need for bilateral credit lines between auction participants is not something that the Shanghai Gold Benchmark Price suffers from, since it is using a central clearing model, something that the LBMA have paid lip-service to but that has never materialised (nor will it if the LBMA has its way).

SGE bar

The Shanghai Gold Benchmark Price – Details

The Shanghai Gold Benchmark Price, which I’ll abbreviate to SGE Gold Fix, is a twice daily auction held on SGE business days at 10:15 am and 2:15 pm (Beijing Time). All time zones in China are officially the same time zone (and run on Beijing Time), with Shanghai Time equivalent to Beijing Time.

The SGE Gold Fix auctions use the exchange code SHAU, and run on the electronic SGE trading platform using a ‘centralised pricing trading’ auction model. The auction is for physically-delivered 1 kg lots of 99.99% purity gold or higher, quoted in RMB per gram, with a tick size of RMB 0.01. Delivery is in the form of 1kg standard gold ingots of fineness 999.9 or higher at SGE certified vaults. For the SGE Gold Fix, standard gold is either gold from an SGE approved refinery, or gold from a LBMA approved refinery. Settlement / Delivery is two days after trade date i.e. T + 2.

At this juncture it is important to emphasise that the Shanghai Gold Benchmark Price is a centrally cleared auction on the largest physical gold exchange in the world, that delivers real physical gold bars at any of the SGE’s 55 certified vaults. Shanghai Gold Exchange uses 55 certified vaults across 36 Chinese cities for gold storage. Unlike the LBMA Gold Price auction which just settles and clears its trades as unallocated gold that merely exists as a book-keeping entry in the database tables of the LPMCL’s AURUM system.

The objective of the SGE Gold Fix auction is to arrive at a ‘Benchmark Price’, which is a price at which supply and demand reach a balance, while allowing a certain imbalance (less than 400 kgs) to remain. The overall auction concept is therefore similar to the LBMA Gold Price auctions in London. However, there are many features unique to the Shanghai auction. The SGE Gold Fix involves a ‘Reference Price’ which is used as the auction’s initial opening price. This reference price is derived from prices entered into the trading system by two specific groups of auction members during a 5 minute pre-auction window period called the ‘Reference Price Submission Window’ which runs from 10:09 am – 10:14 am for the morning auction and from 2:09 pm – 2:14 pm for the afternoon auction.

These two sets of members are ‘Fixing Members’ and ‘Reference Price Members’. All of the Fixing members are financial institutions. The Reference Price members include gold mining companies and gold jewellery companies. The logic of obtaining opening reference prices from both fixing members and reference price members is that the SGE feels it will minimise price manipulation and price collusion since the reference prices submitted include a broader set of entities (i.e. include non-financial entities). This is a clever ‘checks and balances’ approach that is lacking in the LBMA Gold Price auction.

The Members

At launch, there are 12 Fixing Members and 6 Reference Price Members. The 12 Fixing Members are all banks, 10 of which are pure Chinese banks. These 10 Chinese banks are the Big 4 state-controlled banks in the Chinese Gold Market, namely Bank of China, China Construction Bank, Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China, followed by Bank of Communications, and also Industrial Bank, Ping An Bank, Bank of Shanghai, Shanghai Pudong Development Bank, and China Minsheng Bank.

The final Fixing members are local entities of 2 foreign banks, namely Standard Chartered Bank (China) and Australia and New Zealand Bank (China) (ANZ). Both Standard Chartered and ANZ hold gold import licenses into China, as does HSBC, however, there is no indication as of yet of HSBC becoming a Fixing Member. This is despite a report in January that China would penalise in some way a foreign bank with a gold import license if it did not join the SGE Gold Fix. Two of the 12 domestic bank holding gold import licenses, Everbright and China Merchants Bank, are also absent from the SGE Gold Fix member list. Perhaps in time, they, along with HSBC will sign up.

The 6 Reference Price members are Chow Tai Fook, one of Hong Kong’s largest jewellery companies and which also has a huge Chinese retail presence, China National Gold Group Corporation (China Gold), the largest of the Chinese gold mining companies, Shangdong Gold Group, another large Chinese gold miner, Shanghai Lao Feng Xiang, a large and well-known Chinese jewellery company, Bank of China (Hong Kong) Ltd, the RMB clearing bank in Hong Kong, and the SGE’s appointed settlement bank for the CGSE-SGE Gold Connect betwen the SGE and CGSE in the Hong Kong Gold Market, and MKS (Switzerland), the Swiss gold trading group that owns the PAMP gold refinery and also owns New York based MTB.

The above is just an initial list of participants that have joined so far. The SGE maintains that any qualified entity can join up in either the Fixing of Reference Price member categories. SGE stipulates that Fixing Member applicants are required to be financially-viable financial institutions that are either active on the SGE or active in the global gold market, while Reference Price applicants can meet one of a number of criteria such as “be a leading producer or consumer in the gold industry” or “be involved in the production, processing, trading, or investment of physical gold“.

SGE Benchmark

The Auction Mechanism

The Fixing members and Reference Price members submit initial reference prices. As to whether all members must submit a reference price is a moot point. Article 12.2 and 12.3 of the Rules for the Shanghai Gold Benchmark Price Trading state that the Fixing and Reference Price members “must provide market reference price at the designated time before the start of centralized pricing-trading“, however, the Shanghai Gold Benchmark Price White Paper (April 2016) describes a hierarchy of contingencies in deriving the reference price, two of which cover situations where less than 50% of members make a reference price submission.

The White Paper calculation methodology (algorithm) is as follows:

If > 50% of members submit a reference price, SGE calculates an arithmetic mean after disregarding the highest and lowest submitted price.

If < 50% of members submit a reference price, the SGE calculates an average (arithmetic mean) of all trades in the Au9999 spot gold contract that have been executed on the SGE during the timeframe for submitting reference prices.

If no trades were executed in the AU9999 during that time, the SGE takes the Shanghai Gold Reference Price from the previous trading session as the initial price. [this would be the previous afternoon benchmark price if applied to the morning pre-auction etc]

The Au9999 is the SGE busiest spot gold contractBased on this three-pronged approach, it would seem that the members are not all obliged to submit a reference price, otherwise the 50% threshold would never arise unless due to communication outages or similar. The only logical interpretation of the two documents is that if a member turns up to the auction (or logs in to the trading platform), then they are obliged to submit a reference price. If they don’t turn up, then there is no obligation. Notwithstanding this grey area, after the reference price is calculated the SGE then publishes the opening price.

Some readers will recall that ICE Benchmark Administration (IBA) uses a ‘human’ chairperson to come up with the opening price in the LBMA Gold Price auction using a number of price sources that ICE Benchmark Administration will not divulge. Nor will ICE Benchmark Administration divulge the identities of the panel of chairpersons that it employs to chair the daily LBMA Gold Price auctions. Frankly, this is a disgrace and a scandal, and shows that the Chinese auction methodology is far more transparent that its London counterpart. My hunch is that there are names involved as chairpersons in the current LBMA Gold Price auction that were also involved in the former London Gold Market Fixing Limited company which operated the London Gold Fixing auctions. Otherwise, why keep the identities a secret. No mainstream financial journalists in London will touch this particular story, although they are all aware of it. See BullionStar blog “Six months on ICE – The LBMA Gold Price” for further details about the lack of transparency in the administration of the LBMA Gold Price auction.

Once the opening price of the Shanghai Gold Benchmark Price is established using the calculated reference price, the auction begins, and participants and their clients submit their buy or sell orders and transaction volumes etc. The auction consists of a first round and possible subsequent rounds if supply and demand don’t reach a balance. There are two distinct time periods in each round, a ‘market tendering‘ session and a ‘supplementary tendering‘ session. The market tendering part is just the normal part of the round where all participants and their clients submit orders. The supplementary tendering session in each round only applies to the Fixing members, and allows them to submit supplementary orders against the remaining imbalanced quantity so as to try to reduce the imbalance to less than 400 kgs and so speed up the auction, because if the imbalance is shrunk to under 400 kgs, there is no need for an additional round(s).

The first round  consists of  a 1 minute market tendering session + a supplementary tendering session of 10 seconds. If the price is not balanced after the first round, the SGE trading system will adjust the price upwards or downwards depending on buy and sell orders, and then a new round begins. Any and all subsequent rounds consist of 30 seconds duration of a market tendering session + 10 seconds of a supplementary tendering session.

Once the imbalance is less than 400 kgs, it is shared out among the Fixing members. The price is then said to be balanced and the SGE then publishes the benchmark price. The ‘Shanghai Gold Benchmark Price’ now has its own web page on the SGE website here, with daily price lookup, daily, monthly and annual charting (which will make sense when the auction has been running for a while), and Trading Rules, Contract Spec and Q & A (to be uploaded, but some of which are already detailed in the Rules and White Paper linked above).

SGE Surveillance Committee

The SGE has also created an Oversight Committee to monitor and oversee the auction’s functioning. This Committee currently comprises 11 representatives from 9 organisations. Although the names of the representatives have not yet been published, the names of their organisations have. The SGE will have 3 representatives, and the 8 other entities will each have 1 representative. The list is as follows

  1. SGE  3
  2. ICBC  1
  3. Bank of China  1
  4. Standard Chartered Bank (China)  1
  5. ANZ Bank (China)  1
  6. China Gold Coin Corporation  1
  7. Baird Mint  1
  8. China Gold Association  1
  9. World Gold Council  1

Of the list of 11, seven reps come from pure Chinese entities, with the remaining four from two foreign banks, the World Gold Council and ‘Baird Mint’. All represented entities have connections with the SGE except it seems Baird.

The Oversight Committee’s remit is to monitor trading, clearing, delivery, in terms with SGE rules, analyse trading behaviour, examine conflicts of interest etc.

Central Clearing

The SGE uses central clearing of the trades executed in the SGE Gold Fix auctions and so there is no credit risk between participants. Under central clearing, the exchange becomes the counterparty to all buyers and sellers. This also avoids the need for participants to maintain bilateral credit arrangements with each other, and so easily allows the number of auction participants to grow, even exponentially. The lack of central clearing in the LBMA Gold Price auction is a huge barrier to entry for non-bullion bank participants and has been kept as such by the LBMA, even though ICE offers central clearing and has been well able to implement a centrally cleared model from Day 1 in March 2015. See ICE Executive Summary which summarises the winning ICE bid for the LBMA Gold Price wherein ICE discusses “moving to a centrally cleared model“.

The Purpose of the Shanghai Gold Benchmark Price

The Shanghai Gold Benchmark Price is but one more step in the growth and deregulation of the Chinese gold industry, and the internationalisation and extended use of the RMB. Much of this scene was set back in 2000 at the China Gold Economic Forum. It’s also a natural step for a country that is the largest gold producer, gold consumer and gold importer on earth. The SGE Gold Fix also provides China with a real role in global gold price discovery and creates the first proper transparent RMB denominated gold price benchmark, calculated within a centralised trading auction setting on an exchange.

An RMB gold price benchmark aids risk management and hedging in the domestic gold sector, and can also now be used within Chinese gold-backed derivative products, a function which the SGE has explicitly mentioned. So expect financial products to appear that use the Shanghai Gold Benchmark Price as a reference or valuation price. In China, where gold is correctly recognised as the ultimate money, there is also the prestige of having an internationally known global gold price benchmark, that will, in SGE’s words “enhance China’s voice in the global gold pricing market”.

In its White Paper, the SGE states that “the relationship between Shanghai Gold and Loco London Gold is non-competitive”, and it lists a number of reasons why this, on paper, is so, such as the London auction is for the OTC trading of 400 oz bars of 99.5 purity quoted in USD, while the Shanghai auction is Exchange-based trading for 1 kg bars of 99.99 purity quoted in RMB. While this is true, these are only ‘contract spec’ differences, and having a PBoC controlled gold benchmark that is not in London and not under the control of LPMCL clearing banks and the Bank of England is a much bigger change than purely differing contract specs.

The Chinese play a long patient game and more often than not just go ahead and do things / make things instead of just talking about doing things. The SGE and the PBoC have now set up another part of the infrastructure that can in time play a critical role in the global gold market as the Renminbi begins to internationalise. Whenever the Chinese Government and PBoC move to allow gold to be officially exported, this will really boost the new kid on the block benchmark.

I would not think that the Chinese will want to make waves with this Shanghai benchmark in the near future that would explicitly jeopardise their relationships with the London Gold Market. The fact that the luminaries of the global gold world were at the SGE Gold Fix launch ceremony and the China Gold Market Summit Forum on 19 April, much like they were at the launch of the SGE International Board in September 2014, attests to the fact that large players such as the World Gold Council, LBMA, MKS, ANZ and Standard Chartered are very much in a cooperative relationship with the SGE, the China Gold Association and the large Chinese banks. As the Chinese Gold Market continues to evolve, my view is that the Shanghai Gold Price Benchmark will naturally move into the ascendancy, and that its physical gold price discovery influence will subtly begin to show up the London Gold Market’s trading weaknesses (i.e. small % of physical traded), or alternatively, the Chinese will at some stage call time-out when ready, and allow the Shanghai Gold Price Benchmark to really shift up a gear to generate physical gold prices that will disconnect from the COMEX and LBMA pass the parcel shenanigans.