Gold's astonishing rise this year confounded analysts until a new player emerged: Chinese retail investors flooded the Shanghai Futures Exchange (SHFE). Despite global pressures such as rising Treasury yields and a strong dollar, SHFE volumes have tripled, pushing up gold prices. Given China's historical affinity for gold and recent market turmoil, this influx signals a significant change in the dynamics of the gold trade. But as prices falter, the debate over SHFE's impact on the global gold market is intensifying.
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By Mark Burton, Sybilla Gross and Yvonne Yue Li
Gold's record rally this year has intrigued market watchers as bullion has soared despite headwinds that should have held it back. With the drop in prices this week, the explanation may lie in China.
After weeks of debate over whether a mystery buyer was behind the rally, several prominent figures in the global gold market are coming to the conclusion that the major new driving force is a legion of light-footed retail investors on the Shanghai Futures Exchange.
In a matter of weeks, SHFE went from an inconspicuous futures trading venue to a link of the global gold market. While rival centers such as London and New York have also seen increased activity, the fact that SHFE volumes have surged from a low level offers a compelling sign that a new cohort of Chinese investors have contributed to skyrocketing prices.
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Gold has soared this year, surpassing $2,000 an ounce since early March, in the face of major pressures that in ordinary times would have capped gains. Driven by fading expectations of a pivot to lower interest rates by the Federal Reserve, these measures included higher Treasury yields and a rally in the U.S. dollar. Added to this is a virtual strike by buyers in India, the second largest consumer, a loss of interest from Western funds and net sales of exchange-traded funds. Still, SHFE volumes began to increase and prices increased.
“The only thing that drives it in a way similar to Bitcoin is massive speculative plays,” according to Ross Norman, a former trader at Credit Suisse Group AG and Rothschilds & Sons, who now runs the Metals Daily newspaper.
Given high rates and the strength of the dollar, this is unlikely to come from hot money in the United States, so the most likely buyers would be highly indebted Chinese investors, he said .
Gold has long been a savings tool in China, and the country is its largest consumer and producer. This traditional interest has been given a new lease of life thanks to turmoil in local real estate and stock markets, with imports rising sharply in 2022 and 2023, although they will be tightly controlled.
Shopping frenzy
For months, consumers and institutional investors in China have been snapping up physical bullion, while People's Bank of China has been on a buying spree for 17 months. These two forces, which have helped to support international prices, are now reinforced by growing speculative demand.
The numbers back up the theory. Trading on SHFE has exploded, with average daily volume nearly tripling in April compared to the previous 12 months. It peaked at around 1,200 tonnes on April 15, the highest since 2019, before prices began to weaken this week.
“This is another sign that emerging markets, and particularly Chinese traders, are wresting price discovery away from Western markets,” said John Reade, chief market strategist at World Gold Council. “We know from other commodity markets that from time to time Shanghai traders become the most dominant players. This has never really been the case for gold, but I think that may have changed. »
For long-term gold buyers, this could prove worrisome if gains prove fragile. State media have recently called for caution in the continued recovery, while the SHFE has increased margin requirements to stifle excessive risk-taking.
It is worth noting that even though SHFE volumes have skyrocketed, the number of active contracts has barely changed. This indicates that participants are day trading and not taking a long-term view. Bullion fell 2.7% on Monday and losses widened on Tuesday, in a move which Reade attributed to short-term investors' profit-taking in the stock market.
“Extreme example”
“It's a bit of a feature of Chinese onshore markets, although it's a relatively extreme example,” said Marcus Garvey, head of commodities strategy at Macquarie Group Ltd. There are “a lot more short-term speculative moves,” he said.
Not everyone thinks Chinese investors are the main driver of gold's rise. “It’s not just about mom-and-pop traders and it’s not just about China,” said Jeff Christian, chief executive of CPM Group. “It’s really a large-scale thing. There is no longer much difference in the commercial behavior of large institutions compared to that of ordinary people.”
Gold could be in favor as higher and longer US interest rates to tame inflation could tip the economy into recession, according to Christian. “They are all convinced that interest rates are not going to fall too soon,” he said. “This could be more negative for other assets than gold.”
Samson Li, an analyst at the Hong Kong-based Commodity Discovery Fund, sees a more nuanced picture. Rather than being a direct driver of prices, rampant demand in China encouraged Western speculators to bet more on gains in New York, he said.
The debate over how long Chinese investors will stay is linked to the question of what brought them to SHFE in the first place. Institutional and retail traders on SHFE may be buying gold to bet on short-term fluctuations in the yuan. This year, the night session of the stock market was the most active, just as a series of encouraging US economic data sent the dollar higher.
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Daniel Ghali, senior commodities strategist at TD Securities, has also been working to identify gold's mystery buyer, and he continues to believe the dominant force will likely be a deep-pocketed buyer in the sector so-called official, which covers state-linked institutions such as central banks and sovereign wealth funds. But he says buying activity there is also closely linked to yuan weakness, and SHFE investors could be acting with the same underlying motivations.
“Trading activity on the SHFE indicates retail speculation and this could be associated with currency pressures,” Ghali said. “It's not just a problem for central banks, it's a problem for ordinary participants who see their currency depreciating and want to protect themselves against that depreciation.”
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