The gold market was potentially changed forever as China announced a new yuan-dominated gold fix on April 19. 1 The Shanghai Gold Exchange will set the gold price twice daily based on a 1-kilogram contract in denominations of renmimbi (yuan). Twelve participants, 10 of which are Chinese banks, will set the price.
The main reason why this is a huge overnight shift in the gold market is because up until this point, London and New York were the only benchmark price setters, and now China has inserted itself into this affair. This is another bold move in China’s long-term plan to increase economic sway and move the world away from the dollar.
Clear Threat to the Dollar
The gold price will be set in renmimbi (yuans) on the Shanghai Gold Exchange. Now, gold traders will not need to convert their yuan into dollars; they can trade directly in yuan—essentially rendering the dollar unnecessary in Chinese transactions. This is a grand move in a long-term plan to reduce dependence on the U.S. dollar and achieve greater world influence. In fact, when the dollar is weak and the yuan is artificially devalued but gaining strength for long-term growth, it may be more incentivizing for traders to bypass the dollar altogether and simply begin trading gold in yuan, which appears to be a clear intention on China’s part.
While there have been signals this move was coming, many are expressing a wide range of opinions about what it means now that it is a reality. The reality is that China has long been the largest producer of gold, and see-saws with India on its role as the world’s largest consumer of the yellow commodity. 2 As China builds up its gold reserves against other nations, it becomes even more incentivizing for traders to choose the yuan over the dollar, which is backed by nothing.
Evaluating the Pieces on the Board
Julian Phillips, founder of GoldForecaster.com, sees this as a very significant step, make it possible for China to “control the price of gold globally… especially due to their deep liquidity with this commodity.” 3 Many analysts note how this varies from other exchanges, such as the Comex, where less than 1 percent of all trades result in physical delivery of gold.
Others are more sanguine about the ultimate impact. For example, Adrian Ash, a leading analyst, believes the new Shangai fix will, “remain just another measure of localized demand and supply, rather than a tool for global traders.”
A key determinant of the ultimate impact of this move is the future move to full convertibility of the yuan. Currently, the markets deal with an offshore yuan (CNH) and an onshore, internal yuan (CNY). With this hybrid closed economy, the impact is less in the near-term than it might otherwise be.
China’s Long-Term Strategy
It is important, however, to evaluate this individual move in the context of other Chinese actions. Their many actions over the past decade have not only enhanced their economic flexibility, it has shown their ability to respond aggressively to issues within their own economy. The Shanghai Gold Exchange news comes also after the first Chinese bank was added as a market setter for the silver price in London in March 2016.
It is often remarked how Eastern thought is more directed to patient, long-term plans of action rather than short-term actions and decisions. This reality seems to be well proven as China continues its evolution from a poor, war-ravaged communist-run nation to a leading world economic power. We are now seeing incremental movements on the global economic chess board that continue to bolster China’s financial power and independence, including continued attacks against the dollar. China has positioned itself as an Eastern economic superpower in the gold market, shifting influence from West to East.
For long-term investors in gold and short-term traders, this action reinforces two points of current market wisdom. First, the Chinese must be considered when looking at overall trends in gold supply and demand. Secondly, the central bank of China seems to share a concern over the strength of other world paper currencies. They may actually see the coming crisis many are predicting as a true opportunity to increase their global power. When another major economic crisis hits, the country is positioned with a strong currency and large reserves of gold.
Additional Sources:
1 – http://www.cnbc.com/2016/04/19/china-launches-yuan-gold-fix-in-bid-to-be-price-maker.html
2 – http://anonhq.com/game-changer-china-set-start-yuan-based-gold-price-fix-april-2016/
3 – http://www.marketwatch.com/story/china-is-one-step-closer-to-global-gold-price-domination-2016-04-19