Globally, gold has been on a bull run since late 2022 amid strong central-bank buying, a weakening dollar, rising geopolitical tensions and expectations for the Federal Reserve to cut interest rates that materialized on Sept 18. At the same time, prices in China experienced even greater volatility, with the Shanghai gold premium - the differential between the domestic price in China and international prices – exhibiting extreme movements.
The premium at the start of 2023 was around $40 per troy ounce and reached an all-time high of $121.2 on Sept. 14, 2023. Just over one year later, the price is hovering around -$10/troy ounce, a whopping drop of over $130 from its peak. What happened?
China’s Affection for Gold and Supply Constraints
The record Shanghai gold premium and the subsequent plunge was triggered by a combination of both demand and supply factors.
Gold has long been a beloved commodity in Chinese culture and the country accounts for about one-third of global gold demand. As a symbol of wealth, store of value and investment tool, gold is widely held in many forms including jewelry as well as coins and bars in China. The ongoing global gold price rally since late 2022 probably made the yellow metal even more attractive, especially compared to the lukewarm domestic stock markets and troubled property segments - both traditionally popular investment options. China’s central bank has also been a significant buyer of gold, although it has paused purchases in recent months.
On the supply side, a short-term shortage was created by government intervention in the middle of 2023. The Chinese Yuan had been depreciating since the beginning of the year amid a tightening of monetary policy by most major central banks and eventually reached a multi-year low in September. As safe-haven gold is also utilized as a currency hedge, China’s central bank decided to tighten gold import quotas to defend the weakening Yuan.
The strong Chinese demand combined with the supply disruption facilitated a sharp upward movement in the Shanghai gold premium, which eventually set a record high. The import ban was lifted shortly thereafter and the premium subsided, but the Chinese gold market stayed elevated against international benchmarks into the first quarter of 2024, with the premium largely trading in the $20-$50 range.
Since the premium hit the record high, CME Group Shanghai Gold futures have gradually gained interest. Combined volume in both the yuan-denominated and dollar-denominated Shanghai Gold futures contracts average about one metric ton per day and account for roughly 35% and 65% of the trading volume, respectively. The two products can be used together to express views on the CNH exchange rate. The dollar denominated contract is also often utilized together with the benchmark Gold futures to manage the spread between China and international gold prices.
The Mean Reversion of the Premium
As the first quarter of 2024 continued, the market soon started to show a slowdown in demand as jewelry consumption was impacted, likely by weak consumer confidence and rising gold prices. By the end of the second quarter of 2024, the price of gold at the Shanghai Gold Exchange was trading at around 550 Chinese Yuan per gram, about 15% higher compared to the price at the height of the Shanghai gold premium in September 2023.
According to data from industry group the World Gold Council (WGC), China’s consumer gold demand in the first three months of 2024 reached 309 tons, the strongest Q1 since 2014. It softened in Q2 to a total of 174.4 tons, registering a 9% year-on-year decrease.
A similar pattern can be observed in the monthly gold withdrawals from the Shanghai Gold Exchange (SGE). Meeting the demand for the Chinese New Year, January 2024 saw the largest ever load-out of 271 tons. Withdrawals, however, flattened and continued shrinking in the following months, with May, June and July figures all below 90 tons. The diminishing withdrawals coincide with the slowdown in local gold demand and are reflected in the lower Shanghai gold premium. By August, the premium had further retreated, fluctuating to around the historical mean of $6 per troy ounce.
Could Gold’s Rally Continue?
It seems global gold markets are finding price support amid lower interest rates, continued geopolitical risks and potential central-bank purchases. A survey of central banks by the WGC in June 2024 shows that 81% of the respondents expect the gold holdings of global central banks to continue growing in the next 12 months. On the other hand, profit-taking, market corrections and competition from other investment vehicles, such as the equity market, could mitigate the rally in gold prices.
If gold prices do stay strong, whether Chinese consumers manage to adapt to the high-price environment and resume purchases could be a factor dictating the premium price. Performance of China’s economy, which has been slowing, and volatility in the Yuan exchange rate could potentially play important roles as well.
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