Commodity Analysis

Bullion Cues: China gets its own gold benchmark

Rajalakshmi Nirmal | Updated on January 20, 2018 Published on April 24, 2016




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The new gold contract, based on the domestic market demand and supply dynamics, will help in better price discovery

China has launched a yuan-denominated gold contract which will act as the benchmark price for gold in the country.

It was only in November that the renminbi was included in the IMF’s SDR basket and it received the reserve currency status (to take effect in October 2016).

The new gold contract, launched last week, is expected to help in better price discovery in gold as it will be based on the domestic market demand and supply.

Also, as the contract will be under the supervision of the Shanghai Gold Exchange (SGE), there will be more transparency and lower counterparty risk for the country’s gold producers and traders in bullion.

The 12 members who will do the fixing and the six members who will provide the reference price include the country’s top banks as well as two gold miners and the jewellery retailer Chow Tai Fook.

The benchmark price for a 1 kg contract was set at 256.92 yuan/gram on Tuesday at the launch of the benchmark contract.

End week, on Friday, the PM session price was 260.41 yuan/gram, up 1.4 per cent since Tuesday (spot gold price in COMEX was down 1 per cent). The Shanghai gold benchmark price will be based on the buy/sell quotes given in the auction conducted on the SGE platform.

Chinese banks may soon launch more derivative products based on gold, say analysts, as there is a spot market for gold in the country now.

Why now?

It was in September 2014 that China launched its own gold exchange, the SGE, and now it is the yuan-denominated gold benchmark which will become the reference price for gold in the country. It is clearly a move to obtain more credit for its currency in the global market, says Gopal Agrawal, Chief Investment Officer, Mirae Asset Global Investments (India). “China is doing everything possible to internationalise its currency. Its move to make yuan a part of SDR was also done with the same intent…” The move also looks like an effort to offer a more transparent gold benchmark for the country’s bullion traders. Last week, Deutsche Bank admitted to rigging the London gold fix.

The gold price fixing scandal came to light in 2014. Deutsche Bank, along with a few other large global banks, allegedly conspired to fix the gold price and distorted the price behaviour in the metal. The London gold fix was replaced by the new benchmark, the ICE Benchmark Administration’s LBMA gold price, last year. While earlier, the benchmark price was set after a teleconference among the members, now, an electronic auction process is in place. The LBMA gold price is the global benchmark price for gold now and all miners, traders, and central banks across the world use it. But, still, note that in London, it is only an OTC market in gold. So, an electronic way of price discovery is necessary. In India and China, the two large markets that consume most of the gold mined across the world, a physical gold exchange and a benchmark gold price in domestic currency is essential for effective price discovery.

Demand to grow

With a local benchmark price in gold now, China’s banks may launch more derivate contracts in gold, say analysts. With the hazy outlook for property and stock market, in the country, middle class people will turn to gold investments, they add. Given that the central banks of Europe and Japan have moved to negative interest rates, the prospects for gold appear bright, says Gopal Agrawal. “The world is moving to a negative interest rate scenario. If growth doesn’t pick up despite this desperate move by central bankers, then all paper currencies will lose value, and gold will be the lone safe asset. Gold prices have a floor at $1,000/ounce, which is the cost of producing an ounce of the metal now…”

A recent report from the World Gold Council (WGC) holds that, currently, about 30 per cent of high quality sovereign debt (more than $8 trillion) is trading with a negative yield, and an additional 40 per cent with yields below 1 per cent. So, the pool of investment options available for investors is very limited now, thus adding sheen to gold. In periods of low interest rates, gold returns are typically more than double their long-term average, adds the report.

Price fixing in India

Gold price fixing in India is still done in a very rudimentary way. With no physical market for the metal in the country despite about 70-80 tonnes of scrap gold being traded in the market every year, there is no rule-book on how gold price is fixed. When the nominated agencies (mostly banks) that import gold supply it to the bullion dealers, they ask for a price which is their cost plus customs duty plus their fee. After getting gold on hand, these dealers sell them to jewellers at a price that is fixed by the bullion dealers’ association in Mumbai, the IBJA. The association announces the rupee price for gold every day based on the quotes it receives from its member dealers through telephonic calls. Since the quote given by dealers to the Mumbai-IBJA is a little arbitrary, it raises doubts about the manner of fixing spot gold prices in India. Talking to large bullion dealers, we found that some use the MCX gold futures near month contract’s price while some take the internationally quoted price of gold and add the import duty to it to arrive at a ballpark price.

Cues for this week

As was indicated in these columns on March 28, gold price is witnessing a consolidation. Chances are that this week’s Fed meet may pull gold out of its narrow trading range. If indications from the Fed signal a low possibility of a near time hike in rates, dollar may edge lower and gold may break resistance at $1,270 and move up. But, gold’s sharp losses towards the later part of last week show the possibility of it breaking the support at $1,230 levels and hitting $1,200. On the higher side, the target is $1,300.

MCX Gold futures contract ended marginally higher last week at ₹29,021. Resistances for this week are ₹29,800 and ₹30,095. Supports are at ₹28,950 and ₹28,000. MCX Silver has moved up smartly tracking gold prices. It is possible that the contract heads up further this week and hits ₹41,000 levels again.

Published on April 24, 2016

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