Gold is widely acknowledged as a safe-haven asset, which is highly liquid, carries no counterparty risk and comes into its own during periods of uncertainty. Gold is often uncorrelated to other assets too – when equities and bonds fall in value, the gold price tends to rise.
Today, against a backdrop of rising economic and geopolitical uncertainty, there is growing interest in gold as an asset class, particularly after a decade-long bull market in equities. Interest has been further piqued by trends within the central bank community. First, the banks have adopted a more doveish stance on interest rates; second, they have been buying gold in greater quantities than at any time since 1971.
“The gold price is influenced by interest rates and the US dollar. When the dollar weakens, gold rises and vice versa. As an important component of financial markets, the gold market has some influence on the transmission of monetary policy as well. The rise and fall of the ratio of gold in central banks’ asset portfolios also have an impact on market expectations and interest rates, thus affecting the asset allocation of market players,” says Madame Wu.
“Research has shown that the real interest rate has a significant impact on the price of gold. As real interest rates fall, gold’s safe-haven qualities come to the fore. Therefore, in an economic environment fraught with uncertainty, discussions around the role of gold can have genuine, practical implications,” she adds.
Such discussions are particularly relevant in China. China’s gold market has already made huge strides since the Shanghai Gold Exchange opened its doors in 2002. Today, it is the largest physical spot market in the world, with a reputation for transparency and accountability. But Madame Wu believes that certain significant changes need to be made for China’s gold market to fulfil its potential.
“The restrictions on the allocation of gold in asset portfolios by insurance companies, social security funds, pension funds and other institutions should be eased at the right time, to introduce more long-term funds to China’s gold market. And we should continue to increase the breadth and depth of the gold market, diversify gold risk management products, and increase the proportion of long-term institutional investors. This would create a more dynamic and resilient onshore gold market,” she suggests.
Madame Wu also believes that China should change its stance on the export of gold. Today, China is the biggest consumer and producer of gold but there is no gold export quota. Madame Wu suggests that two-way opening of China’s gold market will expand its international influence.
“New York and London are the financial centres of the world, and the New York gold futures market and London gold spot market are the pricing centres of gold, and they also affect the gold price. Expanding financial openness is an important part of China’s all-round opening up in the new era. And the introduction of a quota system for gold exports in line with the current quota system for imports will make the two-way flow of gold smoother. China’s gold market is one way, with import quotas and no export quota. A two-way opening of its gold market could attract more overseas long-term institutional investors to participate in the Shanghai Gold Exchange international board, enrich the trading varieties with different maturities, and improve product liquidity, which could expand the international influence of China’s gold market,” she says.
Gold and the RMB
There are broader issues too. Over the years, the liberalisation of China’s gold market has supported the internationalisation of the RMB. This trend has been particularly evident since the Shanghai Gold Exchange launched its international arm in 2016, allowing foreign investors to use convertible foreign currencies and offshore RMB to participate in China’s gold market.
Further internationalisation of the RMB will promote growth in China and help the country to overcome current and future challenges. Madame Wu is confident that gold can play an integral part in this process.
“The further liberalisation of the gold market in China, especially the market denominated in RMB, is a crucial step in the internationalisation of the RMB. We need to further liberalise the gold market in China, so as to support the internationalisation of our currency and expand our international influence,” she explains.
Ever since the Global Financial Crisis, economists, policymakers and regulators have recognised that the international monetary system needs to evolve. Traditionally it has been heavily reliant on the US dollar, but there is a growing belief that nations around the world need more settlement options.
In 2016, the International Monetary Fund (IMF) launched a new Special Drawing Right (SDR) valuation basket, adding the RMB to the four other SDR currencies, the dollar, the euro, the yen and pound sterling. In time, this should facilitate international payments in the Chinese currency and thereby expand China’s role in the global settlement market. Opening up of China’s gold market could play a part in this process.
“Taking the lead in the two-way opening up of the RMB-denominated market is more conducive to the internationalisation of the RMB. With China being a net importer of gold, a gold market denominated in RMB would promote the circulation of offshore RMB and increase the source of funds for offshore RMB investment in China,” says Madame Wu.
For Madame Wu, the need to act is particularly important against a backdrop of economic and social change.
“It has been 40 years since China began to reform and open up its economy. Undoubtedly, the gold market has played a crucial role in that process. Today, amidst escalating global uncertainty, China’s financial markets are facing enormous opportunities and challenges. A healthy gold market may be the foremost internal spur to reform,” she says.