Gold’s Pricing Power Moving East
Gold’s Pricing Power Moving East Julian D. W. Phillips – Gold Seek
How is the gold price made?
When we hear commentary on why the gold price has moved, we usually hear of U.S. economic or political factors and a move in the U.S. Dollar. Most times these do not precipitate the buying of physical gold.
What they do do, is to spur the buying or selling of futures or Options on the COMEX gold market. Many commentators attribute moves in the physical gold price to moves on COMEX.
But this link is tenuous, as COMEX does not [except for a maximum of 5% and minimum of 1% of contracts that disclose they will deal in physical gold, upfront] deal in physical gold.
The dollar gold price is the one that most investors look at, even though they may deal in a different currency to the dollar. This is because the dollar is the key global currency against which all others are measured.
Price differential between Shanghai and London/New York
U.S. gold prices today are primarily driven by demand for physical gold in gold ETFs, such as the Gold Trust and the SPDR gold ETF [GLD].
But the bulk of physical gold traded in the world now happens on the Shanghai gold exchange. There are 10 million investors, including 10,000 institutions that are able to deal over their cell phones at any time on the Shanghai Gold Exchange. Such a market dwarfs both London and New York on the physical front, as all transactions have to be backed by physical gold.
With gold exports not permitted from China, there are obstacles to the free flow of gold globally. The International Gold Exchange in Shanghai has not yet attracted sufficient numbers to allow this. But the major banks can and do hold stock both in Shanghai and London and by running a dollar/Yuan currency book can arbitrage gold between the markets to smooth out the bulk of price differences between markets.
While there are frequent fingers pointing to the ‘premium’ of Shanghai prices over those of London and New York of $5 all the time, it is because Shanghai prices 0.9999 quality gold whereas London prices 0.995 quality gold. One has to deduct this before comparing the prices in the two markets.
On top of this we see between $5 – $15 an ounce difference on a daily basis,which can include the cost of moving the gold from London to Shanghai.
On top of this cost lies the difference in liquidity between the markets andthe differences in local demand and supply. In the very liquid Shanghai market,bullion banks do not exert the same influence as in London and New York, sospeculation is restricted. It is further restricted by the much higher costs oftaking large speculative positions in Shanghai. These costs were increased atthe beginning of the year to discourage speculation.
Shanghai, as a result, gives less volatile prices, more indicative of[Chinese] physical demand. While no gold flows out of China [removing itsdownside pressure on the gold price] Chinese demand draws from the rest of theworld.
Gold enters China from the rest of the world’s gold markets primarilyvia Switzerland where it is refined into metric bars. We see metric measures ofgold dominating the global gold market in the future. Imports comes from allover the world in all forms, with a reducing amount coming in via Hong Kong.
Consequently, the Shanghai Gold Exchange gold price, although higher [forreasons given above] is exerting a growing influence on the global gold pricein all currencies and better reflects the physical gold price of gold.
London, New York and the Gold Price
With London having been the global center of the physical gold world untilrecently, one would have thought that the influence over the gold price wouldhave resided in London. But this is no longer so, as history over the last fewyears, has shown that London has usually followed COMEX prices.
Of course, this would give rise to charges of ‘manipulation’from U.S. and other sources. The not uncommon bear-raids by the big U.S. banksand high frequency traders ensured that the gold price bore little resemblanceto the real global physical gold demand and supply factors.
But on closer examination of the chart above, one sees that all but a smallpercentage of “gold” is traded not in gold but in some form ofderivatives, such as shares in GLD, futures, options, or even gold shares,where the buyer does not own physical gold but a piece of paper to the goldprice.
Take out this ‘paper’ gold and London and New York’s 88%of gold traded, falls to around less than 1% compared to Shanghai’s 5% ofphysically traded gold. i.e. five times asbig.
When there is a real premium in Chinese gold prices over London and NewYork’s Chinese gold importers [Like the ICBC/Standard bank and HSBC bank]then export gold bullion to China to meet that higher demand and smooth outprice differentials. Consequently, we have witnessed a steady very, very largeflow of gold pass through the refineries of Switzerland [to be upgraded to0.999 fineness] and onto the Far East.
This has allowed both Russia and China in particular, to acquire hugetonnages of gold [on top of their own production] at what really are, discountprices over the last decade!
With gold now an integral part of the Chinese financial and banking systems,China cannot afford to be at the mercy of the capricious, non-representative,U.S., physically-small gold market, even though the volumes of paper goldtraded are huge as you can see in the pie chart above.
Day to day news items are not the real reasons gold is bought and sold inthe west. It is the profit motive inherentin western financial markets, driving traders and funds to buy and sell goldfrequently. Gold holdings are changed even by large funds from day-todaypositions to monthly or three monthly. There are few that hold a long-termholding. The demand for short-term performance prevents that.
The Chinese view of gold
The motive east of Greece is to acquire gold holdings as a prime financialasset that, over time, provides secure wealth for the long term. Trading ofgold is an ancillary function only. East of Greece it is the sheer volume ofgold kilos held that’s important.
China’s gold holdings are far greater than the available statisticstell us. Gold is held as jewelry at retails levels, on the balance sheet ofbanks, in the Shanghai Gold Exchange, for clients, as well as for the Exchangeitself, in government agencies, for the government and by the People’sBank of China, for the nation.
In summary, as the People’s Bank of China put it, “We own goldthrough the people of China!”
This is resulting in China moving to take over gold’s globalpricing power.
In Part 2 : –
-China excluded from the global gold price or arbitrage includes it?
-Shanghai twice daily Gold Fixes
-De-Globalization, Protectionism and Capital Controls
-Is the Yuan a problem in pricing gold?
This will ensure a 24-hour global gold marketwhere prices relate to the gold market and not to the U.S. economicsituation.
This article takes from previous articles featured in the Gold Forecaster weekly issues and updated. Subscribe directly to: www.GoldForecaster.com
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