Wednesday, October 27, 2010

Why is Korea opening a gold exchange?

Because it wants the local gold trade to become larger, fairer and more transparent.
August 21, 2010
There are already securities exchanges and for stocks, futures, forwards and options. There are also currency exchanges where the local currency, the won, and the U.S. dollar are traded. But what about a gold exchange?

The Korean government said in June that it would establish a national mercantile exchange - the country’s first - in 2012. When the exchange opens two years later, the first thing it will trade will be gold.

Gold was chosen to open the market because most gold trades occur behind closed doors and are very complicated. It takes multiple steps to acquire, involving importers, wholesalers, middlemen, consumers and sometimes jewelry shops. However, on an open market, the distribution route can be made much simpler: from importer to exchange, to customer.

Why is everyone so obsessed with gold these days? Gold has a lot of uses. It’s used in sporting medals, various electronic components and in some tooth fillings. Gold is also one of the most popular metals for jewelry, and often wedding rings are made out of gold. Gold rings are also given to infants on their first birthday in Korea. Gold is also used to make necklaces, bracelets and other accessories.

But for many wealthy people, gold is an investment. It’s considered safer in times of economic uncertainty to hold gold than a national currency, because governments can choose to print more money, easily and instantly devaluing one’s investment. Mining more gold is a very slow and expensive process, on the other hand.

Before it’s made into jewelry, or stored by investors, gold is usually traded in the form of bars, which is called bullion. Bullion is made of 99.5 percent gold.

In Korea, there are only one or two gold mines where the precious metal can be extracted. However, they only produce 160 kilograms (353 pounds) of gold each year, while usually Koreans buy 120 tons to 150 tons, worth about 5 trillion won ($4.2 billion), every year. That means most of the gold used in the country comes from imports.

According to consulting firm GFMS, the global demand for gold was 3,659 tons in 2008, while supply was 3,412 tons. Of total demand, 58.4 percent was used to make accessories, 11.8 percent was for industrial use and 29.8 percent was bought by investors.

In Korea, something strange happened last year: The country became an exporter of gold. According to the Korea Customs Office, the country exported 91 tons of gold for $2.8 billion last year, while it imported 37 tons worth $1.1 billion.

In 1997 and 1998, people voluntarily donated gold in the aftermath of the Asian financial crisis - the only other time in Korean history that the country exported so much gold. So how did Korea become a gold exporter when this country produces only a tiny amount of the element?

Last year, Korea became a net exporter of gold because gold was cheaper in Korea than in other countries. This imbalance occurred because of the global financial crisis. As the crisis increased economic uncertainty, international gold prices started to skyrocket. People began purchasing large amounts of gold.

Gold once served as currency. Historically, gold coinage was widely used as currency for thousands of years. After it became impractical and unwise to carry around real gold coins, governments started printing paper money. Yet even then, each unit of paper money was supposed to represent a real amount of gold in the national treasury. A citizen could go to the treasury and turn in paper money for its equivalent in gold. Because of this, governments could only print as much money as they had gold. This is called the gold standard.

Today, major world governments no longer practice the gold standard, and are free to print as much paper money as they want, which makes gold a much safer bet than cash.

In 2008, when the global financial crisis erupted, international gold prices soared. They also rose in Korea, but since the crisis originated from outside, prices here climbed less rapidly. When gold prices increased, Koreans started taking out their gold jewelry and selling it, while fewer people wanted to buy gold. There was a large supply of gold relative to demand, and this made Korea into a gold exporter last year.

Yet some research shows that 60 to 70 percent of gold trades in Korea take place on the illegal black market, meaning they are not counted in the official numbers.

The government wants the gold trade to become more transparent. A gold exchange will help with this, and it would also have resolved the imbalance between the prices of gold in Korea and overseas in 2008.

A gold exchange also enables trading in large volumes of gold. Legal trade will be rewarded and become more transparent. This will decrease the amount of gold traded on the black market.

When a gold exchange actually opens in 2012, it will be exempt from taxes and trading commissions for a while until trade picks up momentum. Financial brokerages and gold dealers will be allowed to participate, and only pure gold will be traded.

To make the trades easier, gold will be traded in denominations of 1 kilogram (2.2 pounds), 100 grams and 50 grams.

The minimum amount of gold acceptable for exchange will be 50 grams, but this only applies to paper transactions. If someone wants to buy a physical piece of gold, the minimum will be 100 grams. Paper exchanges of gold will not be taxed, but taking out actual gold requires the payment of a value added tax.

Gold exchanges already operating around the world include the Shanghai Gold Exchange and the London Bullion Market Association, which is an over-the-counter market founded in 1987. The price there is considered the global benchmark.

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