Chinese cherish gold as a symbol of fortune, a sign of prosperity and a hedge against inflation.

 

Now there are even more reasons for the Chinese to love the precious metal which made a strong debut in China's futures market.

 

While investors can't wait to make big bucks out of the newly launched gold futures, the futures exchange and analysts are discouraging retail investors from dashing blindly into the market.

 

Trading cap

 

The gold futures made a strong debut on the Shanghai Futures Exchange on Wednesday, with opening prices hitting the daily trading cap. It then corrected in line with declining global prices.

 

The most actively traded contract, gold for June delivery, opened at 230.95 yuan (US$31.77) a gram, almost hitting the 10-percent daily trading cap, from a benchmark price of 209.99 yuan a gram on Wednesday. It then tumbled to end at 218.10 yuan on Friday.

 

"Gold futures is the only futures product in China that also has a financial status (others are all commodities), that's why it attracted heavy buying interest from investors," said Jing Zhuocheng, a Shanghai CIFCO Futures Co analyst. "The huge rise in gold prices in New York the night before (Tuesday) also helped to boost the new product to open at the daily trading cap on Wednesday" before succumbing to the influence of global prices.

 

Retail investors had swarmed futures brokerages to open accounts before the launch of gold futures trading.

 

"Lots of newcomers opened accounts before the introduction of gold futures, indicating the strong interest in the product," said Lin Hui, a Dongzheng Futures Co analyst.

 

Small capital

 

Futures contracts are generally considered one of the most speculative instruments in the investment market, with investors leveraging against the fluctuations in price.

 

Chinese investors, familiar with massive profits from the domestic stock market, dream of making it rich while betting small capital on the futures market where money can be made whether prices drop or rise.

 

However, industry experts said unprepared retail investors may find their dreams busted.

 

To cut risks, the exchange has also raised the minimum margin requirement to nine percent in the early stages of trading. The figure will drop to seven percent after some time, the country's biggest commodity bourse by value said, without giving a time frame.

 

The bourse has also increased the margin requirement, which will top a maximum 40 percent, when the date of delivery gets closer.

 

Besides the current nine-percent transaction margin requirement, futures brokerages also require another two to three percentage points of margin to ensure that clients have ample capital to protect against risks.

 

"The total 12 (9+3) percent margin doesn't mean that investors can trade futures equal to 12 percent of the contract value," said Lin. "It's risky for clients to bear such a concept."

 

In futures trading, the profits and losses are settled on each trading day. If an investor loses money on the account, and the capital goes below the margin requirement, he has to add funds or the bourse will force him to close his position, which may lead to a huge loss.

 

For instance, an investor bets on buying a lot at 230 yuan with the minimum margin. He pays 27,600 yuan (230*1000*12%=27,600). If the price drops to 220 yuan, he needs to pay 26,400 yuan (220*1000*12%=26,400) on the account. But the price drop from 230 yuan a gram to 220 yuan means he will face a loss of 10,000 yuan (10*1000=10,000). If the investor has put only 30,000 yuan in the account, he now has 20,000 yuan left, already below the 26,400 yuan minimum margin requirement. The investor has to add capital to the account, or be forced by the bourse to close his position and face a loss of 10,000 yuan.

 

Shanghai CIFCO's Jing advised investors to better put only 30 percent of the capital on the position to cut risk.

 

This means investors should have at least three times the capital of the minimum margin requirement.

 

False concept

 

Getting enough capital is not enough.

 

Some retail investors have the false concept that if they can't make profits in the futures market, they won't lose at all or at least they can take the bullions home.

 

The futures bourse has also taken other measures to discourage naive retail investors. It bases each contract, or a lot, on one kilogram of gold, more than triple the previously planned 300 grams per lot. This means a higher capital requirement than planned.

 

The bourse also prohibited retail investors from taking delivery of gold futures. Retail investors are also banned from holding positions into the delivery month.

 

"Futures are for hedging and pricing. Physical delivery of the product is not the main purpose," said Cao Yue, a senior official with the products innovation division of the exchange. "Chinese retail investors are familiar with the traditional gold bullion investment, but the futures market may be a novelty for them. The rule is to ensure they are reminded of risks and hope they are fully prepared for risks."

 

The bourse will force retail investors who hold the contracts into the month of delivery to close positions. Investors will then have to bear the loss due to mandatory position closure.

 

The gold industry has cheered the futures as a hedge to protect against price fluctuation while speculators see a new vehicle to make big bucks as the stock and property markets start to correct.

 

The stock market's benchmark Shanghai Composite Index has undergone a correction after touching an all-time high in mid October on concerns of over valuation. The excess liquidity is pushing investors to seek more investment channels, and the launch of the gold futures amid three-decade high gold prices has placed the debut of gold futures trading under limelight.

 

Gold prices soared on concerns of inflation, higher oil prices and a weak US dollar. Gold topped US$880 an ounce last week - a 28-year high. Some analysts even expect the metal to crack US$1,000 an ounce this year.

 

"Gold's movement is against that of the greenback and can be a hedge against a weak US dollar," said David Leung, chief investment officer of wealth management of consumer banking of Standard Chartered Bank (China) Ltd.

 

"The US dollar has the chance to make a short-term recovery in the first half but may tumble in the second half," giving a golden opportunity for the metal's price to soar, according to Leung.

 

(Shanghai Daily January 14, 2008)