-- Published: Monday, 19 June 2017 | Print | Disqus
China excluded from the global gold price or arbitrage includes it?
China is unhappy that gold prices should be driven by U.S. and dollar concerns. But many state that because there is no free flow of gold in and out of China, China will remain a parochial market, not integrated into the global gold market. Nothing is now further from the truth.
The author has worked with successful arbitrageurs in London in the past, so we can clearly see that through the London and Shanghai Gold Exchanges via bullion banks such as ICBC/Standard, HSBC and many others, arbitrage in gold is not just feasible but practiced.
Any overweight London gold stocks can easily be sent to Shanghai from, in particular the ICBC/Standard branch in London that control two warehouses capable of holding 3,500 tonnes of physical gold. With this bank being a ‘market maker’ in London and a member of the LBMA price setting body, such a trading activity would be consistent with its normal functions.
As to gold leaving China, it is not permitted, but the export of Yuan is. So a sale in Shanghai of gold receives Yuan which can be exported to buy gold in London. This is, in essence, giving arbitrageurs the ability to lower prices in Shanghai and raising them in London.
Capital Controls in China do not pose a hurdle for this business. We believe that while capital exiting China is now heavily restricted, it is not withheld for the purchase and import of gold bullion.
What this trade does do, is to smooth out price differentials between Shanghai and London. With Shanghai’s physical gold prices being more representative of physical gold demand and supply [due to volumes of gold traded] it is inevitable that Shanghai becomes the leading gold Benchmark pricer in the future.
Shanghai twice daily Gold Fixes
Shanghai Gold Exchange does and will collaborate with foreign exchanges and allow them to use its Yuan-denominated gold benchmark prices in developing derivatives products, its chairman said last year. The Shanghai Gold Exchange has also stated, "We would collaborate with various exchanges and authorise these external exchanges to start business outside China to use it as a basis for development of derivatives products." Other exchanges are approaching the SGE to do the same. The SGE stated, "Some of the exchanges are approaching us. Collaboration is a win-win for all. In Latin America and Africa the SGE wish to offer more collaboration with them."
Shanghai has already completed a deal with the Dubai Gold & Commodities Exchange for it to use the Shanghai gold price Fixing in pricing its derivatives markets.
With the Chinese Fixes being used for this purpose it is most likely that producers and users of gold south of Europe and east of Greece will come to favor setting contract prices based on the Shanghai Fixes. This could account for up to 85% or more of the gold produced in the world. We see Russia favouring the SGE Fixes too.
Both gold producers and fabricators have based their contract prices on the London p.m. fixes to date, so a more stable and representative Shanghai Fix may well persuade them to use Shanghai rather than London in the future.
The Shanghai twice daily Gold Fix was launched in April 2016. We have followed these fixes twice daily since then and translated them through to the dollar gold price, in our daily, ‘Gold & Silver Market Morning’ [email to email@example.com to be added to the list, receiving it daily]. We saw this as part of China's bid to exert more control over pricing of the metal and increase its influence in the global market.
Until the beginning of October 2016, Shanghai’s Fixes were roughly in line with both London and New York. Since the Yuan became one of the currencies that make up the basket of currencies of the IMF’ SDR on the 1st October 2016, we have noticed that the Yuan price of gold has been higher than both London and New York [even allowing for the different price bases]. Most recently, instead of maintaining this differential, we have seen both London and New York follow Shanghai’s prices higher. This was at a time when demand in the U.S. for gold ETF shares has been absent from the market in 2016.
De-Globalization, Protectionism and Capital Controls
We are certain that we face a future of de-globalization in the west while China seeks to encourage it, through its Silk Road [Belt and Road] policies.
We see China and the U.S. work for their own separate and conflicting interests. China has and will work at ensuring that it is not under the influence of the U.S., as far as is possible, just as the U.S. will make sure its interests are not vulnerable to outside influences, as far as they can. China ignores the morality of politics and works with governments unacceptable to the U.S. to develop resources not under U.S. influence.
We quote a respected billionaire investor, who said, “Demand for gold is often stimulated by the same factors that fan protectionist and populist sentiment" and that "abrupt declines in cross border trade, investment and immigration, the dislocation of global economic policies, and a beggar-thy-neighbor approach to trade is almost tailor-made for higher gold prices. Events show nations are becoming less willing to cooperate, more willing to contest. If these de-globalization trends continue, gold will be a good investment. Gold prices tend to rise during periods of contraction in world trade."
He pointed out that the World Trade Organization cut back its expectations for global trade this year to a mere 1.7%, compared with its 2.8% projection in April. However, shipping figures coming out of the world’s largest shipping companies, show global trade as growing, particularly shipping figures coming from China. This is still a symptom of the growing global contest between east and west.
We agree with these views and see an unstoppable trend along this road leading to much higher gold prices in the future and a greater monetary role of gold in the global monetary system. This makes it all the more important that fund managers include a rising proportion of gold in their portfolios for the long term.
Is the Yuan a problem in pricing gold?
China has baulked at depending on a dollar price for gold in international transactions and believes its market weight should entitle it to set the price for the precious metal in its own currency. The Shanghai benchmark gold price is based on clearly defined rules and is transparent, traceable and auditable, backed by 12 price-setting institutions and six reference members.
Bear in mind that Shanghai is the hub of gold trading in China. The SGE has set up 61 designated warehouses across 35 cities in China to expedite deliveries and other services.
As to the Yuan itself being a problem currency, we do not see this as a problem. Since arbitrage in gold markets began when currencies began to float, professional arbitrageurs have run a ‘book’ in gold and associated currencies, so a Yuan ‘book’, a dollar book, et al, is the normal operation of such a dealer.
The clipping of small profits, on a daily basis [taking no overnight positions] is a most profitable business and one that has the power to smooth out price differentials between markets and currencies globally.
Consequently, the major steps in shifting gold’s pricing power to the east have been completed. It is only a matter of time before we see the influence of COMEX decline considerably and the link between London’s physical gold market and the Shanghai Gold Exchange be consolidated with Shanghai dictating daily gold prices.
This will ensure a 24-hour global gold market where prices relate to the gold market and not to the U.S. economic situation.
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