China Changing the Global Gold Market
Source: Larry Spears, Money Morning (11/23/11)
"There's another effect of this push for gold ownership: it's dislodging the dollar as the world's main reserve currency."
The goal: To dominate the global gold market and carve out a new role for its currency, the yuan.
China and other developing nations like India have been encouraging citizens to buy and hold physical gold, in forms ranging from jewelry and coins to bullion bars. China's aggressive promotion has pushed Chinese consumer demand for gold up 25% overall this yearmuch higher than the 7% global average.
World Gold Council (WGC) Far East Managing Director Albert Cheng, who predicted in March 2010 that Chinese gold demand would double by 2020, noted: "We now believe this doubling may, in fact, be achieved far sooner."
China is pushing gold because it wants the government and citizens to build financial reserves in assets stronger than the U.S. dollar, euro, and other weakening currencies. It also increases China's role in the precious metals market.
But there's another effect of this push for gold ownership: it's dislodging the dollar as the world's main reserve currency.
China's Gold Push Efforts
China's push for private gold ownership represents a major policy shift.
Chinese citizens were barred from owning physical gold under penalty of imprisonment until 2002. Since that policy was dropped and the Shanghai Gold Exchange opened, China has steadily stepped up efforts to encourage precious metal ownership.
The government now airs news programs on state-owned China Central Television describing how easy it is to buy and sell gold and silver. It also started its first gold vending machine, letting Chinese customers easily buy gold coins and bars using cash, debit cards and credit cards.
Current plans call for an additional 2,000 gold vending machines to come on line in the next two years. If they prove as successful as they did in Germany, where metals vending machines were first introduced, China's consumer gold demand will surge.
Chinese consumers turned off by the vending machines' high price mark-ups have another optionofficial government-operated "Mint Stores." Structured like a typical jewelry store, they feature specially minted bars in a variety of sizes. Mark-ups are minimal since each store has a Bloomberg screen tracking the current spot gold price, usually quoted in renminbi based on Shanghai trading, rather than in dollars on the London or New York market.
China also has encouraged more gold investment through new exchanges and yuan-denominated products.
The country on June 28 opened its first precious metals spot exchange. The South Rare Precious Metals Spot Exchange offers spot tradingas well as deferred and long-term electronic tradesin gold, silver, bismuth, indium and tellurium, with plans to add 13 other metal-related products. Chinese citizens can trade the metals through either direct margin accounts with the exchange, or through their banks and brokerage firms.
These efforts have increased Chinese consumers' gold interest, but it's the next development that will make China a major global player in gold trading.
A Global Gold Market Game-Changer
China plans to open the Pan Asia Gold Exchange (PAGE) in June 2012. PAGE will feature a market-driven pricing system and offer both physical gold purchases, including distribution or storage, and derivative products based on physical gold.
It will be open to anyone, either directly or through an agreement with The Agricultural Bank of China (ABC). Customer information for the exchange and the bank will be fully integrated, giving PAGE direct access to the accounts of 320 million retail customers and 2.7 million corporate clients in roughly 24,000 branches. The partnership makes gold buying incredibly easy for customers, who will be able to buy gold and silver online, with payment coming right out of their bank accounts.
Analysts expect the impact of this arrangement to be enormous, perhaps even changing the way global gold prices are established.
Currently, the futures market in Londonoverseen by the London Bullion Market Association (LBMA)"fixes" the spot price of gold each morning and afternoon, based on trading action in London and on America's COMEX market. However, the LBMA and COMEX contracts are backed by just 10% of face value in physical gold, while the PAGE derivatives will be backed by a much larger percentagemeaning trading volume there could change worldwide supply-and-demand dynamics for the yellow metal.
This means the focus of global gold trading could shift quickly to China, where ABC and five other major Chinese banks will fix the gold price each morning at 8 a.m. local timewell ahead of the opening of European and U.S. metals markets.
If the link between PAGE and ABC accounts is a success, other small Chinese banks are already poised to offer over-the-counter (literally) and online gold sales to their customers.
This will push up prices as consumer demand climbs even higher. And, since the price fix will be in yuan, the currency will gain significant international legitimacy as a result.
A Bigger Role for the Yuan
China's efforts to encourage gold ownership haven't just put upward pressure on gold prices. They've given the yuan a bigger role in global trade.
In fact, one of China's new gold-related investment products is considered "really less a development for gold than another step in the yuan's internationalization," Adrian Ash, head of research at BullionVault.com, told MarketWatch.
The new "Renminbi Kilobar Gold" is the world's first offshore yuan-denominated spot gold contract. It started trading in mid-October on Hong Kong's Chinese Gold & Silver Exchange. This is the exchange's first product that's open to individual Chinese investors and is denominated in something other than Hong Kong dollars.
The contract is designed to appeal to Chinese retail investors while also attracting foreign private and institutional investors who prefer yuan-denominated products "as an alternative reserve currency to the embattled dollar and euro," according analysts at GoldCore.
This will increase the yuan's role in global investment, something China has been working on for years.
"For Westerners who are struggling to come to terms with the notion of a disarrayed dollar, the thought of oil, gold or other commodities being priced in yuan instead of dollars has to seem about as likely as having another country put a man on the moon," Money Morning Chief Investment Strategist Keith Fitz-Gerald wrote in May 2009. "But the Chinese yuan is already well on its way to becoming that globally accepted standard unit of exchange, and the proverbial genie, as they say, is out of the bottle."
China's push for increased gold investment and a bigger role for the yuan will likely irritate U.S. and European economic officials who have long called for letting the yuan appreciate relative to other currencies. Beijing is unlikely to let its currency rise and devalue gold investments now that more of its citizens are holding the precious metal.
The yuan has appreciated about 3.7% this year against the dollar, but isn't expected to gain more. It fell 0.7% yesterday (Monday) to 6.36 per dollar in Shanghai, according to the China Foreign Exchange Trade System.