East looking for more gold pricing power

With the London Gold Fix under regulatory pressure and consumption of gold increasingly shifting East, Asian based exchanges are increasing looking at increasing market share and pricing influence over gold.

The Shanghai Gold Exchange has announced that it will operate within the Shanghai Free Trade Zone to provide yuan-based gold pricing for local banks.  Singapore is also making moves to increase gold trading given it is increasingly becoming the hub for commodities trading in Asia.

While there is clearly an opportunity for Asian based exchanges to lift volumes, the jury is out as to whether this will markedly change price behaviour.

While the SHFE has seen explosive growth in gold futures trading, Comex is still a long way from being displaced as the dominant exchange.

And while London may become less important in the location for the pricing of physical gold, the fact that futures markets remain dominated by Western exchanges remains important.

To be sure, there is very good reason to believe that it is marginal buying/selling in these markets that is the most liquid and the most important in setting prices and should remain that way for sometime.

For all the changes in the composition of physical demand for gold, it would appear that gold pricing behaviour is still mostly a function of factors that affect other large, key asset markets, like debt and currency markets.

Building simple models of the gold price using these variables continue to give credible results.  The key take out is that most of the movement in the gold price (~80%+) is to do with factors driving real interest rates and the USD, rather than Chinese/Asian physical interest.

As I've posted before, these models have undergone paradigm shifts throughout the last 30 years.  Most recent was in 2008 in the aftermath of the global financial crisis. This is shown in the chart on the left, with the model that worked pretty well from 2000-2008 not working in 2009 - today.

We have also seen similar paradigm shifts at the end and start of the 1990s.

There isn't much evidence to suggest we are seeing such a paradigm shift at the moment. There have been brief periods where modelled and actual gold prices have diverged, but this is by no means reason enough to throw away the current model.

However, there is a possibility that the emergence of Eastern trading hubs could create a paradigm shift in the way gold pricing behaves.  And this would be unusual in the context of the last 30 years, given such changes have been around major changes in the macro environment rather gold market specific issues.

For that to happen, it seems likely that Western futures markets would have to be displaced by Eastern trading, rather than just greater competition for physical clearance vs. the LBMA.  This is certainly possible, although even then its not clear whether gold would tend to follow different factors.

For me, I would wait to see whether this occurs rather than assume it will and have some kind of impact on gold prices.