The Hong Kong-based Chinese Gold & Silver Exchange (CGSE) has launched the world’s first offshore renminbi-denominated spot gold contract, offering investors a chance to speculate on appreciation of the mainland currency while hedging in gold.
The new product, known as Renminbi Kilobar Gold, enables institutional and retail investors to settle either through a spot contract or physical delivery. As with most developments in the internationalization of the Chinese currency, the launch of the new contracts has been carefully managed.
The product has been on trial since May 16 and CGSE president Haywood Cheung tells Euromoney that there will be an initial ceiling on trading volumes. "There is an initial cap of 300 kilos a day for physical gold trading," he says, "because we want to see a gradual development in the product and make sure no single investor can suck up all the liquidity. But electronic trading is limitless."
Liquidity will be important for the new gold trading programme, since the lack of it has blighted the development of the renminbi bond market in Hong Kong. Limited supply of bonds relative to the volume of renminbi deposits in Hong Kong, estimated by Cheung at around Rmb600 billion ($94 billion), means that investors tend to buy and hold. That means there is little secondary trading. This situation is exacerbated by the People’s Bank of China’s habit of occasionally announcing that the offshore renminbi settlement quota has been filled, causing a temporary liquidity squeeze. This happened most recently in October, causing a sell-off in CNH bonds (renminbi-denominated bonds held in Hong Kong) and a discount in the price of those bonds relative to their onshore equivalents. Investors in any renminbi-denominated product in Hong Kong are likely to be extremely wary of being left holding illiquid instruments.
Two-way price
"These contracts should be easy to liquidate," says Cheung, "because physical gold always trades with a two-way price, unlike other markets where you always have to line up a buyer. We’ll always quote a price."
Cheung draws an interesting historical parallel with the late 1980s and early 1990s, when both local and foreign goldsmiths traded contracts in Hong Kong as a means of hedging the Hong Kong dollar against the US dollar as Sino-British negotiations over the territory’s future caused uncertainty about the former currency’s future.
"Now we are seeing some of these old gold players come back," he says, "to hedge against the renminbi. After the launch on October 17 we had a lot of foreign banks and goldsmiths calling."
Gold and the renminbi are both at the forefront of investors’ minds at the moment, and Renminbi Kilobar Gold is being marketed accordingly as a combination of two hot commodities. CGSE is hoping that the contracts will attract investors looking to bet on the appreciation of the renminbi who want to diversify away from CNH bonds, with Cheung saying he expects a 30% increase in trading volumes on the exchange within six months.
That will depend, however, on whether investors continue to be spooked by the early October selldown in onshore renminbi products, leading to a discount between the offshore and onshore bond markets of 1.5% as of October 3.