Can I still buy gold now? UBS conducts in-depth research on the Chinese gold market

This year's record-breaking rise in gold prices is widely believed to be driven by Chinese investors playing a significant role. The People's Bank of China has increased its gold reserves for 18 consecutive months, becoming one of the most closely watched central bank buyers; retail investors have shown strong enthusiasm for gold ETF products; and sales of gold jewelry in gold shops have been exceptionally hot.

UBS, a major Wall Street bank, conducted on-site visits to the gold markets in Beijing and Shanghai, China's gold market centers, at the end of April last year, obtaining first-hand market intelligence and customer feedback. Nine months later, as gold prices soared historically, UBS conducted a follow-up in-depth research on the Chinese market.

UBS pointed out that Chinese investors tend to buy gold on price pullbacks. Therefore, investors may be more willing to react elastically to prices in the future, with a willingness to buy on dips around $2250 per ounce.

According to UBS, some investors tend to believe that the Federal Reserve will not cut interest rates, maintaining a view of higher levels for longer periods, which will further support the pullback in gold prices, and the reasons for long-term holding of gold still hold.

Market Sentiment in China - Buying on Dips

China is one of the world's largest gold consumer and producer: globally produces about 3500 tons of gold annually, with China consuming one-third and producing about 350 tons, with the remaining gap needing to be met by imports.

The Shanghai Gold Exchange (SGE) is the main channel for gold retail imports in China. Currently, 15 domestic banks hold gold import licenses and import gold through the SGE. The standard gold bar required by the SGE is a 99.99% purity 1 kg gold bar, roughly the size of an iPhone.

In addition, there are 4 foreign banks' subsidiaries in China with import licenses - they are obligated to meet the needs of Chinese companies and engage in SGE/London gold arbitrage trading at the right time.

Market demand usually peaks before the Lunar New Year and Golden Week. The People's Bank of China has a significant impact on market activities by controlling the quantity and timing of import quotas.

UBS clients noted that during the recent surge in gold prices, the SGE premium over the London market was strong. By the end of 2023, the SGE premium once approached nearly $150 per ounce, and currently remains above $30 per ounce.

UBS pointed out that the Lunar New Year's gold import quota has been used up, but as gold remains irreplaceable for retail investors, potential demand will continue to exist.

Chinese investors tend to buy gold on price pullbacks. Therefore, investors may be more willing to react elastically to prices in the future, with a willingness to buy on dips around $2250 per ounce.

Clients are more inclined to believe that the Federal Reserve will not cut interest rates, maintaining a view of higher levels for longer periods, which will further support the pullback in gold prices, and the reasons for long-term holding of gold still hold.

Gold Price Breaks 2400, Is SHFE the Key Driver?

Recently, Western views suggest that the Shanghai Futures Exchange (SHFE) gold contracts are a key factor driving the gold price above $2400 per ounce, with commentators pointing out that the trading volume of its gold contracts has significantly increased, and the outstanding long positions are astonishing After conducting surveys on most clients during its operations in China, UBS found that the so-called "SHFE Effect" seems to be purely coincidental and lacks definitive causality.

Domestic banks are the main market makers in the Shanghai Futures Exchange (SHFE) gold futures market. These banks' proprietary trading departments often engage in an arbitrage trading strategy, trading gold price differentials between the Shanghai Gold Exchange (SGE) and SHFE (similar to the gold EFP trading in Western markets). The deep involvement of domestic banks in the SHFE and SGE markets lends credibility to their views.

It is worth noting that in the SHFE gold futures market, most participants are not there to acquire physical gold but rather for hedging purposes. When contracts expire, they usually do not opt for physical gold delivery.

Instead, these participants often "roll" their positions to the next contract delivery month or close out positions before expiration through cash settlement. This means that while the trading volume of SHFE gold futures is significant, it rarely involves physical gold delivery.

Due to the limited involvement of physical delivery in SHFE gold futures contracts, it lacks direct connections and interchangeability with other major physical gold markets globally, such as the London gold market and COMEX gold futures market.

This lack of interchangeability implies that despite the substantial trading volume of SHFE gold futures, its impact on global actual gold supply and demand, as well as prices, is very limited.

It is noteworthy that participants in the SHFE gold market rarely engage in physical delivery, and positions are typically rolled over or closed out through cash settlement. Therefore, given the lack of interchangeability with the London gold and COMEX gold futures markets, the influence of SHFE is minimal.

Previously, media reports indicated that in recent months, a significant amount of long open interest contracts had accumulated, equivalent to around 300 tons of gold, without mentioning the net long open interest positions, currently amounting to 100 tons of gold. In comparison, the most liquid global contract, COMEX gold, currently has a net speculative long position of 700 tons.

Compared to SHFE, the COMEX gold market is much larger in scale