The Gold Market
Chapter 9
The Gold Market
1. Overview of China’s Gold Management System
The Shanghai Gold Exchange (SGE) opened offcially on October 30, 2002, marking the beginning of China’s gold market. As a result, the financial factor market, consisting of the currency market, security market, insurance market, the foreign exchange market, and the gold market, has now been completely established.
1. Overview of China’s Gold Management System
Shortly before the founding of the People’s Republic of China in 1949, the Kuomintang government fled to Taiwan with all the gold reserve of the central bank, making gold a strategic resource of vital importance to New China and a scarce national reserve. In order to establish the legal tender status of the Renminbi and set up the authority of the Renminbi, as well as stabilize the prices in the market, the People’s Bank of China (PBOC) stipulated in April 1950 that the purchase and sale of gold and silver in China were subject to its unified management. Thereafter, the PBOC took measures to freeze all civilian trading of gold and silver and strictly crack down on silver speculation and gold smuggling, which consolidated the status of the Renminbi.
To encourage gold production and satisfy the huge demand for gold due to China’s tremendous economic growth, the PBOC and the Ministry of Finance adopted measures such as increasing the bank’s buying rate and canceling taxes on gold production. In October 1977, the People’s Bank of China formulated the Interim Administrative Measures of the People’s Republic of China on Gold and Silver, providing a guideline for gold management in China. In 1979, the State Council authorized the PBOC to release commemorative gold coins publicly. In August 1982, Circular of the People’s Bank of China concerning Resuming the Sale of Gold Jewelry was issued, allowing gold jewelries to enter the retail market.
The gold management system in the 1980s was the continuation of the policy of unified control, monopoly purchase, and distribution of gold and silver. With the continued development of the socialist market economy, the old management system could no longer adapt to the new situation. Therefore, the State Council proposed in 1993 to reform the gold management system. The goal was to discontinue unified control, monopoly purchase and distribution of gold, liberalize the gold market, and allow the market to play a fundamental role of gold resource allocation.
In June 2001, the PBOC submitted a proposal for building a gold exchange in Shanghai to the State Council, which approved it in October. The Shanghai Gold Exchange (SGE) was put into trial operation on November 28 of the same year, and then was put into offcial operation on October 30, 2002. The primary objective for establishing the Shanghai Gold Exchange was to promote the healthy development of the gold market, guarantee the normal operation of the gold trade, maintain the legal rights and interests of traders and the public, and provide a standardized trading platform and channel for gold trading. Since China’s entry into the WTO, the gold trading in China has gradually brought itself in line with international gold trading practices.
2. Market Operation
Over the past three years, SGE has run smoothly with its trading volume rising gradually. In 2005, the trading volume of gold and platinum hit a record high since they were first traded in the market. The trading volume of the gold throughout the year was 906.42 tons, up 241.11 tons or 36.24% from the previous year. The turnover was RMB 106.976 billion, up 46.35%. The average daily trading volume
was 3,745.52 kg, up 40.74% compared with the previous year. The trading volume of platinum for the year was 40.81 tons, up 13.03 tons or 46.89%, with a turnover of RMB 9,867 million, up 53.57%. The average daily trading volume increased by 51.74%. Thus, SGE has become a relatively important physical market of gold in the Asia-Pacific region.
In 2005, the capital clearing and physical delivery of the exchange went smoothly. The capital cleared amounted to RMB 94 billion, up 30% from the previous year, among which the self-run business was RMB 58.3 billion, accounting for 62.02%; the agency business came to RMB 35.7 billion, accounting for 37.98%; the number of clearing invoice issued totaled 3,898 valued at RMB 97.6 billion, up 43.02% and 95.20 % respectively from the previous year. The physical appearance of gold and platinum was 312.10 tons, up 41.87% from the previous year; the disappearance of gold and platinum totaled 295.59 tons, up 36.65% from the previous year. The delivery rate of gold was 60.72% in 2005, almost the same as the previous year.
2.1 Tightened Links between Domestic and Foreign Markets
In 2005, the international price of noble metals continued to rise, maintaining the bull market for the fourth year. In the first half of the
year, the gold price swung between US$410 and US$448 per ounce; in the second half of the year, the price picked up rapidly and broke through the integral mark of US$500 per ounce and hit the 24-year record of US$541 at the end of the year, up 17.44% throughout the year. The international platinum price was also extremely strong, rising from US$858 per ounce at the beginning of the year to the year-end US$969 per ounce, up 12.94% across the year.
The domestic gold price soared continuously, rising from RMB 114.76/g at the beginning of the year to the year-end price of RMB 133.39/g, up 16.23%, though it was 19.93% lower than the increase rate of the international market. The top price reached RMB 139.15/g, the highest since the opening of the market. The bottom price was RMB 110.40/g, and the weighted average price RMB 117.26/g, being RMB 7.51/g higher than that of 2004 (see Figure 9.2).
Throughout the 242 trading days, there were 139 trading days when the domestic gold price was higher than the international gold price, and the average gain was RMB 0.52/g. The domestic gold price was lower than the international gold price in the other 103 trading days, and the average gap was RMB 0.58/g (see Figure 9.3). The overall trend was basically the same.
The price of platinum hit the record again, up 10.96% from RMB 232.39/g at the beginning of the year to the year-end
RMB 257.86/g. This was lower than the increase of the international market price, which was 13.68%. The top price was RMB 270.96/g and the lowest, RMB 230.79/g. The weighted average price was RMB 241.77/g, up by RMB 10.51/g from 2004.
2.2 The Market Function has Improved Constantly
In 2005, the domestic gold market was still dominated by the spot trade, although the service functions of investment, risk aversion, and hedging began to appear. Thus, gold became a hot investment in the market. The turnover of Au (T+D) became increasingly heavy. The number of members and clients participating in the margin trade increased remarkably. The hedging, investment, and financing functions of the gold market were brought into full play. The proportion of the trading volume of margin in the total trading volume increased obviously. The Au (T+D), especially, was widely acknowledged by the market. Its trading volume rose rapidly, up 140.29 tons from the previous year, or 649.54%, achieving the fastest growth at SGE. Its proportion in the market increased from 3.25% in the previous year to 17.86% (see Figure 9.4).
In the second half of the year, SGE began to attract individual investors to trade in the market, added the evening session,
continuously improved the service measures, and further met the increasing investment demands for gold.
On July 18, the Industrial and Commercial Bank of China (ICBC) launched the Gold Expert, an individual gold business through the trading platform of SGE. Its unique price-matching method attracted the extensive attention and active response of the market. By the end of 2005, the number of accounts opened with ICBC reached 1,534, realizing a trading volume of 1,749.05 kg.
On November 8, SGE began to prolong the trading time and launched the evening session, which promoted the link between the domestic and foreign markets, improved the liquidity of the market, and increased the investment trading, which accounted for relatively big portions in the evening session. The trading volume of the evening session was 11,532 kg, with average daily trading volume of 372.01 kg.
2.3 Members’ Participation in the Market has been Enhanced
The market players consist mainly of gold producers and smelters, gold-using enterprises and other enterprises, commercial banks, and agency clients. The diversified structure of market players has come into shape. By the end of 2005, SGE had 128 members, including
16 commercial banks, 31 gold producers and smelters, 81 gold users, and other enterprises.
Gold producers and smelters are large gold mines and smelting companies in China, whose gold output accounts for over 90% of that of the country. The successful operation of the gold market has provided favorable opportunities and broader space for these enterprises to develop their business and speed up their expansion and M&A pace. These producers and smelters have also actively refined and distributed gold on behalf of many small domestic gold production enterprises. They are the most active players in the market. In 2005, the performance of the Shandong Zhaojin Group Company, Zhongjin Gold Corporation Ltd., Lingbao Jinyuan Tonghui Refinery Company, and Shandong Gold Group Company stood out. The trading volume of members of the gold production and refinery category was the highest, reaching about 349.69 tons, accounting for 38.58% of the total, up 33.83% or 88.39 tons from the previous year (see Figure 9.5).
The commercial banks, such as BOC, ABC, and ICBC, took full advantage of their mature network, good credit, strong fund strength, and abundant professionals in actively participating in the gold self operation and best efforts Offering business, the import and export of physical gold, and the square business in the international market. They have played an important role in activating the market, alleviating the seasonal imbalance between supply and demand in the domestic market, and improving the market liquidity. The trading volume in 2005 hit 279.55 tons, accounting for 30.84% of the market, up 41.91 tons or 17.64% from the previous year.
Gold-using enterprises and other enterprises are the end customers of the market and an indispensable part of the gold market. Against the background of a sustained rise in the domestic price, the physical gold consumption and investment demand have increased simultaneously, becoming the market player with the biggest growth potential. In 2005, the trading volume reached 277.18 tons, accounting for 30.59% of the total, up 110.80 tons or 66.60% from the previous year.
Commercial banks, large-scale gold mines, smelting enterprises and jewelry enterprises, as new intermediary agencies in the market, have actively promoted the agency business, and their trading volume has increased remarkably. By the end of 2005, they had 1,139 agency enterprise clients and 1,534 agency individual clients, with an agency trading volume of 340.32 tons, accounting for 37.55% of the total, and the business volume of the agency business had increased by 53.57% (see Figure 9.6) from the previous year, which was much faster than the growth of the self-run business.
3. Building the Market System
SGE has formulated and improved about 40 business rules and regulations on trading, delivery, clearing, quality certification, and risk management, and has initially built a system of business rules covering every aspect of the trading process.
3.1 The Trading System
The trading system is the basic system of the exchange, which includes provisions for such aspects as trading, clearing, delivery, agency, risk management, abnormal situation management, information
management, supervision management, resolution, arbitration, and punishment. The exchange organizes the trading of products in accordance with the principle of “being open, fair, just, and honest,” concludes business mainly by means of order matching, and forms the equilibrium price according to the principle of prioritizing price and time. Each market player performs the trading, delivery and clearing responsibility according to the provisions. The exchange investigates and handles behaviors violating the contracts by means of real-time and dynamic monitoring.
3.2 The Clearing System
The capital clearing at the exchange follows the principle of “centralization, netting, and secondary (clearing).” The exchange is responsible for clearing the capital in a unified manner. It settles the netting for the transactions of its members, and implements the secondary clearing system, namely, the exchange settles with its members, while its members settle with the clients. It implements the clearing velocity of T+0 for the capital and it also requires its members to open accounts separately for the self-run business and the agency business, as well as prohibits its members from misappropriating clients’ funds.
The exchange also implements the capital clearing bank system. The clearing bank is a nationwide commercial bank or shareholding bank with certain assets and credit approved by the exchange. The clearing bank is responsible for transferring capital for the exchange and its members so as to ensure that funds between the exchange and members can be credited into an account timely and safely. The exchange has formulated strict measures on the routine business operation of fund transfer between the capital clearing bank and the gold transaction accounts as well as emergency handling measures.
In addition, the exchange has developed a client margin safe operation system, which has helped technically reduce the incidence of its members misappropriating their clients’ funds. The exchange has also sped up the accounting of the capital and brought market risk under control.
3.3 The Delivery System
The delivery system consists mainly of basic provisions on the physical delivery principle and process, inventory management, in/ out warehouse management, management of ordered warehouse, allocation management, fees collection, secondary clearing, and quality dispute resolution. To simplify and standardize the delivery process, the exchange implements the system of one account with one code to the physical management. The physical delivery management covers both members and clients. With 50 designated warehouses in 34 regions across the country, the physical delivery speed has achieved T+0. It has established a gold logistics network management system to meet the needs of enterprises to store and pick up goods.
The delivery authority checks on the quality and safety, prevents risks, standardizes the designated warehouse operation, and manages the in/out warehouse handover process such as the identity authentication process of the consignee, and voucher management. The authority also conducts periodical or non-periodical checks of the warehouses to ensure consistency between account and goods, account and account, eliminate potential safety problems, and wall up the oversight in time.
3.4 Quality Certification Systems
SGE has put in place a strict access system for the products of enterprises engaging in gold production. The system has specified the basic conditions and requirements for listed products, the on-the-spot accreditation process, supervisory management, and penal punishment on contractual breach. The exchange also conducts strict inspection of the enterprises’ gold refinery, their testing and analyzing capacity, their process of casting gold ingot and gold bullion, etc. Qualified enterprises are accredited with the ability to provide standard gold ingot and gold bullion and allowed to trade their products in the market. By the end of 2005, there were 25 gold ingot enterprises and 17 gold bullion enterprises that had passed the quality certification.
3.5 The Risk Management System
The risk control system is the core management system of the Exchange. A scientific and effective risk management system identifies, quantifies, monitors, and controls market risks. It also requires a corresponding internal control system and internal incentive and restrictive mechanisms to be established. At the same time, there should be means and measures for preventing and eliminating risks. Of course, market discipline should be strengthened and the disclosure of information and risks should be sufficient.
SGE has implemented a series of control measures, such as the maintenance margin system, price limit system, position limit and large position reporting system, forced sale system, and risk warning system, to effectively enhance risk control. Additionally, it has stepped up its efforts to raise market players’ awareness of risk prevention through communication, coordination, risk warning, pertinent guidance, strengthened inspection, real-time settlement, and restricted sale of gold. It also conducts dynamic tracking and monitoring of the trade, and establishes the risk prevention joint meeting involving relevant business departments. SGE has also formulated The Methods of the Shanghai Gold Exchange for Handling the Violations of the Rules and Contracts. All these efforts have not only guaranteed the orderly operation of gold trading but also improved the credibility of the gold market.