The Shanghai Stock Market Crash and China Gold Demand

What Does it mean for the future of the gold market?

At present, up to 12 trillion yuan stays in domestic residents' saving accounts. The launch of individual gold investment, therefore, will allow residents to change currency assets into gold assets. At the macro level, it will expand channels for changing savings into investment, thus adjusting the money supply; in the micro aspect, allowing citizens to trade and keep gold can improve social welfare, benefiting both the country and the population.

Moreover, with the dual attributes of common commodity and currency commodity, gold is a desirable instrument for hedging. Therefore, developing gold trade for individuals is practical." – Zhou Xiaochuan, Governor, the People's Bank of China.

Shanghai stocks have fallen over 30% since mid-June. The equivalent in U.S. terms would be for the DJIA to fall 6000 points to the 11,000 level – a crash by any definition. Most of the commentary on this important subject has centered around the potential contagion effect for stock markets in the rest of Asia and beyond. There is another aspect to the crash worth considering though, and that has to do with the effect it will have on Chinese gold demand.

The Chinese people, it is well known, already have a cultural affinity to gold. That attachment just received a shot of adrenaline. Prior to June, trading volumes on the Shanghai Gold Exchange (SGE) were already running 20% higher than the previous year. Now, with crash psychology affecting thinking up and down the spectrum of investors, SGE is reporting volumes off the charts. In early July, Want China Times reported that "SGE posted a record trading volume of 48.33 million grams in a single day in late June." (48.3 metric tonnes, a big number.)



Typically stock market crashes inspire gold demand. In the case of China, where the government and central bank encourage citizen gold ownership as a matter of public policy, that lesson could become enshrined in the national psyche. The important consideration for investors elsewhere around the globe is what effect even stronger gold demand from China will have on the gold price both now and in the future.

Flow of physical metal between buyers and sellers will govern prices in China not paper trades

Ever since 2011 when China's demand began to ratchet up, clients have asked how the price of gold could be stagnant to down under the circumstances. The short answer to that question is that price discovery for gold does not occur in the physical market, but in the multi-trillion dollar leveraged paper trade in London and New York – a volume that dwarfs the physical delivery market. Now China is about to challenge that price discovery mechanism through significant infrastructure changes slated to take effect by the end of the year.

This new construct has as its base China's fundamental understanding and goals with respect to gold as summarized by Peoples Bank of China governor Zhou Xiaochuan in our masthead quote above; its affinity for delivered physical ownership, as opposed to paper-based metal; and, the official measures it has undertaken to make inroads into the international gold market's price discovery mechanism.

To gain a better understanding of how China is likely to affect price discovery in the gold market, let's start with something of interest that surfaced as a result of the recent Shanghai crash. Financial Times reported rumors floating the markets that Goldman Sachs was responsible for manipulating stocks downward. Officials denied those rumors and a spokesman for the exchange stated that "foreign investors with access to the futures market via theQualified Foreign Institutional Investor (QFII) program were only permitted to use futures for hedging operations and are not allowed to make directional bets. 

All recent trades by QFIIs complied with regulations." Of course if any manipulation of stocks were to occur, it would be executed in the leveraged futures market where bets can be placed at pennies on the dollar.

Up until I read that quote I was unaware of the strict procedures governing foreign trading on the Shanghai Futures Exchange (SHFE), China's only futures trading venue. A further investigation, helped along with some links from Koos Jansen, the Netherlands based expert on China's burgeoning gold market, revealed stringent rules governing trade on the SHFE for domestic participants as well, though not quite as stringent as the rules for foreigners. 

At the heart of those rules, SHFE imposes strict position limitations and margin requirements on traders in order to keep price speculation (or directional bets to use its term) to a minimum. Futures trading in China, clearly is meant to serve as an adjunct to the physical market instead of the other way around as it is in western gold trading centers. 

Hedging is maximized. Speculation is minimized. Leverage is controlled within reasonable parameters.

Link SHFE "Operational Manual for Gold Futures Contract Trading"

Fake SJC Gold Bullion Returns to Market

Gold bullion copying SJC, the country’s most popular brand name, has recently re-emerged on the market, dismaying both gold traders and the bars’ authentic producer, Saigon Jewelry Co.
While forged gold bullion used to be produced only under the form of the 1/5-tael, or 0.24 ounce, bar, it is now circulated in the form of one-tael bullion, according to gold traders.

Faking SJC gold bullion will help gold smugglers regularize their contraband raw material gold, and rake in huge profits.

With SJC gold bullion chosen as the national gold brand name, Saigon Jewelry Co has called on the State Bank of Vietnam and police to probe into the case.

Many gold shops in the Mekong Delta provinces have reportedly refused to buy gold bullion, fearing that the metal has not been authentically produced by SJC.

On the fake gold bullion, the first letter of the word ‘tael’ is embedded on its surface in a slightly larger font than that of the authentic bars, according to an owner of a gold shop in Ho Chi Minh City’s District 8, who currently has an allegedly fake SJC gold bar.

“Its purity is also less than 99.99 percent, which an authentic SJC gold bar is supposed to have,” he added.

The fake bullion is made in such a sophisticated way that it is almost impossible to tell it apart from the real deal with the naked eye, gold traders said, adding that even the distinguishing differences on the fake gold bullion have all been rectified.

Gold shop owners are now more wary of customers wishing to sell SJC gold bullion than ever before, and all refuse those with old or torn packaging.

“We only earn a little profit by buying SJC gold bullion. But a fake gold bar will cost us a huge loss,” the owner of a gold shop in District 1 said.

Whopping profits

In response to the market concern, Saigon Jewelry Co said the root of the problem stems from the fact that domestic gold prices are still VND2 – 3 million higher than their global counterparts.

“With such a huge price difference, gold smugglers are willing to spend millions of US dollars investing in machinery to create fake SJC gold bars, as they will soon recoup the investment,” a company chief official who requested anonymity told Tuoi Tre.

Experts also said narrowing the price gap is the only solution to the issue.

“Successfully producing a fake SJC gold bullion will bring in a VND3 million profit to the producer, and with 1,000 bars sold, the figure is an enormous VND3 billion ($143,888),” a CEO of a gold company, who preferred to be anonymous, revealed.

Demand leads China to increase 2012 Panda bullion mintages

Pandas have notoriously sensitive populations, but the coins depicting them are proliferating at least: amid soaring demand the People’s Bank of China has announced higher mintages for 2012 Panda bullion coins.

The 2012 mintages for the coins will in some cases double or triple compared to 2011 mintages, according to the June 20 announcement.

The decision to increase mintages was reported by state news agency Xinhua and confirmed by a spokesperson for China Gold Coin Corp., the distributor of the coins in China. PandaAmerica, the California-based distributor for the United States, also confirmed the increased mintages for 2012, the second consecutive year China has raised mintage figures for the Panda precious metal bullion coins.

The stalwarts of the program are the 1-ounce .999 fine silver 10-yuan coin and the 1-ounce .999 fine gold 100-yuan coins; the mintage for the silver 10-yuan coin will double from 3 million pieces to 6 million coins, while the mintage limit for the 1-ounce gold coin is raised from 300,000 coins to 500,000 coins.

Four different sizes of fractional gold bullion coins — the 20th-, 10th-, quarter- and half-ounce pieces — will see the largest increases, rising from mintage limits of 200,000 in 2011 to 600,000 next year, per size.

“Chinese investors have rushed to buy precious metals this year to hedge against rising inflation,” according to the Xinhua report.

In the first quarter of 2011, China became the world’s largest market for gold coins and bars for investment, according to a May 19 report from the World Gold Council, a trade group.

China currently issues 10 different Panda coins annually. The six pieces for which mintage increases have been announced are issued as bullion pieces. Four additional coins, 5-ounce and kilogram sizes of both silver and gold coins, are issued in Proof versions and were not discussed in the recent announcement; their mintages will not be revealed until later this year.

That doesn’t mean they will immune to increases; mintages for eight of the 10 Panda coins (bullion and Proof combined) rose from 2010 to 2011, in some cases dramatically.

The mintages for small Panda gold coins, those of half-, quarter-, tenth-, and 20th-ounce sizes, were raised from 120,000 each in 2010 to 200,000 each with the 2011 coins, a 67 percent increase.

Mintages for some of the large versions were also raised: the kilogram gold coin went from a mintage of 200 pieces in 2010 to a 300-coin mintage maximum this year.

The kilogram-sized silver 300-yuan coins for 2011 have a limit of 8,000 pieces, twice the 2010 mintage, and the maximum of 20,000 5-ounce 50-yuan silver coins compares to 10,000 for 2010.

But the biggest increase for 2011 was registered for the 1-ounce silver size, as the 10-yuan coin, which had a mintage maximum of 800,000 pieces in 2010, saw its maximum shoot up to 3 million pieces, a 275 percent increase in 2011.

The only mintage limits not increased in 2011 were the 1-ounce 500-yuan and 5-ounce 2,000-yuan gold coins, remaining stable at 300,000 pieces and 1,000 pieces, respectively.

The accompanying table lists full details of the rising mintage limits from 2010 through the announced limits for 2012.

The obverse of each Panda coin shows the Hall of Prayer for Good Harvests (the Temple of Heaven). The reverse design has changed every year since the Panda made its debut, except for 2002, and shows a different design of a panda or pandas.

China’s Panda coins are minted at the Shenzhen Guobao Mint, Shenyang Mint and Shanghai Mint, and are generally not identified with a Mint mark.

2009 China Commemorative Silver and Gold Panda Coins

Each coin’s reverse bears the same Panda design as depicted on the 2009 Gold Panda and 2009 Silver Panda bullion coins. The new commemoratives, however, feature a ring surrounding the pandas with the inscription "30TH ANNIVERSARY OF THE ISSUANCE OF THE CHINESE MODERN PRECIOUS METAL COMMEMORATIVE COINS."

The obverse design of both coins has the traditional image of the Hall of Prayer for Good Harvest in the Temple of Heaven in Beijing.

The central bank said it would issue a maximum of 10,000 gold coins in 1/4 oz size, with a diameter of 22 mm and a fineness of 99.9%. Up to 300,000 of the 1 oz silver coins are to be struck with a diameter of 40 mm and the same bullion 99.9% purity. The legal tender face value of the gold and silver commemoratives are 10 and 100 yuan, respectively.

Panda coins are among the most popular in the world, featuring adorably detailed images of playful pandas that change annually. Although the Chinese precious metal coin program dates back to 1979, the Gold Panda coin design was first introduced in 1982 while the silver version debuted in 1983.