The PBoC Manipulates the SGE Gold Price
The PBoC Manipulates the SGE Gold Price
How China's central bank controls gold flows to manage capital flight and defend the renminbi, creating artificial premiums and discounts in Shanghai markets
Introduction
By obstructing gold import and export, the People's Bank of China (PBoC) greatly amplifies the gold premium or discount on the Shanghai Gold Exchange (SGE) relative to metal traded in London. In the past 12 months, the PBoC has restricted gold import to curb capital flight and defend the renminbi, resulting in exaggerated SGE premiums.
With these interventions, the Chinese central bank risks the gold market it supervises from functioning properly and stagnates internationalization. The difference between the gold price on the Shanghai Gold Exchange (SGE) and Shanghai International Gold Exchange (SGEI) reveals manipulation on the part of the central bank.
Key Market Impact
The core responsibilities of the PBoC are to "maintain financial stability and to maintain the stability of the value of the currency and thereby promote economic growth." This creates a dilemma when Chinese people rush to buy gold as a form of capital flight, which undesirably weakens the renminbi.
Table of Contents
Understanding PBoC Gold Market Control
Since 2016, there have been several periods in which the PBoC restricted gold imports into the Chinese domestic market to stem capital flight, lifting SGE premiums over the international benchmark (London spot). Remarkably, when there is no capital flight, and China is a net gold importer, the PBoC seems to aim at a 0.5% floor for SGE premiums.
Import Restrictions
The PBoC controls gold imports through a licensing system. Fifteen or so banks are eligible to request licenses for each batch of imports, giving the central bank complete control over domestic gold supply.
Export Prohibitions
Gold export from the domestic market is more or less prohibited by the PBoC. As a consequence, when the Chinese turn into net sellers, gold on the SGE trades at a steep discount versus London.
Capital Flight Defense
The central bank uses these controls to manage the renminbi's exchange rate and prevent excessive capital outflows during times of economic uncertainty.
Market Distortion Effects
These interventions create artificial price differences that disconnect Shanghai gold prices from global market realities, potentially undermining China's goal of internationalizing its gold market and establishing yuan-denominated benchmarks.
How to Measure PBoC Interference
Tracking if the PBoC is manipulating the SGE gold price by curtailing imports or exports is fairly easy: if the gold price on the SGE in the Chinese domestic market differs from the gold price on the Shanghai International Gold Exchange (SGEI) in the Shanghai Free Trade Zone (SFTZ), the PBoC is interfering.
The Two-Market System
Gold trading on the SGEI in the SFTZ is separated from trading on the SGE in the Chinese domestic market. Gold enterprises can freely import and export gold in and out of the SFTZ, while the PBoC controls import and export into and out of the domestic market.
- SGE (Domestic Market): Subject to PBoC import/export controls
- SGEI (Free Trade Zone): Free movement of gold, reflects international prices
- Price Spread: Indicates level of central bank interference
- Licensing System: PBoC controls through batch-by-batch approvals
Simplified, the SGEI gold price is the "uncensored version" of the gold price in Shanghai. The difference between the gold price on the SGE and SGEI reveals if there is any obstruction going on.
| Market Indicator | What It Reveals | Policy Implication |
|---|---|---|
| Positive SGE-SGEI Spread | PBoC restricting imports | Capital flight concerns |
| Negative SGE-SGEI Spread | PBoC blocking exports | Preventing domestic gold outflows |
| 0.5% Premium Floor | Artificial support level | Maintaining market appearance |
| Aligned Spreads | Normal market conditions | Minimal interference |
A Short History of PBoC Interference
This methodology allows us to observe interference since 2014 when the SGEI was launched. In the first years after the SGEI was erected, SGE and SGEI premiums coincided. Then, in 2016, the SGE premium started to drift higher than the SGEI premium because the PBoC was battling capital flight.
2016-2017: First Major Intervention
Capital flight pressures led to significant import restrictions. Even after the storm passed in 2017, the PBoC maintained a 0.5% premium floor.
2019: Renewed Restrictions
Another stage of capital flight made the PBoC step up blocking imports into the domestic market, pushing the SGE premium above 0.5%.
2020: Export Restrictions
When Chinese became net sellers as prices rose, the PBoC wouldn't allow exports, causing steep discounts to London prices.
Strategic Considerations
Possibly, the 0.5% base conceived by the PBoC is to make Chinese demand appear stronger (national pride) or create extra profit for importing banks. This artificial floor demonstrates how policy objectives override market mechanisms.
Around 2020, the Chinese became net sellers as the price went up, though the PBoC wouldn't allow exports from the domestic market, causing gold on the SGE to trade at a steep discount to the price in the SFTZ and London. When the gold price stabilized in 2021, the SGE premium reverted to positive territory.
Capital Flight Since 2022
A useful approach to measure if the PBoC is interfering and why, is charting the spread between the SGE and SGEI gold price, and the renminbi's exchange rate versus the US dollar. It's mainly the gold price that influences Chinese supply and demand trends, but the renminbi's exchange rate can affirm if said trends are countered by the PBoC.
Recent Market Dynamics
The analysis illustrates that often when the renminbi weakens, the PBoC is allured to restrict gold imports, which drives up the SGE premium. This happened in late 2022 and February 2023. Recently, Reuters confirmed that the PBoC is limiting import licenses on the back of a weak renminbi.
"Currently, no new import quotas [Licenses] have been issued, and there have been no gold imports into China from previous issued."
— Bernard Sin, regional director, Greater China at MKS PAMP (July 7, 2023)
Although the PBoC has restricted imports and exports almost continuously since 2016, it's hard to say how much metal has actually been blocked from entering or leaving the domestic market. On average, China has imported 1,000 tonnes per annum since 2016, making it one of the world's largest gold markets alongside investors who purchase gold in Western markets.
Current Market Status
The ongoing restrictions demonstrate the PBoC's willingness to prioritize currency stability over market efficiency, even at the cost of hampering their gold market's international credibility and functionality.
Market Implications and Future Outlook
At some point in the future, the PBoC will need to cease interference for its gold market to continue functioning properly. The blocking of exports, for example, is a major problem.
Liquidity Concerns
China as a whole can buy gold in amounts tolerated by the PBoC but can't sell. What if the Chinese citizenry starts to fully grasp they can't sell at the international price at all times?
Unintended Consequences
When international prices spike drastically, people may sell to smugglers that arbitrage between domestic and foreign markets, potentially destabilizing the carefully designed system.
Investment Psychology
Chinese people may lose interest in owning an asset that has limited upside potential due to export restrictions and artificial price controls.
International Benchmark Challenges
The Shanghai Gold Benchmark Price (SHAU), initiated in 2016, was designed to compete with the LBMA Gold Price auction held twice daily in London. However, the underlying contract of SHAU is listed on the SGE, not SGEI, making it subject to PBoC's price manipulation.
Which foreigners are going to use a benchmark that is detached from the international reality? The PBoC would be wise to eliminate confusion regarding these matters for the Chinese gold market to play a key role internationally. For global investors tracking gold price movements, understanding these dynamics becomes crucial for market analysis.
Future Market Evolution
The success of China's gold market internationalization depends on resolving the fundamental contradiction between capital controls and free market pricing. Until these issues are addressed, international investors and institutions will likely continue to rely on London-based pricing for their gold investments and portfolio decisions.
- Market efficiency requires elimination of artificial restrictions
- International credibility depends on transparent price discovery
- Yuan-denominated benchmarks need legitimacy through free markets
- Long-term success requires balancing policy goals with market function
As global gold markets continue to evolve, the resolution of these structural issues in China's gold market will significantly impact international gold price discovery and the broader precious metals landscape.
Disclaimer: This analysis is for educational purposes only and should not be considered financial advice. Gold investments involve risk, including potential loss of principal. Market conditions and regulatory policies can change rapidly. Always consult with qualified financial advisors before making investment decisions.