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“This could
turn into a very violent wake-up call for [screen-traded gold]. People talk
about ‘fiat currencies’, but we also have ‘fiat
gold.’ Volatility is too cheap right now.” — Gold refiner
quoted by John Dizard in his Financial Times column
this weekend
Note: This post is a follow-up to last weekend’s China’s
London-Zurich-Hong Kong gold conduit — a major financial coup d’etat
In the initial
Reuters report on the London-Zurich-Hong Kong-Shanghai gold pipeline,
Macquarie gold analyst Matthew Turner suggested that the 1016 metric tonne United Kingdom export (up from 85 tonnes the previous year) might have been shipped to
Switzerland for refining into “smaller bars more attractive to Asian
consumers or to be vaulted there instead.” Though vaulting cannot be
ruled out, the recasting explanation makes considerably more sense given the
times and the extraordinary amount of gold being imported by China –
over 1500 tonnes so far this year according to
research published by the Koos Jansen website. It is difficult to imagine a
scenario in which China would be interested in vaulting gold in the West
– particularly at a time when the West is experiencing difficult
financial and economic circumstances.
On the other hand,
we know that four of the world’s top gold refineries are located in
Switzerland — Valcambi, Pamp,
Argor-Heraeus and Metalor.
Roughly 70% of the world’s annual gold production is refined in
Switzerland and it is considered the center of the world’s gold
refinery business. Its bars are trusted on the world’s gold exchanges
by the top banks, bullion dealers, jewelry manufacturers, and nation states
alike. If Turner is right about recasting the bars into Asia-friendly units,
and I think he is, Switzerland would be the place to do it, particularly in
light of the volume reportedly being re-refined. In my view, China intends
for this gold to be transported to and remain in the East otherwise it would
not have gone to the trouble to have it recast into Asia friendly bars.
To gain a deeper
understanding of what China might be up to, some background is essential.
Let’s start with the trading units at the two major Chinese exchanges
involved in the gold trade – the Hong Kong Gold and Silver Exchange and
the Shanghai Gold Exchange (SGE) – because that goes a long toward
explaining why the 1016 tonne export made an
initial stop in Switzerland before moving on to China.
The tael is the standard unit of weight on the Hong Kong
exchange. It equals 1.20337 troy ounces, or 37.4290
grams, fineness in the past has been 99% but this standard has been upgraded
to 99.99% to conform to international trading standards. According to gold
expert Timothy Green’s The
Gold Companion (1991), the standard trading sizes on the Hong
Kong exchange is five and ten taels. The basic
contract is 100 taels, or 120.377 troy ounces, as
opposed to the standard 100 troy ounce contract on U.S. futures’
exchanges.
The Hong Kong Gold
Exchange is an outlet for much of Asia and the tael
trading units, once again according to The
Gold Companion are used in China, Taiwan, South Korea, Thailand
and Viet Nam. The SGE is the only gold exchange in China and its
contract-trading unit is the kilo bar (32.15 troy ounces), once again a
significant deviation from the western exchange standard.
Dragon’s
hoard includes Chinese people, Peoples Bank of China
Should this scenario
prove to be accurate, most of the metal moving from London to Asia through
Switzerland will more than likely end up in the
hands of consumers in the form of jewelry and small bars. What few people
realize is that all of this activity is fully sanctioned by the Chinese
government and the Peoples Bank of China (PBOC). In fact, once again
according to the Koos Jansen website, the Shanghai
Gold Exchange is owned by the PBOC and as a result any gold imported and
stored at the exchange for future delivery is, indirectly at least, gold
inventory at China’s central bank. SGE widely publicizes itself as a
“delivery market” thus the smaller and familiar kilo bar size as
its chief trading unit makes a great deal of sense.
If, as the smaller
bar sizes suggest, the UK-Swiss aspect of the pipeline functions as a bar
resizing operation, then we may have a long way to go before China’s
official sector (central bank) needs are satisfied simply because so much of
it is going directly to Chinese consumers. It also implies that the demand we
have already seen, as large as it is, could be just the tip of the iceberg.
It is no secret that the Chinese people have a traditional, transcending
attachment to gold. That same attitude, it should be kept in mind, permeates
almost the whole of Asia, and as more and more people partake in the fruits
of Asia’s rise economically the demand for gold is likely to grow with
it. China is likely to take advantage of any drop in the price to load up as
it did in the April-August, 2013 time period. In one of my early articles on
China’s burgeoning interest in gold (June, 2009), I
indicated that Chinese demand would likely put a floor under the market for
many years to come. The statistics below bear that out.
Drawing again from
the Koos Jansen analysis, the China Gold Market
Report – authored by the key players in China’s gold market,
including analysts for the SGE – lists the following distribution of
physical metal through the Shanghai exchange in 2011:
456.66 tonnes – Jewelry manufacturing
53.22 tonnes – Industrial raw materials
21.55 tonnes – Gold coins
213.85 tonnes – Investment gold bars
13.52 tonnes – Other, unnamed industrial
purposes
284.88 tonnes – Net investment (??) “…[D]emand arising
from the transfer process of gold as an investment tool (This might be the
portion that goes to central bank reserves.)
Total = 1043.68 tonnes
To offer a measuring
stick that might give that number additional meaning – the total equals
roughly 40% of annual mine production, one-eighth the U.S. gold reserve, and
nearly one-third Germany’s reserve. (Keep in mind, too, we are talking
2011 numbers not 2013 numbers after the latest massive imports.)
Fiat
currency, fiat gold
John Dizard’s column in this weekend’s Financial
Times explores the unsettling developments in the physical gold market and
what problems they might impose on the paper gold market. Though the column
itself is a very positive one for gold’s prospects, it runs under a
negative headline that has little to do with the content: Cry of negative gofo
heralds trouble for gold. The words “paper
traders” should have been added to end of the headline, because that is
clearly the point Dizard is making.
He points to the
very situation we have just covered in depth on the China connection, and
talks about the shortage of kilo bars globally, the recasting of 400 troy
ounce LBMA/ETF (exchange traded fund) bars, and the upside down forward rate
on physical gold. Dizard poses the question,
“Could the gold flow back from those kilo bars to recasting as good
delivery 400oz bars?” In other words, does the London-Zurich-Hong
Kong-Shanghai pipeline run in both directions? An unidentified gold refiner
answers: “Much of that has been converted to jewelry. It would be a
lengthy process. Those are pretty sticky hands…This could turn into a
very violent wake-up call for [screen-traded gold]. People talk about
‘fiat currencies’, but we also have ‘fiat gold.’
Volatility is too cheap right now.”
Final
note
One more point of
interest before I put this piece of the China analysis to rest: HSBC, the
multinational bank headquartered in London, is the chief storage facility for
the largest gold ETFs. As mentioned in my previous article, much of the gold
transferred to Switzerland by HSBC came out of the ETFs. In addition, HSBC is
an important trading member in the daily London Gold Market Fixings. Founded
by Sir Thomas Sutherland in the British colony of Hong Kong in 1865, HSBC
stands for the Hong Kong Shanghai Banking Corporation.
____________
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