China Loosens Grip on Gold, Shanghai Exchange Ready

October 28, 2002
By Kathleen Kearney

HONG KONG, (Reuters) - China formally launches trading in physical gold on the Shanghai Gold Exchange on Wednesday, a long-awaited move and a significant milestone in liberalisation of precious metals trading and reform of its financial markets.

The opening of the exchange will be the first big step on the road to ending more than 50 years of absolute control over gold trading in China by the central bank. It will be the second exchange in the world to trade only physical gold.

The other is Turkey's Grand Bazaar in Istanbul, where physical gold is sought as a hard currency in the hectic world of Middle East trade.

The China Foreign Exchange Trade System Building, the gold exchange's first home, will serve one of the five largest gold producers in the world. Membership is initially limited to 108 domestic entities, Yin Po, an exchange official told Reuters.

About a quarter of members are from the gold mining industry, 56 percent are end-users including jewellery makers, and 12 percent are banks and other financial institutions, Yin said. Gold refineries and coin minters make up the remainder.

These members signed up nearly one year ago and have been conducting simulated trading since November 28 last year.

Trading will initially be limited to three or four types of physical gold and settlement permitted only in physical gold.

The exchange is also permitted to trade physical silver and platinum, and those products may be offered once smooth gold trading is established, Yin said.

PBOC'S ROLE

On Wednesday, the People's Bank of China (PBOC) will give up its role as the sole fixer of the domestic gold price. The PBOC used to set the domestic price of gold at irregular intervals.

Then, ahead of the gold market opening, it began to set the domestic buying and selling prices at weekly fixings every Monday since June 2001. It also made some unscheduled fixings.

Now the exchange will be taking over the price discovery role and the nation's gold industry will be thrown from its cozy protected world, where all output was sold to the central bank at a fixed price, into the cut-throat world of efficient markets.

"The opening of the gold exchange will enable China to keep its gold price closer to the international price," said Chen Shufang, analyst at Antaike Information Development Co Ltd.

"For producers, they will be taking on greater risk if they cannot adjust, but there will be benefits for those that can correctly judge the gold price trend," Chen said.

The central bank is thought to have set aside a portion of its 456 tonnes of gold reserves to stabilise the market in times of great volatility and uncertainty, said one Hong Kong banker.

China produces about 180 tonnes of gold a year, chiefly from mines in the northeast and northwest of the country. The country's mines will now sell their output on the exchange and not directly to the PBOC as stipulated previously by law.

PROBLEM AREAS

Over the past year or more, the gold industry has struggled with several thorny issues, including the need for hedging by the designated settlement banks and whether to exact the nation's ubiquitous value-added tax on gold transactions.

The VAT has been waived. But settlement banks, Industrial and Commercial Bank of China (ICBC), Construction Bank of China, the Bank of China and Agriculture Bank will initially not be allowed to hedge their exposure on overseas markets.

"Transactions will only be among (exchange) members and so there is no big need for hedging or arbitrage," said Jason Wong, senior manager and head of bullion at Bank of China Hong Kong.

Market-making on the new exchange will be done by the commercial bank members, while the PBOC will stand ready to step in if and when the market becomes too volatile, Yin said.

Gold's value as a reserve currency or asset of central banks, and as an investment vehicle for others, has diminished over the years, but it still has a role to play and this small opening of the gold market may carry some risks for the yuan currency.

Businesses, investors and individuals may choose to buy gold -- and thereby sell yuan -- if they believe a devaluation or depreciation in the yuan currency is on the way.

Hong Kong's gold traders have forecast China's gold demand could soar to 500 tonnes from the current 200 tonnes as a result of such safe-haven buying.

http://biz.yahoo.com/rf/021028/markets_china_1.html