China’s Long-Term Plan to Impact Gold Pricing

Rumors of China’s intention to be actively involved in gold price fixing have been confirmed by the recent actions of a number of Chinese banks and lenders. In June, Bank of China joined the London Bullion Market Association, a group of banks that set the twice-daily gold price. (The traditional London Gold Fix was replaced by the LBMA in March.) Bank of China Ltd. joins the 10 other firms that participate in the twice-daily auction, including Bank of Nova Scotia, Goldman Sachs, Barclays, HSBC Bank, and JPMorgan Chase London.

Chinese Banks Join Pricing Group

While Bank of China was the first Chinese bank to become a part of the gold fixing process, at least two other banks are expected to start participating in the coming months. Industrial & Commercial Bank of China Ltd. has announced its intentions and is expected to join the pricing group in the next few months.

In addition to this active involvement in the London markets, the Shanghai Gold Exchange also seeks approval from the People’s Bank of China to launch its yuan-dominated gold fix prior to the end of 2015. Combined with further participation by as many as 15 additional Chinese banks, these moves are intended to ensure China is no longer at the mercy of the New York and London markets.

Physical Gold Vs. Speculators

While China and India are often in competing positions as the largest global users of gold, China wants to ensure the role of speculators in the Comex and London markets is tamped down. Specifically, the Chinese at the Shanghai Gold Exchange note that less than 5 percent of the contracts initiated on Comex result in physical delivery of gold. On the other hand, the world’s largest over-the-counter gold trading market is currently found in London. Most recent clearing data indicates an average $20.2 billion in gold was traded each day in April, according to the LBMA.

Unknown Role of a Yuan Fix

While China is currently the world’s largest producer and consumer of gold, it is forced to use dollar-denominated pricing affected by the huge volume of trading on the Western exchanges. It would benefit China to trade in yuan, as has been proposed.

The mid- and long-term impact of producing a yuan fix is a hotly debated question. Since the yuan is not fully convertible between the current dollar fix, there is some question of which will become the preferred pricing option. When the yuan fix becomes an accepted pricing medium, as expected, it will provide China the significant market influence it is seeking. For example, the nation could well demand both foreign companies and local consumers of gold to conduct transactions based on the domestically controlled yuan price.

If the yuan fix takes off, China could compel local buyers and foreign suppliers to pay the domestic yuan price, making the London fix less relevant in the world’s biggest bullion market. This could occur even as the two forms of price setting might find a way to co-exist in the marketplace.

Part of a Larger Strategy

These initiatives to play a larger role in setting the price of gold are part of a larger effort by China to influence international trade and finance in many commodity sectors. It has also been active in the currency markets to increase the viability of the yuan as a recognized and serious competitor to the dollar.

Adding to the mix of tactics to achieve its strategic financial goals, China is known to be stockpiling huge quantities of physical gold. While the actual numbers of tons held are under question, some analysts put the amount as high as 2,500. This plays well into the strategy of stabilizing the country’s foreign exchange holdings and increasing global respect for the yuan. (This strategy is even further aided by the large investments into the Silk Road Gold Fund, a government-controlled gold investment fund.)

The sum of these actions is expected to play an increasing role in global gold prices in the coming months. Notwithstanding the current uncertainty in China’s equity markets, the overall expectation is that China’s role in gold fixing and the anticipated yuan-denominated trading currency will ultimately weaken the dollar, and therefore most likely result in an upward pressure on gold prices.

Published by: Eric Sepanek