17 July 2014

How Eastern Gold Demand Is Transforming The Gold Market

GoldSilverWorlds has a good post up summarising my tweets and Al Korelin interview about the LBMA Forum in Singapore. Below are some additional notes I took which I didn't tweet or talk about.

Zhang Bing Nan of China Gold Association (view his slides here) when asked about the West to East flow gave what I think is a classic Chinese answer: the globe is round so what is East and what is West, which got a laugh. Other comments:
  • no matter who you lend your dollars to it is not safe; not the same with gold
  • fortunate we have different perspectives on gold (ie you Westerners want to sell while we want to buy)
  • gold in people’s hand makes them feel safe
  • Asians unlike westerners as don’t have same financial products hence they buy gold
From the Zhang slides I thought the comment that "improving the gold market and pushing forward the gold consumption and the “gold held by people” will play a important role in promoting the gold-content of RMB" shows that for China it isn't necessarily important how much gold they have in official reserves, it is about just increasing the total gold held in the country. Whether that indicates they have a contingency plan to confiscate privately held gold if the world moves back to a gold backed monetary system of some sort, or just that they see the country as more wealthy the more gold its people hold I think is an open question.

Note also that China's development of its gold market is not just about physical: "China is speeding up the legislative process of the gold market, actively developing the gold derivatives quoted in RMB". Zhang also made a point about the China Gold Association being a 5A class national social organization which "ranks the highest level assessed by China's Ministry of Civil Affairs and ranks the fifth in the 177 participating national social organizations", which shows how importantly the Government views the gold market.

While we are on China, I would recommend reading this post by Ben Hunt:

"A number of readers asked if China’s accumulation of physical gold played a significant role in China’s current and forthcoming challenges to the Western monetary policy status quo. Absolutely! It has exactly the same meaning as the recently announced dollar-free natural gas trade agreement with Russia. It’s a fang. It’s a claw. It’s a tool in the construction of an alternative monetary policy regime structure."

Hector Freitas of UBS said that their wealth management division saw clients selling gold for a couple of months post the April gold price crash but that these were opportunistic investors who were now in equities, rather than being longer term diversification holders. He said UBS was seeing demand to shift physical gold to the East for storage and noted that there was more wealth in the West than the East, so if the West begin to distrust currency or war or other events occurred than the West will dominate gold demand. In that situation I can't see the East selling it so not sure where the West will get it from.

Tony Reynard of Singapore Freeport was interesting, saying that they never intended to build the Freeport for gold storage and that it was planned for art but they were asked by the market if they could store gold. Of the 25,000m2 of vault space only 10% is for gold. He said that gold is not a good return for them as they lease space by the square foot and gold doesn’t take up much space (note that Freeport is just a landlord, they don’t operate the vaults themselves, so the money is made by the storage firms who have a fixed lease cost but change a % of value). Of most interest was the statement that they have been asked to build similar facilities around the world including Luxembourg, China, South Korea, Macau, Japan and that all of these were requiring precious metal vault capability, which he took as a sign that the operators see a market for precious metal storage. Related comment from Guy Bullen of Brinks was that they found it physically challenging to handle the 2013 volume of gold going into China.

Regarding the talk about new Asian price benchmarks in competition with the London Fix, I missed who made this comment but they said that whether a benchmark can compete or become established depends not just on its volume but also whether there a big enough premium/discount due to fundamental difference between the location and existing benchmark locations from a physical point of view. For example, if the cost of moving gold from an existing benchmark location like London and the new one is say only $0.20 per ounce, then the market will just continue to use London as a benchmark due to its liquidity and the new benchmark won't get volume. Liquidity will only move if there is a big enough difference.

On India, Rashesh Shah of Edelweiss said that Indians save approximately $500bn each year of which 10% goes into gold resulting in a $40-50bn flow of money into gold each year. One ongoing debate with pro market analysts is whether gold demand will hold up as China and India develop, the theory being that people are mostly buying gold due to a lack of trusted financial and insurance products and as those products become more widespread gold demand will reduce. Rashesh felt that as India's financial sector become more sophisticated Indians will still buy gold but there will be more willingness to buy gold in financial vehicles, so he thought it would be the same consumption of physical gold and the change would just be in how it was bought. He said that currently India’s interest in gold was due to a view that it was the best bet against inflation, was easy to invest in and was a cheap way of "exporting" capital (getting around capital controls) by getting exposure out of the Rupee.

Finally, Harriet Hunnable of CME Group made the following comment on a panel session which she shared with LME and Tocom (it turned into a bit of a competitive pitch between CME and LME for the silver fix):

"We are not keen on financially settled gold contracts, market wants integrity of a physically settled contract."

Only comment I will make is that there is a big difference in "integrityness" between a market with the option of physical settlement and where only a few percent of contracts physically settle (eg Comex) and one where you have to physically settle and there is a 10% penalty if you don't (eg the new SGX kilobar contract).


  1. "no matter who you lend your dollars to it is not safe; not the same with gold"

    what does this mean? if you lend your gold out you have the same risk as if you lend out anything else...

    and it doesn't matter what % of the CME contracts are physically settled - it matters that the default is physical settlement. if they were cash settled, there would be no mechanism by which they would bear any resemblance to the price of gold. as they are currently - physically settled contracts, regardless of the fact that trading volume and open interest dwarf physical settlement - the price is arbed out vs global gold at all times.

  2. I think you misunderstood what he meant,which is understandable given the guy is a Chinese speaker and the statement is ambiguous.

    I'm pretty sure he meant that lending dollars isn't safe, but OWNING gold is.

  3. KD,

    My brief notes probably didn't reflect the statement correctly, it was as fallingman said, contrasting to physical gold.

    Fair points re futures, seems I got a bit carried away there with goldbug hype myself - it will be interesting to see exactly how much of the SGX kilobar IO actually physically settles rather than be closed out.

    I would note the fact that the seven SGC contracts only go out to 1 week makes this a much more "physical" contact than Comex.

    I am still not entirely comfortable with such a low amount of actual physical trading, shouldn't there be a bit more balance between specs and actual users? I know a lot of legitimate industry users just use futures as a hedge and close out, but I'd still expect a lot more than a few percent physical delivery going on.

    I'm not aware of CME's rules on failure to deliver physical but doubt there is a 10% penalty. It may actually turn out with SGX that such a heavy penalty results in different dynamics around expiry. Will be one to watch.

  4. Bron, is there really a requirement to deliver in the sgx contract, meaning if I sell I have to deliver, i can't just buy my position back? That is not how i read the sgx rules.

  5. That is Kid's point, one will be able to buy back their contract so no there isn't really a forced requirement to deliver.

    However, the lack of a significant penalty for not delivering allows for gaming, eg a short finds that the cost of closing out is high as longs aren't puking themselves so they strategically default. At 10% penalty that is unlikely to happen on the SGX.

  6. CME has penalties as well, they are not black and white but i do not recall a single instance of failure to deliver (but i have only been paying attention a handful of years)