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China and the Manipulation of Gold Prices

Written By Geoffrey Pike

Posted October 26, 2015

chgoldWhile China is currently the biggest consumer of gold out of any country – including India – the Chinese government is also taking a more active role in financial markets and gold markets in general.

It was recently reported that China Construction Bank Corp. will become the second Chinese bank acting as a participant in helping to set the daily benchmark price for gold.

Since this past March, the London Bullion Market Association (LBMA) Gold Price has replaced the previous London Gold Fix. With the new group and process in place, the gold benchmark is set twice on a daily basis. This benchmark pricing of gold is widely used by gold retailers and gold miners.

The London Gold Fix had been in place for nearly a century and consisted of daily telephone conference calls. After allegations of price manipulation, the system was revamped.

With the addition of a second Chinese bank, there will now be 12 participants in the price setting for gold. Participants include Goldman Sachs, JP Morgan Chase, Morgan Stanley, and many of the big international players.

With an elite group of bankers such as these, what could possibly go wrong? These players should surely knock out all doubt of any manipulation (note the sarcasm).

China Construction Bank Corp. is based in Beijing and is unsurprisingly a state-owned bank. Out of China’s four major state-owned lenders, two of them will now be participants of the LBMA Gold Price.

It is not clear what the objective is of Chinese officials here. If there is going to be any manipulation in setting benchmark gold prices, perhaps the Chinese feel they should at least be part of the process so they know what is going on.

This move is consistent with China’s increasing role on the world financial stage. It has taken a more active role in financial markets and world trade. It has also been a net buyer of gold.

The Chinese Contradiction

The entire Chinese economy and Chinese system seems to be one big contradiction. This is not completely unlike the American economy, but it is to a much greater degree.

The Chinese have liberalized markets considerably over the last few decades, which has helped raise living standards dramatically. At the same time, we still see signs of the old Communist Party, especially when the booms turn to bust.

In some ways, the Chinese government and central bank have adopted some of the Keynesian policies of the West and put them on steroids. This resulted in huge bubbles in real estate and stocks. When stocks were falling dramatically, Chinese officials stepped in with authoritarian rules preventing selling and trying desperately to prop up markets. They showed that property rights are still not strong in China, especially when a crisis hits.

The Chinese have been doing trade deals with other countries and has also been attempting to get the yuan included as part of the Special Drawing Rights basket of currencies. Meanwhile, they still will not allow the yuan to trade freely on the open market.

The Chinese central bank has been buying gold, although it still does not come anywhere close to its holdings of U.S. government debt.

While central planners cannot possibly know how to effectively plan an economy, especially with over a billion people, there are times that the Chinese officials have a decent understanding of some economic cause and effect. At other times, they are completely clueless – or worse, tyrannical.

This latest move to get another state-owned Chinese bank as a participant in setting the gold benchmark is not surprising. The Chinese want to be involved and they want to be considered a major player.

We don’t know if there is purposeful manipulation with the new group setting the gold price, but it is understandable in a way that the Chinese would want to be involved.

Still, I like to remind my readers that the market ultimately sets the price. The big financial institutions can try to manipulate the price and may even make some short-term profits from doing so. But regardless, it is buyers and sellers in the open market who have the final say on the price.

If you aren’t trading metals on a short-term basis, then there isn’t much to worry about. Worst case is that you may pay a fraction of a percent more when you buy, if there is any funny business.

Either way, the Chinese are helping to set the gold price in another way. The Chinese central bank is accumulating more gold, seemingly on an almost constant basis now. This is helping to put a floor under the price of gold.

Even with a stumbling economy and an increase in government dictates in financial markets, the Chinese are only going to help the price of gold in the long term. This will be from the Chinese central bank, as well as the Chinese people looking for a safe asset that doesn’t require leverage or buying something digitally.