The gold futures contract launched by the Shanghai Futures Exchange today is another step in the liberalisation of mainland financial markets, but trading rules remain too restrictive for the contract to garner much interest outside of the mainland.
Domestic gold mining firms had to sell their product to the People's Bank of China until 2002, when the government opened a spot gold exchange in Shanghai.
The deregulation was followed by the listings of several large state gold mining firms, and today's launch of a pricing and hedging tool puts the finishing touches on a modernised, efficient gold market, except for one very important thing: gold, like oil, is a global market where money moves across borders and currencies.
Shanghai's gold futures, like other mainland financial markets, are for domestic players only, meaning they will never develop beyond the needs of the mainland's own precious metals industry.
The exchange said trading will initially be limited to China National Gold Group, Shandong Gold Mining, Shandong Zhaojin Group and Zijin Mining Group, the mainland's most influential gold processors and suppliers.
'Gold is an international market, so it's hard to see how it will work to have a purely domestic contract,' said Anderson Cheung, a trader at Mitsui Bussan Precious Metals in Hong Kong.
'Gold is big news these days with prices hitting new highs, so of course it's a very good time to come out with a new contract. But everyone is coming out with contracts, Dubai, Shanghai, and I think Hong Kong will have its own contract as well before too long.'
Gold contracts listed by the New York Mercantile Exchange's Comex and the Tokyo Commodity Exchange are the industry standards, although other competitors have been launched, such as that by the Dubai Gold and Commodities Exchange. Futures are uniform contracts between a buyer and seller for the delivery of gold at a fixed future date.
It would certainly make sense for the mainland to have a gold futures contract as it is the world's fourth-largest producer at about 200 tonnes per year and it consumes about 300 tonnes of gold annually, the World Gold Council said.
'China, India and the eastern part of the world have always been the demand centre for gold, so it makes sense to have a contract in Shanghai. But gold has always been more of a physical market for jewellery out there, so we'll have to see how that translates to the futures market,' said James Moore, a British precious metals analyst with TheBullionDesk.com.
The timing could not be better as the precious metal grows in value and popularity during uncertain times. Gold for immediate delivery in London climbed to a record US$868.89 an ounce on January 3, the same day crude oil broke the US$100 a barrel barrier.
Gold prices rose 31 per cent last year, thanks to geopolitical turmoil and a weaker US dollar - gold is generally priced in dollars. However, those gains pale in comparison to the mainland stock market, which soared 97 per cent during the same period.
The exchange has set the base price for all of the new gold futures contracts at 209.99 yuan a gram, which translates into US$897.34 per ounce. Yesterday, spot gold hit a fresh high at US$875.80. Comex gold for February delivery was trading at US$864.90 per ounce.
The exchange would not comment on why its initial price was higher than the benchmark.
One of the exchange's key concerns has been to keep the contract from becoming another plaything of mainland speculators.
The exchange has raised the margin requirement to 9 per cent on a temporary basis, up from the 7 per cent it will maintain over the longer term. The margin for its other metals contracts is 5 per cent.
Each contract represents 1,000 grams of gold, raised from the initial planned size of 300 grams in an attempt to curb retail market speculation. Tocom has two contracts, a standard contract of 1,000 grams and a 'Mini' contract of 100 grams, while the Comex contract is 100 ounces, or 3,110.3 grams.
'Making the contract bigger will probably keep some retail investors out, but there are still plenty of rich people in China who can afford the bigger contracts,' said Mr Cheung.
Individual investors are also banned from settling contracts with physical gold, as institutional traders are allowed to do.
This means they will have to liquidate their positions ahead of the delivery date.
Mainland retail investment demand for gold increased 43 per cent to just over four tonnes in the third quarter of last year, although jewellery accounted for the vast majority of consumer gold demand in the mainland. Indian investors bought 12 times as much gold for investment purposes, according to the World Gold Council.
Overall, mainland demand was up 25 per cent at 78.9 tonnes in the quarter.
'It will probably be pretty slow in the beginning, but if they can build some liquidity, of course it will be a good contract. The growth of gold is very big in China, so that should help it become a success,' said Ellison Chu, manager of precious metals at Standard Bank Asia in Hong Kong.
The exchange issued a statement saying the contract would complement spot trading and help form an integrated market on the mainland.
Futures also help producers and wholesale buyers hedge against the risk of price fluctuations.
'In tandem with an ever-increasing gold price, China's gold industry is grappling with higher risks,' the exchange said. 'Gold futures could be of help as gold companies can make the most of it to ward off risks.'Topics: Finance Financial Economics Finance Commodity Market Futures Exchange Business