Undoubtedly, the central theme over the past 18 months that has driven the performance of the global financial markets more than any other single factor has been the “hard landing” for the Chinese economy as it finally begins to slow down. (You could also make a case for the huge drop in crude oil prices—due to oversupply—as the biggest factor, but this is closely related to weaker energy demand from China, anyway.)
In a way, you could say that China’s economic planners saw this coming the whole way.
Why? Look no further than the state-sponsored shift toward massive gold accumulation of the last 5-to-10 years. The Chinese government’s pivot toward gaining a foothold in the global gold market is a clear indication that it took steps early on “plan for a rainy day” and hedge itself by diversifying into precious metals.
How China Turned to Gold
There were two major developments in the last year or so that swung China’s gold strategy into action. China was adding considerable amounts of gold bullion to its foreign exchange reserves for several years beforehand, showing that these steps were planned well ahead of time.
First, the Shanghai Gold Exchange was established. This created several conditions. It ensured that bullion trades and price discovery would take place closer to home for financial interests in China, cutting down the premium over London spot that Chinese buyers paid for gold. It helped facilitate the rapid flow of gold from vaults in the West (London, Switzerland, and New York) to Asia in the East. Finally, it greatly expanded Chinese firms’ access to the gold market thanks to all the throughput of gold bullion through Shanghai. This added to the gold that already flows through Hong Kong. All of these developments together meant that China had greatly improved access to precious metals stockpiled overseas.
Second, major Chinese banks extended their reach into the global bullion market, penetrating key areas of the Western system. These firms bought up the world’s most productive gold mines in South Africa; they also purchased stakes in some of the West’s biggest banks in the gold trade. For instance, the Industrial and Commercial Bank of China (ICBC), the world’s largest, spent $5.4 billion on a 20% stake in the massive Standard Bank in 2008. ICBC then got into the forex markets and the bullion trade by acquiring Standard Bank’s London global markets unit for an additional $765 million in 2014.
Filling in for Deutsche Bank
Now, ICBC is making two big moves to solidify its growing presence in the global gold trade. It has applied to become a member of the London Precious Metals Clearing (LPMCL) company in order to become more involved in the $5-trillion trade of gold and silver in London. ICBC is seeking to replace Deutsche Bank, which exited the London bullion market last year. The rest of the LPMCL is currently made up by HSBC, JPMorgan, UBS, Barclays, and Bank of Nova Scotia (ScotiaBank).
Moreover, ICBC has targeted the physical vault it will need to effectively replace Deutsche Bank. Although it may be a few months before the over five members of the LPMCL approve ICBC’s application, the Chinese megabank has taken strides to purchase Deutsche Bank’s London vault. The vault is said to have a capacity of 1,500 tonnes (or 50 million troy ounces) of gold.
Even with the gradual slowdown of its manufacturing-heavy economy, China has vastly increased its position in the global gold trade as a way to stabilize and diversify its underdeveloped financial sector.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.