My last blog entry quoted a North American industry source who was concerned over the potential for physical delivery on the Dalian futures exchange to flood the real market and send prices crashing.
In my ignorance of how futures markets works, and as a typicaql semi-numerate journalist, I therefore asked a colleague with a futures/mathematical bent to help out. This will hopefully allay the above fear.
Here is his explanation (please feel free, as always, to disagree):
If you look at the English part of the website you'll see that several months before a contract expires (.e.g. in April for July delivery) there is an enormous amount of open interest (the dating system is confusing as each contract starts with 10 after which it makes sense).
This huge volume of open interest mainly involves financial speculators who have no intention of either acquiring or taking delivery of physical material.
They will agree in advance to cash settle before the expiry of the contract and so you if then look at a few days before a particular contract closes the open interest declines dramatically as once a contract does close and no cash settlement takes place, physical delivery has to take place. This helps to explain the very small delivered volumes also reported on the site.
See an Insight piece from my colleague Becky Zhang in our Shanghai office -. It seems as if the producers and buyers are not using the market in a big way to hedge; it's more the speculators trying to make lots of good money.
This raises an interesting separate point on the debate over whether there are large volumes of physical polyolefins in inventory.
Why would a lot of people bother renting a warehouse, taking delivery and taking all the risks associated with this when you can just go on the exchange and make money out of purely paper trading?
The other good thing about Dalian, as I understand it, is that you can get your money out straightaway - and with such incredible volatility on a daily basis you stand to make (or lose) money very quickly. This a lot quicker return than waiting to close a physical position.
This still leaves the longer-term issue of whether the market could become a de facto pricing influence. This could happen either because people believe it's important (to use another cliché again a self-fulfilling prophesy) or if the big producers and buyers start using it in a big way to hedge.
This is all work in progress so I will keep asking.
The above also doesn't explain why LLDPE demand has apparently remained resilient in the physical market, even though this is not an agricultural film-buying season.
I am also still working on the issue of the influence of availability of imports of recycled polyolefins.
Comments (2)
John
You ask 'Why would a lot of people bother renting a warehouse, taking delivery and taking all the risks associated with this when you can just go on the exchange and make money out of purely paper trading?'
The answer is that they wouldn't. Futures markets are for paper trading, not physical.
But what Dalian does highlight is the enormous amount of speculation that is taking place. In April, over 80 million tonnes was being traded on Dalian, versus total global annual production of c20 million tonnes. The current paper:physical relationship in the US oil futures markets is only 13:1, whereas Dalian was at c50:1! There's nothing 'wrong' with this, but it is a lot of speculative interest, which normally happens near a market top - when 'everyone' knows that prices can only move higher.
The physical import demand is a different issue. Has this actually been used to make things to be sold in shops either for domestic or export demand? If so, given that China's exports are down 26%, then it seems that domestic demand must have increased substantially.
If this hasn't happened, then maybe people may have been taking advantage of easy credit conditions, and low interest rates, to speculate on physcial markets as well? If I was a trader, this might have looked like a good idea back in February/March, when the import surge began. Crude oil was low, and I stood to make $100/t or more, simply by storing the polymer whilst the crude price recovered, given that polymer prices follow crude.
Again, there is nothing 'wrong' with this. But IF (and it is only an 'if') the product has indeed gone into store, either as polymer of finished goods, then at sometime it will re-emerge on world markets. And if it all comes at one time, when 'everyone' decides prices are falling, then there is clearly a risk that it might have a major deflationary impact on world markets - reversing the positive impact it had when it was all being bought.
Paul
Posted by Paul Hodges | July 16, 2009 7:52 AM
Posted on July 16, 2009 07:52
Hi Paul
Thanks for for this.
So in short we are talking about a different kettle of fish - the established polymer traders, distributors etc who've already got their supply and storage lines well established and could well have been awash with liquidity?
I guess also the upside from taking punts like this (especially if you don't have to pay your loans back) are much greater per trade than on the Dalian Exchange (5 tonne lots only).
I heard a couple of months from a Singapore trader (when arbitrage was strong to China and demand good) that he was selling to other traders who didn't normally deal in polymers. He had one of those Joseph Kennedy moments and so quit most his positions, in hindsight too early.
Posted by John
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July 16, 2009 9:32 AM
Posted on July 16, 2009 09:32