Open Letter To CPM Group
To CPM Group,
On January 15, 2013 CPM Group released a Market Alert addressing the facts and fantasies being spread throughout the mainstream media and the financial blogosphere regarding Chinese central bank gold purchases. An endeavor much appreciated by me as I'm highly concerned with credible figures. In the article various subjects about the Chinese gold market are discussed, not on all do I wish to comment, but there was one I feel obliged to respond to. At one point CPM stated:
One of the commentators added gold deliveries via the Shanghai Gold Exchange to gross supply figures, apparently unaware that the gold involved in these deliveries gets re-delivered repeatedly via the exchange over time. Adding this gold to supply is confusing new supply with market turnover.
Because I have been the most active reporter on SGE deliveries (or actually withdrawals) chances are this "one commentator" is me. Hence my desire to share my point of view on this matter. I have written extensively on this in the past (which you can read here, here, here and here) but would like to present the rules as disclosed by the SGE and the implications from it on Chinese demand for physical gold once again.
Physical delivery on futures exchanges relates to the amount of gold in the vaults of the exchange that changes ownership after settlement between long and short contracts, a process that in theory can be repeated to infinity and therefore a completely inaccurate indicator for physical supply and demand. The Shanghai Gold Exchange, however, does not only publish data on physical delivery, they also publish data on the amount of physical gold that is being withdrawn from the SGE vaults. There has been confusion about the difference between SGE deliveries and withdrawals because the SGE has been naming withdrawals as deliveries inconsistently. The numbers I've published on this website always related to the withdrawals from the SGE vaults (these numbers are only released by the SGE on their Chinese website).
The crucial SGE rule that makes the withdrawal numbers significant is this: once SGE bars are withdrawn from the vaults they are not allowed to be re-deposited. This rule can be found in the SGE rule book (#23), and, for example, is disclosed on several ICBC webpages regarding gold products.
(2) According to the Shanghai Gold Exchange rules, physical gold taken out of the warehouse cannot be taken into the gold warehouse designated by the Shanghai Gold Exchange again.
To be absolutely positive please call the SGE (phone number; 0086 2133189588), they speak fluent English and will confirm this rule.
The rule implies these withdrawals can't be re-delivered. The purpose of the rule is that SGE bars are granted to be of the highest quality, no one can counterfeit an SGE bar and bring it in the vaults. The same rule applies on the Borsa Istanbul:
Once gold bars have been released from the Istanbul Gold Exchange vaults, they cannot be re-admitted to the Exchange vaults. They must be melted again and assayed and tested by an Istanbul Gold Exchange approved authority. Such re-melted gold is admitted in the Istanbul Gold Exchange again essentially as new gold bars and can then be traded.
We can compare this type of policy with the LBMA Chain of Integrity. Bullion Management Group, which is an LBMA associate, states on its website:
If the documentation and the background checks passed scrutiny, then all bars coming from outside the Chain of Integrity are re-assayed and re-cast to Good Delivery standards.
The SGE rule, combined with the Chinese laws that require all imported and mined gold to be sold through the SGE, implies that the withdrawals are equal to total Chinese gold demand. The following quote is from the Chinese media, translated by Soh Tiong Hum:
China's explosion in demand for physical gold in 2013 left a deep impression on international investors. The Shanghai Gold Exchange withdrawals for the year up till 27 December 2013 exceeded 2180 tons. Considering the exchange's position as a hub for domestic gold circulation, in conjunction with a system that forbids withdrawn gold from re-entering inventory, to a large extent the withdrawals number can be treated as the best benchmark for physical gold demand in the Chinese market. Not to mention that the entire 2013 global mined gold production does not exceed 2700 tons. China's massive demand has to a large extent remade the world's gold circulation system. Newly mined and stocked gold is moving through trade links in London – Switzerland – Hong Kong – into China in a large scale orientation towards the East. The impact of China's demand on international gold price will inevitably increase.
I sincerely hope this information will clear up some of the misconceptions of the Chinese gold market.