China continues to open up its gold market, with plans to launch a renminbi-denominated gold fix and talking with the CME to “list its products and prices on CME, whose members and clients will be allowed to trade the Chinese exchange’s products”. Such news reports are usually accompanied by references to China wanting to “increase its influence in global gold markets” in line with its size in the physical market.
Such developments are generally seen by goldbugs as positive, the narrative being that China is a physical gold market and they love gold and only buy it (never sell), which will mean that will we have a market “that is not distorted by the banks, their proprietary trading, or control of the gold distribution system globally”, according to Julian Phillips, for example.
No doubt Pierre Lassonde will be right when he said that “10 years down the road, the Shanghai Gold Exchange (SGE) is likely to determine the gold price, not the COMEX” but a closer look at the Chinese market reveals it may well be a case of “Meet the new boss, Same as the old boss”.
While the SGE’s most popular contract is the 9999 Gold, the deferred delivery contract (like a forward) also attracts a lot of volume. People also forget that there is a Shanghai Futures Exchange, which has a gold contract no different to Western gold futures.
Consider also the Bank of China International, who recruited a “former Goldman Sachs metals trading chief as an adviser to help it expand its commodities business”, someone who was on the management committee of the London Bullion Market Association and an executive committee member of the London Metals Exchange.
Or how about the Industrial and Commercial Bank of China, who is reported as launching “gold accumulation schemes, swaps, forward hedging, lease/financing, collateralized loans and other financial services” and who “is working with HSBC, JP Morgan Chase, Brink, Metalor and other professional logistics providers”.
Chinese have been involved in using “gold to engage in currency and interest rate arbitrage transactions”, collateral financing trades, or leasing and selling gold “from banks to solve their short-term funding problems in the hope of buying back the gold at lower levels to repay the lease” (see here), so much for Chinese only being buyers.
While the Chinese are indeed large consumers of physical, I think it is naïve to think that as their gold market matures their bullion banks will refrain from the same exchange/over the counter proprietary paper trading activities that Western bullion banks do, or that the same greed dynamic we have seen driving leveraged Chinese stock market investing (via official and hidden margin lending: link) will not occur in the gold market.
This dynamic is no doubt what was behind Pierre Lassonde’s forecast that “when we reach the peak in this gold cycle, the SGE will resemble a casino. The Chinese have a huge propensity for gambling, and this is what will likely propel the gold price to levels that we probably can’t even imagine.”
And then to a crash we probably can’t even imagine.