China – the great disrupter of commodities markets (and not in a good way)
Another China drama is unfolding (on top of their $30 trillion corporate debt time-bomb, that is). This time it’s wild speculation in commodities that has driven up prices of several metals.
So we get one more example of incoherent Chinese economic “policy”. As I write this on a day when news has come that Australia is now in deflation and its dollar has taken a bath, we can only look at this latest headache in relation to China with growing concern, as any commodity-producing country and company should also be viewing it. If it were the Congo, no one would worry (much); but so much in the technology metals world revolves around the health (or otherwise) of Chinese demand and production.
Various analysts, including Goldman Sachs, became alarmed recently when iron ore suddenly went from under $40/tonne to over $70.
As Peter Strachan at Perth-based StockAnalysis writes today, “news out of China supports the idea that futures trading is distorting the market”. He quotes a Shanghai-based analyst at Tebon Securities Co saying that “the great ball of China money” was moving away from bonds and equities and into commodities.
Is it ever? Iron ore contract trading volumes at the Dalian Commodities Exchange have soared by 400%. As the Goldman analysts wrote, “there have been two days in the past month where futures volumes have been greater than the total amount of iron ore that China actually imported for the whole of 2015 (which was 950 million tonnes)”. Goldman is forecasting that iron ore will be at $35/tonne by the end of the year.
But it’s not just iron ore. Last week futures trading at the commodities exchanges in Shanghai, Dalian and Zhengzhou soared for things like hot-rolled steel coils, sugar, cotton, coal and polyvinyl chloride. Deutsche Bank noted that onshore Chinese commodities markets last week traded daily futures deals worth 17 times what the daily value had been on February 1.
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Today Vivek Dhar, commodity analyst at Australia’s Commonwealth Bank, noted that “the average tenure of an iron ore futures contract on the Dalian Commodity Exchange is under four hours”. To put that in perspective, the average tenure for a West Texas Intermediate crude oil contract on Comex is about 40 hours; for copper it is around 60 hours and natural gas 70 hours.
The Dalian and Zhengzhou exchanges have since introduced measures to cool the gambling: transaction costs have been raised, as have margin requirements, and some contracts now have daily limits.
Frightening as this may be, it gets even scarier when you put these events in some context. What emerges is a picture of Chinese commodities policies that has little consistency combined with an inability to actually regulate the sector (as in the case of illegal production and smuggling of rare earths).
So let’s recap that story.
In the 1990s China dumped metals on the world market, driving out of business Western producers of tungsten, graphite and several other metals, as well as undermining attempts to set up non-China rare earths operations. But, at the same time, this led to the squandering of precious reserves within China of these metals. The world’s biggest antimony mine is now close to exhaustion. We don’t know to what extent China is running down its iron ore resource. Or its coal.
And now they are flogging their gold mining industry to death, pushing up production as reserves decline rapidly. In 2013 the World Gold Council estimated that, on known reserves, China had 4.7 years left of high-scale gold mining, against 19.7 years for the rest of the world.
We have seen China trying to retain control of the world’s rare earths markets by restricting exports at one turn, then trying another strategy. The rare earths story is a particularly interesting one. In 2011 the prices of these elements roared, europium reaching $US3000/kg as China placed export limits on them. The geniuses behind the restriction of exports must have thought it was a great idea. But the buyers (led by the Japanese) decided to reduce their reliance on rare earths; they looked at recycling programs, found ways to reduce the amount of rare earths needed in various products and, most importantly, found substitutes for the various rare earths.
Today much of the Chinese rare earth sector is under water. Nor has Beijing been able to stop the illegal production and smuggling, which means Japanese and other companies can pick up their supplies at prices far cheaper than those on the official market. And the final twist: China set the production quotas too low, so they cannot legally supply the neodymium and praseodymium quantities needed by magnet manufacturers, thus delivering the illegal boys a ready and eager market.
Now Chinese policy has disrupted the global tin industry. China at one stage last year was importing 98% of its tin from Myanmar at undisclosed prices. This has punctured the traded tin price to the extent that no new tin mine development can go ahead at this level of prices. China will be one of the parties to suffer when tin shortages begin emerging later this decade and the many of the Burmese alluvial resources have been mined out.
And on The Financial Times arm, FT Alphaville, last year, Professor Christopher Balding from Peking University wrote that China was lurching from one incoherent policy to another, shedding credibility and its aura of omnipotence at every stage. “There is a very real risk that Beijing is losing control of the story,” he said.
And they want to be the dominant economic power?
How can you be a world economic leader and have a shambles like the Fanya Metals Exchange which had to suspend payouts after a range of specialty metals, such as indium, tungsten and bismuth, had fallen so much in price that the Fanya exchange could not meet its commitment to pay a 10% return on funds invested, the problem being that the metals were being used as collateral against the cash invested by the punters?
And don’t get David Stockman started on the subject of China. This former congressman, Wall Street player and budget office director in the Reagan administration regularly warns that China is a train-wreck. This is a sample from his output:
“China is not a $10 trillion growth miracle with transition challenges; it is a quasi-totalitarian nation gone mad digging, building, borrowing, spending and speculating in a magnitude that has no historical parallel.
“So doing, It has fashioned itself into an incendiary volcano of unpayable debt and wasteful, crazy-ass overinvestment in everything. It cannot be slowed, stabilized or transitioned by edicts and new plans from the comrades in Beijing. It is the greatest economic train-wreck in human history barreling toward a bridgeless chasm.”
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