Is the Chinese Derivatives Tail Waging The Precious Metals Dog ?
Cause and effect are funny things — a bit like the chicken-and-egg conundrum — and so it seems with precious metals just now.
Excessive and exuberant Chinese speculation, in my view, is wreaking havoc on the price discovery process for bullion. And the volatility seems to be developing momentum in a feedback loop in each direction, creating its own narrative, removed from the real market and its drivers. It is eating itself.
What is 'fair value' for gold and silver ? Honestly, I have no idea at the moment. In theory, the answer should lie in the market’s positive supply-and-demand fundamentals, but the data tells us little these days. The gold market has become relatively opaque, as central banks prefer to keep their de-dollarisation plans by acquiring bullion under wraps, rather than draw the ire of the U.S.. Meanwhile, local Shanghai gold premiums swing wildly — from a $100 premium to a $10 discount. Silver, meanwhile as a high beta gold trade is especially volatile and taking a position risks serious whiplash.
Much of the gold rally since 2022 can hitherto be attributed to high-quality, high-conviction buying from the official sector. Think of it like a Victoria sponge cake: add a layer of retail and ETF buying — the jam, if you will — and then top it with a layer of speculative activity from China. It’s this tranche that’s distorting the market, swinging from exuberance to outright rage in almost schizophrenic fashion. The behaviour is driven by the level of leverage allowed by global futures markets, which are now turning cautious and seeking to curb over-speculation by raising trading margins. They’re trying to clip that derivatives tail. As time passes, it becomes easy to lose sight of true supply-and-demand fundamentals and what the price should be — which remains attractive, but not extraordinary.
The Chinese market has always been highly speculative and volatile. The problem is, it’s now so large that it dominates and distorts the entire process. The grown-ups in the room (institutional players) soon realise the market feels more like a casino than a marketplace and step aside. Industrials re-double efforts to find substitutes, retail clients burn out, potential jewellery buyers walk away, investors look non-plussed and go elsewhere, while central bankers press the pause button ... and before long the bullion trading landscape looks utterly desolate like a moon-scape.
How does this end ? Well eventually the Chinese player driving these price swings discover they’re only talking to themselves... everyone else has gone home
Not helpful — not helpful at all.
Ross Norman