Zhou Xiaochuan: Gold market functions to hedge against risks
Speech by Mr Zhou Xiaochuan, Governor of the People's Bank of China, at the 2004 London Bullion
Market Association Annual Precious Metals Conference, Shanghai, 6 September 2004.
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I would like to congratulate, on behalf of the People's Bank of China and in my own name, the
convening of 2004 London Bullion Market Association Annual Conference on Precious Metals. Relying
on improved infrastructure and as a cohesive force in the national economy, Shanghai is developing
various types of financial markets. Any of these markets, be it a foreign exchange market, a bond
market, a futures market or a gold market, serves as an important center that connects and influences
the rest of the country. This is why it is so encouraging and appropriate to hold this year's Precious
Metals Conference in Shanghai.
London gold market is the biggest as well as the oldest gold market in the world. In 1804, London
replaced Amsterdam to become the world's gold trading center; in 1919, London gold market was
formally founded; and in 1982, London futures market for gold declared its foundation. Currently, the
London gold market is trading at a per week volume of 2-3 billion U.S. Dollars, accounting for 43% of
the world's total gold transactions, establishing itself into not only the world's largest gold sales market,
but also a governmental gold trading market for most of the world's central banks. It is even a major
force in influencing the gold prices in many other countries and regions.
As the administrator of London gold market, LBMA enjoys authority as well as fame in world's gold
circle. And each year in different cities of the world, LBMA holds its global annual conference on
precious metals - one of the world's most important international conferences of the gold industry. The
Shanghai conference creates conditions for exchange and cooperation between market participants in
China and the world and will promote the reform and opening up of China's gold market.
Compared with the time honored London gold market, Chinese gold market is only two years old.
However considerable progress has been achieved with the market notably expanded, investment
ratio rapidly improved, pricing mechanism gradually formed, investment instruments diversified and
market participators increased. By the end of 2003, Shanghai Gold Exchange already had
108 members. The transaction volume in 2003 was 235.35 tons or 22.962 billion RMB, of which
148.62 tons were actually delivered. China's gold production of the same year was 200 tons. A sound
prospect for Chinese gold market is unfolding.
International gold market and colleagues present at this conference have paid a lot of attention to the
past and present of Chinese gold market, but the future of a reformed and open market is of even
greater concern to all of us. So today, I would like to associate myself in the discussion of the future of
the market where I see three transformations: first, transformation from a market majoring in
commodity transactions to financial transactions; second, transformation from spot transactions to
futures transactions; third, transformation from a domestic market to an international market.
1. To transform Chinese gold market from one for commodity transactions to one for financial
product transactions. Gold as a commodity has the multi-characters of a currency, a financial
product and an ordinary kind of good. Globally speaking, gold is phasing out as a currency,
but the thriving investments in gold demonstrates its financial characters and its
indispensability as an investment instrument. In all the major international financial centers,
gold market is an integral part of the financial markets consisting of the money market,
securities market and foreign exchange market.
As an ordinary commodity, gold has become a consumption product for the urban and rural
residents after the reform and opening up. The gold market can meet the demand of the
consumers, and the gold producing or consuming enterprises. But gold is yet to be cultivated
as a financial instrument for investment and store of value. Transaction of gold as a financial
product is still restricted in China, and it has not been brought into full play the financing
function of the gold market.
How can we transform the gold market into a financial market from its present stage as a
commodity market? The current situation presents individual investment in gold as a realistic
answer to this question. Our total domestic household savings amount to as high as
12 trillion RMB, readily conditioned for investment in gold or rather turning the asset of the
ordinary people from currency into gold. From the macro-economic perspective, it creates an
additional channel to convert savings into investment balancing the demand and supply.
From the micro-economic perspective, allowing people to hold assets in gold can improve
social welfare benefiting both the country and its people. Also, the dual characters of being
an ordinary commodity and a currency allow gold to well hedge against risks. So it is
practical to develop individual gold trading business.
2. Transform the gold market from spot transactions to gold derivatives transactions. There are
two major types of transactions in the international gold market: the traditional spot
transactions taken place basically in the gold markets of London, Zurich and Hong Kong;
and the futures transactions including gold options, forwards and swaps basically on
Chicago Board of Trade, New York Mercantile Exchange, the Mid-America Commodity
Exchange and Tokyo Commodity Exchange. A fledged gold derivatives market can
effectively function for market players to hedge against risks and carry out investment and
financing.
The current major form of gold transaction at Shanghai Gold Exchange is firm order spot
transaction. With the development of Chinese gold market, we will phase in a variety of gold
derivatives including forwards and futures. In February and August this year, Shanghai Gold
Exchange has put forward successively T+5 and deferred delivery products in addition to
spot transactions. The attempts help the enterprises to fix costs, further preserve value, and
avoid the uncertainties in production costs caused by price fluctuations. Currently, the
deferred delivery is done on a trial basis by means of down payment. The transaction could
be settled before, after or on the contracted date as negotiated by the buyer and seller. The
price is decided on the day of transaction. This product avails gold producing and demanding
enterprises to hedge against risks, diversifies tools for investment and enlarges the variety of
transactions on the market. The PBC will conduct further research on gold forwards and
futures provided that financial risks can be effectively contained.
3. To integrate Chinese gold market into the international market. We all know that the present
Chinese gold market is a relatively closed one with membership accessible only to domestic
gold producers, intermediate consumers and commercial banks; exports and imports have
not been liberalized; and no round-the-clock synchronized transactions with the international
market. Therefore, we plan to open the market further in an effort to solve the above
problems, fuse the Chinese gold market into the global market and create conditions to forge
our market into a global player.
We see as central bankers, that developed gold market can help to compliment the monetary policy
instruments and improve macro-economic management. This is because gold still apparently
demonstrates its character as a currency in the modern financial system. Even after the collapse of the
Bretton Woods System, the price of gold is still an important index for central banks to evaluate
inflation. Also, all central banks still hold considerable amount of gold as government reserves. Gold
reserves, foreign exchange reserves and quota at the International Monetary Fund form a nation's
international reserves that can be used to weather risks. The establishment and development of
Chinese gold market symbolizes a preliminary completion of a financial market system consisting of
the money market, securities market, insurance market and the foreign exchange market. An
improved financial market system will serve as a firm and effective micro-economic basis for macro
economic adjustment. So we aim at realizing these three transformations to establish a secure, and
effective gold trading system where hedging instruments are widely available, and to foster the
development of the gold market. This is to be achieved with the joint efforts of out colleagues from the
world financial circle especially colleagues of the gold industry, and my colleagues in China.