Chinese New Year is a joyous occasion. The annual festivities bring together families and many citizens return to their ancestral villages to celebrate with friends and relatives. It usually falls between January 21st and February 21st – the exact data varies from year to year as it is set according to the Lunar calendar. In the run up to the celebrations, gold retail demand typically increases as Chinese residents seek to acquire gold for gifting or as a personal investment. Given China’s predominant role in the global gold market, how does New Year buying influence pricing in the precious metal and how can market participants manage this premium risk?
A quick look at below time series shows that the period leading up to the Chinese New Year is often characterized by a disconnect between Shanghai and global gold prices. The premium for Shanghai over global reference pricing tends to increase in the run up to Chinese New Year, as should be expected when additional demand for gold results in upwards price pressure in China. This effect was particularly strong in 2016, 2013 or 2010 and seems to appear in most years.
Source: Bloomberg, SHGF9999 Index and XAUUSD. The 50 days ahead of Chinese New Year are highlighted in light blue.
Looking at the average Shanghai premium over the entire period (4134 daily observations from 2002 to 2019), a “Chinese New Year” effect seems discernible, as the three months with the highest average premium fall just before and during Chinese New Year: December stands at $5.71 /oz, January at $7.45 and February at $5.93. The average across the entire period is equal to $5.06/oz.
Source: Bloomberg, SHGF9999 Index and XAUUSD
Using a simple linear regression on this dataset and including dummy variables for each calendar month, we can look further into the premium components and separate how each calendar month contributes to the premium. The regression results show a constant premium of 4.70 USD/oz. The data indicates that certain months have a statistically significant (at the 5% confidence level) effect on the premium: December, January, February and May correlate with a higher premium, and August and September tend to go hand in hand with weaker premiums. The regression results do not suggest that the premium, in itself, is a function of the time of the year, but they do show that seasonal effects have some influence on the premium.
Source: Bloomberg, SHGF9999 Index and XAUUSD. * indicates statistical significance (t-stat above 1.96)
The newly listed Shanghai Gold futures on COMEX allow market participants to have seamless access to the domestic Chinese gold price and hedge any outright price exposure to the Chinese market or to the price difference between the price in Shanghai and the international gold market. Two contracts are available, allowing participating to trade Shanghai Gold both in local Chinese renminbi and in U.S. dollar.
A market participant seeking to hedge the risk of an increased premium around Chinese New Year can use the Shanghai Gold and the Gold futures (GC) to hedge exposure to a widening regional spread by buying Shanghai Gold January contract month and selling GC January contract month. If liquidity is concentrated in the nearby contract month, the participant may use the nearby contract and roll over a position from nearby to January or February when liquidity develops.
Calendar spreads – effectively selling a futures contract in a nearby month and buying a futures contract in a deferred month (or vice-versa) - also allow traders to take a view on possible seasonal effects in the Chinese gold market while reducing outright price exposure. For example, an investor taking a directional view on the premium difference between October and the following January contract month could sell October/buy January in Shanghai Gold and buy October/sell January in GC. Here, the investor may benefit if the “Shanghai premium” in January increases by more than it does in October (or decreases less): the investor is long the premium in January, and short the premium in October.
Our analysis suggests that there is a seasonal component in the Shanghai gold premium. A possible explanation for increasing Chinese premiums around year end is the effect of the Chinese New Year on gold demand. By offering trading in nearby and deferred contract months, participants can use the COMEX suite of Shanghai Gold futures contracts to hedge exposure and lock in regional spread levels for up to twelve months ahead.