The Shanghai Gold Exchange (SGE) is a Chinese platform where precious metals like gold, silver, and platinum can be traded. It is a non-profit organization that regulates itself and that has emerged as an important voice in the global precious metal market—and, in particular, the gold market.
Given the country’s large population and potent economy, it comes as no surprise that China’s gold market would be a key player. But understanding a bit more about the way the Chinese gold market works, and who the market participants are, can help anyone buying gold anywhere. Individuals throughout the international gold market benefit from learning about the SGE by better understanding its role on gold price trends.
What’s Shanghai Gold Exchange’s Role in the Global Gold Trade?
The Shanghai Gold Exchange is one of the largest gold marketplaces on Earth. And yet, throughout its 18-year history, it has remained a little mysterious.
For instance, until a recent development, the SGE only allowed sales within China. This meant that the SGE was effectively a pathway for Chinese banks to import gold, but it would not facilitate sales leaving the country.
The 2002 formation of the Shanghai Gold Exchange marked the beginning of an aggressive build-up of China’s gold reserves. Its place in that process has grown into a large and valuable piece in the overall global gold trade today.
To understand how gold is traded now, where it is bought and sold, as well as how China can impact prices even in London and New York, it’s important to first get to grips with this Shanghai Gold Exchange.
How the SGE Works
The People’s Bank of China created the SGE in 2002 to control all gold traded in China, which meant it became central to all imported, domestically-mined, and even recycled gold. The primary purpose was for the central government to gain a monopoly on how much gold was cycling through its economy and the price of that gold.
It also came about at a very distinct period of time for China’s own government holdings.
2002 was the exact year that China began one of the largest gold grabs of all time. The country’s reserves more than quadrupled from less than 500 tons of physical gold to nearly 2,000 tons today.
Having a domestic exchange controlled by that government to handle this influx made this huge grab more manageable, but it has also changed the global trade to an extent.
Much of this gold comes from other exchanges. If you want to import tons and tons of gold, your options are limited; almost inevitably, you’ll have to go through London.
Chinese commercial banks–which received permits to trade on the SGE–would go purchase large amounts of gold elsewhere, primarily London and through direct deals with miners. They would then import this gold into China and sell it there on the SGE. Other domestic commercial banks could then buy the gold alongside China’s central bank and other consumers.
Another distinction important here is that unlike London or COMEX in the US, every ounce of gold traded on the SGE must be held at the exchange or by its trading partners. That means even more expenses for physically moving the gold around.
This extra step and cost of transporting gold to China from other exchanges has historically created a price disparity between the SGE and elsewhere.
Still, to this day, there’s debate over what all goes into the pricing disparities between SGE gold and others, like the London spot price, which are driven by a known set of factors including gold demand. But transportation costs are certainly part of it.
Since the physical gold has to physically travel from wherever it was sold to China to be settled on the SGE, it involves what you can think of as a shipping fee. Though this is not actually a line item we can see on SGE trades, it is something we can measure through the SGE-London spot premium.
Over much of the last two decades of trading, that premium held to just over 0%%.
That has begun to change the last few years primarily because this premium between the two exchanges isn’t only due to transportation costs. There are other pressures at play.
As with anything, supply and demand come into play here. The Chinese market for gold is often very different from others, with one of the main differences being jewelry.
China is one of the largest markets in the world for jewelry. According to a recent report, China makes up just under one-third of the entire global jewelry industry with roughly $110 million in annual sales.
Since the only buyers on the SGE are from China itself, jewelry demand makes up a larger portion of SGE demand.
As COVID-19 swept the world in 2020, that specific demand drastically dried up. Despite rising prices in general for gold, that weak jewelry demand significantly impacted the SGE-London spot premium. In fact, for the first time in years, the Shanghai price actually started coming in at a discount to London.
Of course, being a “Chinese-only” exchange also has another knock-on effect for gold prices. The People’s Bank of China, the founder of the exchange, is also one of its largest customers.
China’s Central Bank’s Effect on the SGE
The nearly 2,000 tons of gold held in reserve in China are all managed through the People’s Bank of China. Just like gold reserves in other countries, the central bank is in charge of purchases and storage. But since all gold trade in China is done through the SGE, that means this single customer is incredibly important to shifts in prices.
For years, China has come under fire from many leaders around the world for being a currency manipulator. In 2019, in fact, the U.S. Treasury officially labeled the country as such.
The weakening of the Yuan does also have a direct impact on both gold’s prices on the SGE and the amount of reserves bought through the SGE by China’s central bank.
These factors make it less than transparent to see how big an effect that central bank might have on SGE’s prices and their knock-on effect over London spot and other global gold prices. However, that too may change. At least, we might see some transparency out of China and the SGE.
Chinese Demand for Gold – Metrics & Breakdown
Particularly given the size of the Chinese population, wholesale demand is a key figure and a major focus in coverage of the SGE and measures of its participating investors. And yet, major Western consultancies like the GFMS and World Gold Council (WGC) use metrics outside of wholesale demand—including retail demand.
Individual Chinese citizens can purchase gold or even trade gold derivatives (gold futures, etc.) on the Shanghai Gold Exchange via a commercial bank.
To give you an idea of the volume resulting from this, the SGE estimates having—in addition to the banks and reserves it counts as clients—about 5 million individual clients and 8000 institutional ones. Bullion bars, coins, jewelry, and chips are just some of the forms that gold and gold products take in these transactions, accounting for a sizable portion of trading volume.
The SGEI and Global Gold Prices
In September 2014, the SGE launched the Shanghai International Gold Exchange (SGEI). This new subsidiary of the Shanghai Gold Exchange itself opened up trade with the international community for the first time.
There are a few things worth noting about the SGEI, however.
It operates in the Shanghai Free Trade Zone (FTZ), which is a small area designated by China to ease trade with other countries, including free currency exchanges.
The SGEI does allow foreign members to trade gold in China for the first time. But each member has to get approval from the SGE beforehand. And the trade is still limited.
The People’s Bank of China, for instance, still only buys directly on the SGE. So, the SGEI is still somewhat a trial exchange. And its use is still limited as to how the Chinese government actually buys and sells gold.
So, the true nature of how the SGE and its latest stab at international transparency with the SGEI is still not fully known. But, reports of massive gold price manipulation by China are not necessarily true either.
At the end of the day, we can say that the SGE and China’s central bank are important players in the global gold trade. But the extent of their importance is far less than some might think. The numbers don’t lie.
The SGE, which in this chart also includes the SGEI, trade next to nothing compared to London. Sure, every physical ounce of gold trading hands through the SGE must be present and accounted for. But the sheer volume of physical gold traded through London compared to the SGE shows that the latter’s effects are still limited on overall gold prices.
The Shanghai Gold Exchange is important in that it facilitates all, or nearly all, trade of gold within China. How it has begun to open up a window into that trade through its SGEI subsidiary too is important. Based on volumes, its effect on global gold trade remains somewhat limited, although not trivial.
How and by what means China increases its gold supply is something absolutely worth knowing. But keeping a cautious, objective view of how that interacts with markets like London and the rest of the gold trade is crucial to understanding this whole picture.