"The market is moving so quickly, yesterday felt just like the stock market in June last year before the crash," warns one Asian trader reflecting on the chaotic rush of Chinese speculators into the industrial metals commodities market Echoing the frenzy that fueled China's parabolic stock market rise (and subsequent collapse), Bloomberg notes one local China broker admits "we’ve seen a lot of people opening accounts for commodities futures recently," adding rather ominously, "the great ball of China money is moving away from bonds and stocks to commodities." The spikes in everything from rebar to iron ore, however, according to Goldman "is not driven by a sustainable shift in fundamentals."
Industrial metals up over 50% year-to-date, amid plunging exports and domestic zombie revival...
Since Dec 23rd 2015 when the US imposed a 256% tariff on Chinese steel imports, composite steel prices have soared almost 50% even as exports have slipped...
Trading in futures on everything from steel reinforcement bars and hot-rolled coils to cotton and polyvinyl chloride has soared this week, prompting exchanges in Shanghai, Dalian and Zhengzhou to boost fees or issue warnings to investors.
Deutsche Bank details the total crazinesss...
The onshore China commodity markets this week traded (conservatively) $350bn notional, a 17x increase on the $20bn notional that traded on Feb 1st 2016 i.e. a month ago (is it coincidence that the notional is about the same as at the peak of the equity frenzy?).
My calculations are pretty basic; I've trawled the screens and chosen 32 commodities in agri, metals and coke/coal and done a quick (contracts x value)/CNY for a dollar amount. I have not used the largest day's volume either (e.g. Deformed Bar, RBTA has traded close to $100bn, but I used closer to $60bn). Cotton (VVA Comdty) has been trading $15bn, up from $500mm in Feb. In the US, the long established cotton contract (CT1 Comdty) trades $600mm. China listed Sugar (CBA Comdty) has traded $14bn versus the US listed sugar beet at $850mm.
What this looks like!!
How much impact is this having on global markets? At first, very little. Many of the China listed futures started to bottom and rally in Nov and Dec last year, with very little relationship to global peers. This very crude chart below is a simple aggregation of all the prices of the 32 commods that I could find, but many of the underlying constituents are exactly the same. The performance looks inversely correlated with the performance of the underlying economy (and demand) but nicely related to the injection of credit.
In recent sessions, some of the US based commods have started to squeeze higher, presumably because the dog and the tail are changing places (clearly these are not apples-for-apples, as it were, in terms of contracts).
There is no correlation between the explosion in interest in Chinese commodity futures and any Chinese economic activity (and it should be a reminder to all who gaze lovingly at the commodity charts of the last decade that credit, rather than true demand, can be the most influential factor in financial markets). Volumes have increased 17 fold in a month. The economy has not. This is simply another speculative excess that will probably (already has) run way beyond fundamentals. It is probably creating a false picture of global demand for commodity stocks of all types, which themselves have rallied far beyond their earnings potential.
Eventually, the excesses will need to be curbed and maybe that starts a new phase of risk-off within China. As Bloomberg reports,
While the underlying products may be anything but glamorous, the numbers are eye-popping: contracts on more than 223 million metric tons of rebar changed hands on Thursday, more than China’s full-year production of the material used to strengthen concrete.
The frenzy echoes the activity that fueled China’s stock market last year before a rout erased $5 trillion, and follows earlier bubbles in property to garlic and even certain types of tea. China’s army of investors is honing in on raw materials amid signs of a pickup in demand and as the nation’s equities fall the most among global markets and corporate bond yields head for the steepest monthly rise in more than a year.
Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong, says the improvement in fundamentals and the availability of leverage to bet on commodities is making them irresistible to traders.
“These guys are going nuts," Hong said. “Leverage exaggerates the move of the way up, but also on the way down - much like what margin financing did to stocks in 2015.”
To cool activity, as we warned yesterrday, the Shanghai Futures Exchange increased transaction fees while the Dalian Commodity Exchange raised iron ore margin requirements. The bourse in Dalian also tightened rules on what it called abnormal trading, which now includes frequent submission and withdrawal of orders and self-trading. The Zhengzhou Commodity Exchange urged prudent investment on cotton futures amid "relatively large price fluctuations."
“There’s a lot of liquidity and there are people looking for opportunity," said Ben Kwong, a director at brokerage KGI Asia Ltd. in Hong Kong. “Investors are just boosted by recent rebound in those commodity prices and it’s speculative behavior."
Goldman agrees, warning that "we believe that it is not yet driven by a sustainable shift in fundamentals..."
The sentiment in commodity markets has clearly shifted towards being more bullish. With steel rebar leading the charge following robust Chinese credit data and oil trading to the top end of our inflection phase trading range of $45/$25 , this leaves the most important question of whether this is the beginning of a sustainable, broad-based commodity rally that marks the end of the inflection phase. While this recent rally has the potential to run further to the upside, with the biggest risk that the Fed chooses not to hike in the coming months despite improving Chinese activity, we believe that it is not yet driven by a sustainable shift in fundamentals. In oil, we do not anticipate a sustainable shift in fundamentals until 3Q16, which creates near-term downside risks. Specifically:
1) The rally has been far stronger in the oil and steel complexes, commodity sectors that have seen near-term, transient, supply adjustments. While these adjustments deal with near-term surpluses through oil supply disruptions and excessive de-stocking in ferrous complex (see Exhibit 2), they do not address the longer-term supply problems of excess capacity in the oil and metals sectors, in our view. Specifically, we believe the current decline in US oil production is still insufficient to offset low-cost supply growth such as Iran, particularly should disruptions in Iraq, Nigeria and Venezuela reverse.
2) The steel complex also benefits from a high level of exposure to the credit-led pick up in Chinese infrastructure activity, which was put in place by Chinese policy makers to contain fears over systemic risks earlier this year that have passed. Outside of commodity demand exposed to Chinese infrastructure, actual demand for commodities didn’t change that much over this time period, only expectations behaved in a V-shaped manner, declining and rebounding.
3) The reflationary pressures from 1) and 2) were reinforced by the macro backdrop of a more dovish Fed worried about Chinese growth and commodity producers which weakened the US dollar and reinforced a stronger China and higher commodity prices. With the global economy on more solid footing, we believe the risks are that these reflationary ‘macro’ stimuli from a more dovish Fed and China are reversed in coming months (potentially flagged by the Fed as soon as next week’s FOMC meeting).
However, we acknowledge that the larger-than-expected China stimulus could support steel intensive infrastructure developments through the remainder of the second quarter. Further, in our view, the rise in prices engenders the risk of a premature supply response, particularly in steel, aluminum and zinc where Chinese margins have improved materially.
In base metals, we do not believe we have seen the lows yet in this cycle.
We leave it to Tiger Shi, a managing partner at Bands Financial Ltd in Hong Kong to conclude:
“The market is moving so quickly, yesterday felt just like the stock market in June last year before the crash... I think how it goes up, that’s how it will come down."
Trade accordingly.