China clamours to set global gold prices

The world’s biggest producer and consumer of the metal sees a golden opportunity to expand its pricing power.

China gold
The Shanghai Gold Exchange ranks fourth worldwide for global gold transactions [Jon Woo/Reuters]

Shanghai, China –  A bored security guard walks around the entrance hall of an unremarkable 11-storey building in downtown Shanghai, desperate to kill time. The receptionist, a young Chinese woman, is flopped across her desk, half-asleep.

It’s a mid-June afternoon at the Shanghai Gold Exchange (SGE), China’s one-and-only trading platform for the yellow metal, but the place is not exactly bustling with activity.

“We are quite recent, nothing like the century-old exchanges of London and New York. All trading transactions here are handled electronically. That’s why it’s quiet,” said Yang Ming, one of the first employees at the SGE.

China hopes to increase its price-setting power to rival London's gold fix [Favre/Bloomberg/Getty Images] 
China hopes to increase its price-setting power to rival London’s gold fix [Favre/Bloomberg/Getty Images] 

The SGE’s Main Board, where Chinese domestic investors buy and sell gold, occupies four floors of the building.

The International Board, which is dedicated to foreign investors, is located in Shanghai’s new Free Trade Zone, on the other side of the Huangpu River. Altogether, more than 180 people work in these two locations.

The SGE was founded in 2002 to centralise all of China’s gold trading, which had been a state monopoly until then, into one single marketplace. 

Now, China hopes to use the SGE to increase its pricing power over the precious commodity. A yuan-denominated gold index will be launched here by the end of 2015 in a bid to challenge London’s own benchmark, the “London Gold Fix”, which has served since 1919 as the global reference point for the industry.

‘Already a regional leader’

While the SGE is the world’s largest trading platform for physical gold – such as bullion and coins – and Asia’s prime destination for gold trading, it hasn’t managed to become a global gold pricing centre rivalling London or New York.

It ranks fourth worldwide for global gold transactions, just ahead of Dubai which is in fifth place. Last year, 18,500 tonnes of gold were traded on the SGE, according to the annual report. That equals to roughly 75 tonnes per trading day.

“Global gold prices are not set here in Shanghai, but in London and New York,” explained Gu Wenshuo, a spokesman for the SGE.

“Yet in Asia, we are already a regional leader. Our plan now is to launch our own price index, the Shanghai Gold, and make it a reference in our time zone. Of course, it’s easier said than done,” said Gu.

London has traditionally been the world’s gold pricing centre. Western banks there have long had a big influence on the quotation of the precious metal. 

But this may change soon with the upcoming Shanghai Gold index, and with China’s “Big Four” banks showing increasing interest in international gold pricing mechanisms.

On June 18, Bank of China  made headlines here after it became the first Chinese and Asian lender to join seven other banks that participate in the twice-daily electronic auction held in the UK’s capital, a big move for the country.

Given China's yuan not being fully tradeable, and other controls on its financial system, I don't think honestly that suddenly consumers will abandon the dollar-per-ounce pricing of the London benchmark.

by Philip Klapwijk, Precious Metals Insights Limited

Before it was transformed into an electronic auction, the “London Gold Fix” was set every day by Western banks who would simply call each other on the phone to set the price of gold on a daily basis.

This interbank system, however, is now under growing scrutiny for alleged price manipulation, and was subsequently transformed earlier this year into an electronic auction to allow more transparency.

A price taker, not a price setter

China now hopes that its “Shanghai Gold” index, expected to be launched by the end of the year, and its outbound-looking state banks will help the country have a greater say in terms of how the market functions.

Despite being the world’s largest consumer, producer, and importer of gold, the Asian powerhouse has never played a big role in determining global gold prices.

“The country’s role in the international gold markets is still surprisingly small. China is very much a price taker, rather than a price setter,” said Philip Klapwijk, founder of Precious Metals Insights Limited, a consultancy based in Hong Kong.

According to the World Gold Council, the market development organisation for the gold industry, China is the number one consumer of the yellow metal with 26 percent of global private sector demand.

It’s also the biggest producer, with nearly 15 percent of global output in 2013.

“You might argue that given its huge consumption, China obviously influences global gold prices. But all the trading activity that goes on in China tends to be a domestic affair,” said Klapwijk.

China’s craze for gold is quite recent.

Gold remained under state control until 2001. Before that year, it was purchased, allocated, and priced unilaterally by China’s central bank, the People’s Bank of China.

Market-driven liberalisation happened a year later, with the birth of the SGE, which in turn triggered a new wave of reforms.

In 2004, Chinese households were allowed to purchase gold bars for the first time since the 1950s.

“The market opened year after year. Now I can’t think of any other country where buying gold would be easier than in China,” said Roland Wang, managing director of the World Gold Council’s  China office in Beijing.

As the market opened, China’s banks rushed in to offer a wide range of gold products to China’s rising urban middle class. However, constraints on China’s financial system made it difficult for them to make inroads outside the country, and thus acquire pricing power globally.

In 2004, Chinese households were allowed to purchase gold for the first time since 1950 [Reuters]
In 2004, Chinese households were allowed to purchase gold for the first time since 1950 [Reuters]

A bigger role

In China, domestic gold prices are set in yuans through the SGE, and are typically higher than international gold prices due to tight supply in China.

In 2013, the country’s gold demand hit a record 1,132 tonnes, twice its domestic production of 563 tonnes, according to the World Gold Council – prompting a big boom in gold imports.

For China, having a one-kilogramme yuan-denominated gold index could be a way to favour its own consumers and protect them from other foreign-currency denominated indexes, which Beijing might say are prone to manipulation, or favour “Western interests”.

Around 15 Chinese banks are expected to participate initially in the SGE’s Shanghai Gold fix, according to an unnamed source quoted by Reuters. But its success depends ultimately on the participation of foreign banks.

The goal, thus, is to attract foreign investors and make them trade gold contracts in Shanghai based on the local benchmark.

Analysts, however, remain suspicious.

“Given China’s yuan not being fully tradeable, and other controls on its financial system, I don’t think honestly that suddenly consumers will abandon the dollar-per-ounce pricing of the London benchmark,” said Klapwijk of Precious Metals Insights Limited.

Yet the SGE still does everything it can to allure foreign investors. It added a third trading session, from 8:00pm to 2:30am, to watch the afternoon price in London and the morning price in New York.

To be sure, the SGE’s “International Board” is the major breakthrough so far.

Launched in September 2014 under the auspices of China’s central bank governor and the mayor of Shanghai, it allows foreign investors who are not legally established in China to trade gold in the country.

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“Before that, the SGE had a small number of foreign investors, and they could participate only if they had local banking licenses,” said Roland Wang of the World Gold Council.

The International Board hopes to tap into the offshore yuan reserves held abroad by big foreign financial institutions. It currently has 52 international members such as HSBC, JP Morgan, UBS, Goldman Sachs and major international gold refiners.

This compares to 167 domestic members on its Main Board.

Nevertheless, the trading volume is still very low. During the 69 trading days following its grand opening, only 190 tonnes of gold were traded on the International Board – less than three tonnes per day.

Source: Al Jazeera