Political Metals

By Ned Naylor-Leylan | Cheviot Asset Management Limited

Pan Asia Gold Exchange (PAGE) building in Kunming City, China

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The Pan Asia Gold Exchange and Hugo Chavez, a curious meeting of minds

The Pan Asia Gold Exchange and Hugo Chavez, a curious meeting of minds? The recent story picked up in the media about Hugo Chavez and the ‘calling’ of Venezuelan Gold held in London generated a good deal of interest and drew attention to the little-discussed issue of Precious Metals custody and ultimately, delivery.

Unlike the Venezuela delivery angle, however, an even bigger and related story is emerging outside of the coverage of the mainstream western press. China has recently launched a new Precious Metals exchange in Kunming City, Yunnan province, called the Pan Asia Gold Exchange (PAGE). I had the great pleasure of being part of a small group of interested parties in London observing and participating in the opening ceremony for the new exchange. We saw the clear support of central and regional government in this venture, evidenced by the participants on the day and their comments. PAGE has been steered at central government level by key economic ministers and mavens and is a formal part of the PRC’s present 5 year plan, one which places Yunnan province as a new gateway to international trade. The photo on the right shows the scale (and colour!) of the new exchange building in Kunming City.

This exchange is offering a new international-facing allocated ‘Spot’ Gold and Silver contract, with an 8am Beijing-time ‘fix’. The fix will only involve Chinese Banks; indeed the owners and members of the exchange are in no way related to the western banks that dominate the existing Spot and Futures Precious Metals markets. PAGE is launching in Q4 2011 a new Spot Precious Metals contract to challenge the emaciated LBMA ‘loco London’ system. International investors will now be able to buy allocated and, crucially, Rmb-denominated ‘Spot’ Gold and Silver contracts. The importance of this cannot be overstated. The Renminbi will be accessible to international investors through this exchange, but in a controlled fashion - using Gold as a synthetic choke on demand for the currency. By buying an Rmb Gold contract on PAGE and selling the equivalent $ denominated contract elsewhere, investors will be left with Rmb exposure. One would imagine that the incentive to own Rmb in the present climate is by inference likely to lead to a whole lot of demand for Gold contracts through this new exchange. Add to that the real demand for allocated Gold that will migrate across from the existing Spot market and you are looking at something that looks sure to have major implications for the Precious Metals market.

Historically the emergence of new Gold and Silver exchanges is met with a collective yawn. The reason for this is that there has never before been any expectation that new exchanges could/would affect the price discovery mechanism. Each new exchange was effectively an extension of the status quo. The mainstream has become dissociated with regard to this issue of price discovery. Many assume that Precious Metals prices are discovered in the healthy way one would normally expect - the body of the market being the ‘real’ Spot market, where the forces of supply and demand meet, with a small tail wagging merrily away in the form of a futures market (see the Jack Russell illustration). In Gold and Silver the size of the Spot market is ten or more times that of the futures market, so the use of a dog as an analogy holds up in scale terms. The current price discovery mechanism, however, as expressed by my Basset Hound illustration, works instead as follows:

The body of the dog (the Spot market) has become the plaything of its ‘tail’. Rather than the dog wagging its tail, the dog is being wagged BY the tail. This is achievable because the actors wagging the dog by its tail are some of the same LBMA (London Bullion Market Association) members that effectively make up the body of the dog. The LBMA system (aka ‘loco London’) has held sway beyond living memory and countless nations rely on the system for both price discovery and storage/custody. This system has not only allowed itself to be corrupted by fractionalisation, it is clear that the body of the dog actually welcomes being wagged, for fear of the repercussions of being caught short were it not! The ‘spot’ dog has been reduced to shell of its former self, so much so that even apologists for the status quo admit that the ‘spot’ market has around 100 paper claims outstanding to each physical bar. At any cost the existing mechanism will resist delivery, which is what makes the recent demand by Hugo Chavez to repatriate Venezuelan Gold reserves so interesting. This move towards delivery by the Venezuela leader plays into the same important dynamic as the Pan Asia Gold Exchange.

My contention is that this new exchange represents a far bigger challenge to the hegemony of the existing bullion banking system and it price discovery mechanism than most realise. Given the choice between being the unallocated and unsecured creditor of a fractionalized LBMA market or holding title to deliverable and allocated bars within the PAGE system I anticipate much of the ‘loco London’ business will migrate east, lured by the twin benefits of certainty of outright ownership and long-awaited international market access to Renminbi.

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Richard Poulden, Director of Power Capital Financial Trading (PCFT) discusses the new Pan Asia Gold Exchange (PAGE) with James Turk of GoldMoney.

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