During China's Lunar New Year holiday, the global gold price shifted downward, falling below the 1,200 mark at one point on February 23.

The decline in international gold prices has spurred strong sales of physical gold and gold jewelry in the domestic market. Among these, gold and silver jewelry featuring the Year of the Sheep theme have been particularly popular. At Shanghai New World Shopping Mall, jewelry brands such as Lao Miao Gold, Chow Tai Fook, and Lao Feng Xiang have all reported daily sales exceeding 200,000 yuan.

In gold jewelry stores in the Xujiahui area of Shanghai, crowds remained bustling even during the Spring Festival, and gold product sales increased by 20% year-on-year. “Some newly designed gold ornaments featuring the Year of the Sheep sold out soon after they were launched,” said Wu Lijun (pseudonym), a Chinese auntie living in Xuhui District, Shanghai, to our reporter.

Throughout the entire Spring Festival period, the premium for gold prices in China was particularly pronounced, rising to as much as $12 per ounce in the days leading up to the Spring Festival on February 19. This premium refers to the additional amount paid above the international price for expedited delivery.

Just after the Spring Festival holiday, on February 25, the April gold futures price on the New York Mercantile Exchange (COMEX) rose by $4.2, a gain of 0.4%. COMEX gold closed at $1,201.50 per ounce. Although the premium over Chinese gold prices has eased somewhat, it still stands at around $5.

The persistently high premium indicates that Chinese investors remain in a buying mood for gold even after the Spring Festival holiday. This also serves as a compelling illustration of the “shift of Western gold to the East,” highlighting the significant and undeniable scale of China’s gold consumption.

However, China’s influence on gold pricing still doesn’t match its market size.

Starting from March 2015, the London gold fixing price will be replaced by a new mechanism. The reform of the London gold fixing price presents China with an opportunity to shift from “Western gold moving eastward” to “Western pricing moving eastward.”

The new alternative mechanism for fixing the benchmark price requires the support of at least 11 members. Ruth Crowell, CEO of the London Bullion Market Association, revealed that Chinese-funded banks are among the members. The participation of Chinese-funded banks will give the world’s second-largest gold consumer greater influence over global gold prices.

Just in time for the reform window

Zheng Lianghao, Managing Director for the Far East Region of the World Gold Council, said in an interview with a reporter: “The original intention behind the launch of the London gold fixing was to facilitate market trading.”

For example, suppose a manufacturer of gold jewelry wants to sell its products to downstream retailers and has agreed that delivery will be completed in ten days. However, since the price of gold keeps fluctuating, determining which price should be used at the time of delivery has become a real challenge. As a result, several major traders in the gold market introduced the London Fixing Price.

“The benefit of setting a fixed price is that it provides a reference price for neighboring manufacturers when they enter the market,” said Zheng Lianghao. “For example, the gold jewelry manufacturer mentioned earlier could base its transaction price on the London afternoon fixing price ten days from now, adding a markup for labor costs. This way, even if the timing of order placement and delivery doesn’t align, they can still find a consistent time and price, thereby locking in their price risk.”

The pricing process of the London gold market, which began in 1919, has always been shrouded in mystery. At that time, representatives from London’s five major banks would gather daily in the “Gold Room”—a specially designated office within the Rothschild firm’s headquarters on Seward Street in central London—to set the gold prices for the London gold market. Trading would temporarily halt at 10:30 a.m. and 3:00 p.m. each day. First, the representative from Rothschild Bank would determine an intermediate opening price based on the New York gold market closing price from the previous evening and the Hong Kong gold market price early that morning. Immediately afterward, the representatives from the other four banks would call their respective clients to report this price. If the opening price turned out to be too high and no buyers appeared in the market, the price would be lowered; conversely, if the opening price was too low, the gold price would be raised until sellers finally emerged. The pricing transaction thus established a new price based on the interplay between supply and demand.

Once the ordering process for approximately 50 gold bars per bank is complete, a representative from Rothschild Bank will announce the conclusion of the transaction, and the final price determined will become the agreed-upon transaction price. This process can take as little as one minute or as long as about an hour. Afterwards, the new price is swiftly communicated to traders around the world. This system has continued to the present day—though today it takes place via conference calls, and the five major banks have been replaced by Barclays, Deutsche Bank, Scotiabank, HSBC, and Société Générale.

The daily London gold fixing influences trading in the $20 trillion gold market and serves as the benchmark price for market transactions.

However, as the securities market has introduced electronic trading systems, people have increasingly favored open, public, and transparent mechanisms. As a result, this closed pricing process has begun to draw criticism from the market.

Starting in 2011, when the London Interbank Offered Rate (LIBOR) manipulation scandal came to light, financial regulators around the world stepped up their scrutiny of various benchmark prices, and the precious metals industry also came under extensive investigation.

A series of scandals involving London’s gold fixing price has come to light after a long-term investigation. In 2014, Barclays Bank was fined approximately £26 million by the UK Financial Conduct Authority due to significant flaws in the bank’s regulatory system. Former trader Daniel Plunkett had falsified sell orders to manipulate the fixing price and reap illicit profits. In May 2014, Deutsche Bank, which had been under investigation, withdrew from the pricing mechanism. Since then, the gold price has been determined solely through twice-daily bidding among four banks. The market urgently needs a new gold pricing mechanism that is more transparent and involves greater market participation.

In response to market demand, on September 4, 2014, the London Gold Market Pricing Company and the London Bullion Market Association (LBMA) officially began soliciting proposals for an alternative to the London gold pricing mechanism. Ultimately, the Intercontinental Exchange (ICE) was selected as the administrator of the new London gold pricing mechanism.

Zheng Lianghao told reporters, “The new mechanism is an open platform that allows anyone interested in participating in price-setting to join and express their intentions through the platform.”

The brand-new pricing mechanism will be named the “LBMA Gold Price.”

According to previous official announcements from the Intercontinental Exchange (ICE) in London, the pricing method to be adopted for London’s fixing price going forward will be as follows: quotations will be made every 30 seconds using three currencies—U.S. dollars, euros, and British pounds. Through ICE’s platform, both direct market participants and users who trade via brokers will be able to manage their transactions via a real-time trading system.

Opportunities for Chinese-funded banks

Currently, the LBMA is selecting gold pricing market makers through a series of certifications. Eleven institutions have expressed interest in participating in the formulation of the LBMA gold price, but they are still undergoing internal compliance approval procedures.

In a previous statement, LBMA CEO Ross Cowell noted that the group of parties interested in participating in the determination of the LBMA gold price has become more diverse, including companies from China.

Market sources pointed out that since Deutsche Bank announced its withdrawal from the London Bullion Market Association’s gold and silver pricing system in early 2014, its membership seat has remained vacant ever since. Among Chinese banks, ICBC, BOC, and CCB have all expressed interest in vying for this pricing seat. Currently, the Industrial and Commercial Bank of China, the China Construction Bank, and the Bank of China are all members of the LBMA.

Zheng Lianghao told reporters: “As long as they can meet the basic requirements, Chinese-funded banks can participate in pricing. The basic requirements include the size of each transaction and whether they have the capability to deliver gold in London. Delivering gold means finding gold in the system and handing it over to the London market; receiving gold means obtaining gold from the London market and having channels to distribute it. The ability to deliver and receive gold depends on the Chinese-funded banks’ extensive network of gold clients behind them. China is a major consumer of gold, and its market foundation is very strong. Therefore, it’s a positive sign that Chinese-funded banks are willing to participate in this market—proof that these banks are capable of engaging in the international market.”

However, Xi Jianhua, Executive Deputy Director of the China Gold Investment Research Institute, expressed concern to reporters: “A potential disadvantage in the competition is that the London gold market is a global gold market, while Chinese-funded banks have relatively fewer international customer resources.”

In recent years, Chinese-funded banks have already established a global presence in the gold business.

The Industrial and Commercial Bank of China (ICBC) recently announced that on February 1, 2015, it had completed the closing procedures for its acquisition of a 60% stake in Standard Bank Public Limited Company (hereinafter referred to as “Standard Bank Public”), in partnership with Standard Bank Group Limited (hereinafter referred to as “Standard Bank”) of South Africa. The successful completion of the acquisition of Standard Bank Public marks another significant collaboration between ICBC and Standard Bank, following ICBC’s initial investment in Standard Bank in 2008 and its subsequent acquisition of Argentina’s Standard Bank in 2012. Industry insiders speculate that ICBC may leverage its relationship with Standard Bank in South Africa to secure a market-making seat in London’s gold pricing mechanism.

In the domestic market, as a member of the Shanghai Gold Exchange, ICBC has maintained a share of over 20% in exchange-traded volume for many consecutive years. It ranks first in terms of agency services for spot gold and deferred trading, agency clearing services, and agency warehousing services.

In March 2012, the Shanghai RMB Trading Business Headquarters of the Bank of China was officially established in Shanghai. Its business scope includes precious metals trading. In addition, the Bank of China has branches in international financial centers such as Hong Kong, London, New York, Paris, Frankfurt, Sydney, and Singapore. Leveraging its global network of branches, the Bank of China conducts 24-hour precious metals trading across three time zones—Asia-Pacific, Europe, and North America—from its trading hubs in Hong Kong, London, and New York.

Supported by Chinese demand

“Being able to participate in the pricing mechanism certainly has its advantages—it provides an additional channel for exerting influence,” said Xi Jianhua. “China’s voice in the gold market doesn’t match its market size.”

In recent years, the phenomenon of Western gold moving eastward has become exceptionally prominent in the international gold market.

According to data from the World Gold Council, last year, gold jewelry, gold bars, and gold coins consumed in Asia accounted for 63% of the global total consumption.

According to the latest statistics from the China Gold Association, China’s gold consumption in 2013 exceeded 1,000 tons for the first time, reaching 1,176.40 tons—a year-on-year increase of 41.36%. As a result, China has surpassed India to become the world’s largest consumer of gold.

Although gold consumption declined sharply in 2014, the upward trend in consumer demand remained unchanged. In 2014, national gold consumption fell to 886.09 tons, yet it still remained at a relatively high level.

In addition to consumption, China’s gold production, imports, and trading volumes all continue to show a growth trend.

In 2014, China’s national gold production will exceed 450 tons, marking the eighth consecutive year as the world’s largest producer. The Shanghai Gold Exchange saw gold trading volume reach 18,500 tons, a year-on-year increase of 59.17%; the Shanghai Futures Exchange recorded gold trading volume of 47,730 tons. Data shows that in both 2013 and 2014, global gold production exceeded 3,500 tons annually. Of this total, China’s annual production and imports of physical gold accounted for nearly 2,000 tons, surpassing 50% of the global total.

Randall Oliphant, Chairman of the World Gold Council, pointed out at the inaugural China International Gold Conference that in recent years, China’s gold market and demand for gold investments have experienced rapid growth, with enormous potential for further development. In the coming years, China’s middle class is expected to grow by 60%, and by 2017, gold demand will increase by 25%.

“However, it’s a pity that global gold pricing still remains dominated by a duopoly between London and New York,” said Xi Jianhua. “Currently, the London gold fixing serves as the benchmark for spot gold prices, while the contracts traded on the New York Mercantile Exchange (COMEX) serve as the benchmark for gold futures. Looking at China’s pricing, after the sharp drop in international gold prices in 2013, Chinese ‘aunties’ went on a buying spree, yet this didn’t boost international gold prices—on the contrary, international gold prices continued to fall. The market hasn’t been sufficiently sensitive to Chinese demand, and factors influenced by China haven’t been effectively transmitted to the international market.”

According to industry insiders, participating in the London fixing system will enhance China's influence in the international gold market.

Zheng Lianghao told reporters, “The benefit of banks’ participation is that it allows them to reflect the interests of the groups behind them. Chinese-funded banks are backed by China’s gold enterprises and investors. By enabling these clients to participate in this mechanism through Chinese-funded banks, their influence can be effectively transmitted to the market.”

“In the past, Chinese clients have also participated in the market, but their involvement was not systematic. China’s gold positions were brought into the market through other market-making banks,” Zheng Lianghao pointed out. “However, only when our level of participation is sufficiently high will we truly have a voice in the international market. Joining the London fixing mechanism is a positive step that will ultimately reflect the influence of Chinese clients.”

On September 18, 2014, the International Board of the Shanghai Gold Exchange was officially launched in the Shanghai Free Trade Zone. As a result, gold prices are gradually shifting from being regionally priced to internationally priced. Internationalization is a key demand for China’s gold industry. Whether it’s Chinese-funded banks participating in the international market or the domestic market opening up to international gold producers and traders, all these developments will accelerate the integration between China and the global gold market, facilitating the shift from “gold moving from west to east” to “gold prices moving from west to east.”