The Ever-Shifting Shanghai Gold Market Landscape

As the world’s largest gold producer, China plays an outsized role in global gold markets. But in order to fully satisfy domestic demand for jewelry and other forms of gold, the country also typically relies on imports.

The effects of the global pandemic triggered new trading dynamics between China and the rest of the world, with domestic Chinese gold now often quoted at a discount to global gold prices, such as the COMEX Gold futures benchmark (GC). With the introduction of Shanghai Gold futures on COMEX in 2019, CME Group offers seamless access to the world’s largest physical gold market, the Shanghai Gold Exchange (SGE).

It is hard to overstate the role that China plays in global gold markets. The country is the world’s largest gold producer, accounting for 10.8% of global mining of the precious metal (383.2 metric tons in 2019)[1]. The country is also the largest user of gold for jewelry fabrication, accounting for 30.1% of global demand. Jewelry consumption was 638 metric tons in 2019 – meaning that jewelry demand alone is nearly twice domestic production. China is also a pivotal country for physical investment demand in gold – meaning the buying of gold bars and coins. In 2019, Chinese investors purchased 211.1 metric tons, or 24.8% of total global physical gold buying. The official sector, acting through the People’s Bank of China, is another large buyer active in the market. It has accumulated official reserves of 1,948 metric tons at the end of 2019. However, government purchases are small compared to total jewelry and physical investment (96 metric tons purchased in 2018). To satisfy this aggregate demand, China typically relies on imports from the rest of the world.

In the years leading up to the launch of Shanghai Gold futures on COMEX, the premium for Shanghai Gold over COMEX GC futures was a positive number that fluctuated narrowly around $5-10 per troy ounce. The premium was due to higher local demand for physical material in China. Importers needed to pay over the global reference price to satisfy local Chinese demand, which is often linked to jewelry buying. Gold buying from the jewelry sector continues to be the largest demand factor, often accounting for more than combined investment demand (investments in ETFs and in physical bars or coins)[2].

The onset of COVID-19 changed this equation. Local demand for jewelry collapsed when the country went into lockdowns prior to the rest of world. This led to a Shanghai discount over global pricing. At its lowest point in Q3 2020, Shanghai Gold was priced at a discount of more than $50 versus GC. Since then, however, the Chinese price has steadily recovered in strength, breaking into a premium environment again by the second half of 2021. However, changing fundamentals during the summer months also pushed Shanghai Gold premiums back into negative territory. Market watchers attributed this change to regional COVID outbreaks in China and weaker economic data, as well as devastating floods and its effects on investor sentiment. As we entered the fourth quarter of 2021, Shanghai Gold prices strengthened again, trading broadly at the same level as GC.  

It is noticeable how both the demand for jewelry in China and Chinese gold imports mirrored the evolution of the Shanghai Premium. China was the first country to be hit by COVID-19, which led to a collapse in jewelry demand and, at the same time, a precipitous drop in the Shanghai premium. After Q1 2020, the country managed to increase demand for jewelry each following quarter right until Q1 2021, when jewelry fabrication was particularly strong; this is also the timeframe when the premium leapt into positive territory again. Q2 2021 saw a drop in jewelry fabrication, and the premium switching into a discount again. Chinese non-monetary gold imports, which mostly include bullion gold, show a similar trend – a precipitous drop in Q1 2020 that is now reversing.

Shanghai Gold futures on COMEX have now been tradable for two full years. The contracts are available both in dollar and offshore renminbi denomination. Activity in the contracts is continuing to grow. This can be seen in improved market liquidity as well as a surge of open interest to all-time record levels.  Open Interest (OI) is on the ascendency in both the USD and the CNH denominated contracts. For the first time ever, the total open interest of both contracts briefly surpassed 1,400 contracts in late August 2021, equivalent to a notional value of $80 million. The growth in OI is well-balanced, and each contract accounts for about half of open positions held at the exchange. As of mid-November, total open interest stood at 1,100 contracts (640 SGU and 460 SGC contracts), equivalent to about $60 million notional value.