The writing is on the wall: Saudi Arabia Selling Oil To China For Gold

Rumours have been circulating that Saudi Arabia is vending oil in exchange for yuan, which is then converted into gold on the Shanghai International Gold Exchange (SGEI). This move could be considered reasonable as numerous countries seek to reduce their reliance on the US dollar, but the renminbi is not a suitable replacement for the greenback as a reserve currency. This is because China has a closed capital account and a weak legal system. Therefore, rather than utilising the dollar, countries could use the renminbi as a trading currency and then swap their yuan earnings for gold on the SGEI. If these rumours are indeed factual, Saudi Arabia is opting to purchase 1 Kg gold bars, as there is negligible trading of 12.5 Kg bars on the SGEI. The advantage of procuring 1 Kg bars is that they are more compatible for fully allocated trading.

The establishment of the SGEI in 2014 paved the way for foreigners to gain access to gold trading in the Shanghai Gold Exchange Main Board within the Chinese domestic gold market, as well as trading in the Shanghai Free Trade Zone's International Board. It is not permitted for foreign entities to load or unload gold into and from Main Board certified vaults. However, they are allowed to load and unload gold in and out of International Board certified vaults, and therefore, they can import and export from the SFTZ.

The primary objective of the International Board is to facilitate offshore gold trading in renminbi in the SFTZ, with minimal impact on China's current account. This is similar to offshore gold trading in US dollars in London, which sets offshore dollar prices for internationally traded commodities. China aims to enhance the renminbi's global economic standing through the SGEI.

Investment possibilities for foreigners in Chinese financial assets are limited, but there are no restrictions to converting yuan into gold on the SGEI. I will write more on the mechanics of the Chinese gold market in a forthcoming article because this will be important in the coming years with respect to de-dollarisation.

Last week, Christopher Wood from Jefferies mentioned in a note that the Saudis might be converting yuan into gold on the SGEI.

If Saudi Arabia would convert yuan into gold on the SGEI, I would expect them to buy large bars weighing 400 ounces (12.5 Kg). Data from the SGE and SGEI, though, reveals there has practically been no trading in 12.5 Kg bars since the SGE was erected in October 2002.

In the aforementioned diagram, we can observe the exchange trading volume of 12.5 Kg contracts. Nevertheless, OTC trading in the same contract on the International Board was nil during the preceding year. OTC trading in the 12.5 kg contract on the Main Board isn't revealed; hence it leads me to infer that it doesn't exist. All things considered, extensive barter on the SGE(I) is unusually infrequent.

It's challenging to substantiate the hearsay based on the trading volume of the 12.5 Kg contract on SGE(I); nonetheless, it doesn't signify that it can't be veritable. Saudi Arabia can also purchase 1 Kg bullions on the SGEI (and SGE), but it won't be able to ship gold traded on the Main Board. Trading in 1 Kg contracts on the SGEI (iAu9999) and SGE (Au99.99) is not dampened. Nevertheless, there hasn't been any significant surge in iAu9999 trading lately.

According to some sources, all gold traded in China's foreign exchange market (CFETS) is settled and cleared through the Shanghai Gold Exchange (SGE) and is fully allocated. This is because the underlying assets are the SGE 1 Kg (9999 fine) and 3 Kg (9995) contracts. In Western foreign exchange markets, the underlying for gold trading is usually the LBMA Good Delivery bar that weighs approximately 400 ounces, which is more convenient to trade on an unallocated basis.

In December 2022, President Xi Jinping of the People's Republic of China visited Saudi Arabia and proposed that trades between China and Gulf Cooperation Council (GCC) nations be settled in yuan. Shortly after, in January 2023, Saudi Arabia's finance minister stated that the kingdom was open to discussions about trade in currencies other than the US dollar.

The Wall Street Journal reported in March 2023 that Saudi Arabia was in active talks with Beijing to price some of its oil sales to China in yuan. These statements suggest that there is a desire in both countries to de-dollarise.

Selling oil for yuan and then converting those into gold would be a logical step, given the renminbi's shortcomings as a reserve currency. However, more evidence is needed to confirm this trend.

According to an anonymous source, Saudi Arabia has been covertly buying gold, but it is unclear where it was bought. It is possible that the Saudis are slowly working on a transition, as de-dollarisation is not a quick process.