An All Mighty Dalian Muddle



By John Richardson

UNDERSTANDING the Dalian Commodity Exchange’s futures contract in RMB-priced linear low-density polyethylene ((LLDPE) requires an understanding of what the traders are up to at any particular point in time, as this is almost entirely a speculators’ market.

So, what happened late last year is very illuminating. The chart below shows a sharp spike in traded volumes, even though the physical market was exceptionally weak due to tight lending conditions, macro-economic uncertainties and the usual end-year destocking in order to beautify financial results.

Dalianslide

A Singapore-based polyolefins trader told us at that time that traders were very active on the Dalian, while their physical positions had been almost entirely closed-off. 

“When bank lending was plentiful in 2010, nobody thought twice about buying local physical cargoes, even though the requirement was – and remains – 100% upfront cash deposits,” he said.

“On the Dalian, the margin call is only 20% of the cost of each contract, and so your ability to leverage is automatically five times higher.

“Plus, if you close your position on [the] Dalian before a contract matures, as most people do, you don’t have to take physical delivery of PE that these days would be very hard to sell.

“The futures exchange is giving traders something to do, somewhere to make money, as there is so little real business out there.”

This tells us that a surge in Dalian activity should not necessarily be interpreted as an improvement in the physical market – in fact, very possibly, the opposite.

And, as this is a traders’ market with very few if any producers taking part, increases in Dalian contract pricing should also not automatically be seen as a sign of a better physical market. The Dalian tends to move on every piece of good or bad economic news, the oil price and the local stock market, and so is often purely a barometer of extremely short-term movements in sentiment.

How we should interpret this week’s events is therefore a challenge of detailed, thorough analysis versus getting carried away with the excitement of stories about a recovery in the physical market.

Domestic linear low-density PE (LLDPE) offers were increased by Yuan 50-100/tonne ($8-16) on Monday, following a rise in the Dalian.

Were these higher offers the result of further intra-trade deals, which were said to be the main reason for price increases before the Lunar New Year?

Or were they local traders’ offer prices to end-users?

Perhaps they were higher producers’ offers, suggesting that the producers have on this occasion taken a lead from the Dalian. That can happen when an improvement in sentiment, registered by the Dalian, spreads beyond the trading community.

The reason for the higher offers might, of course, be a combination of all the above, with the weighting between each of these factors of importance to anyone who cares about “real” analysis.

Will the recovery last? That, actually, might not be the relevant question here.

Perhaps more relevantly is, “Will the recovery last long enough for you to make money?”

This, of course, depends on your time frame, from the one extreme of Dalian day traders to producers trying to estimate demand patterns for the rest of this year.

What is crystal clear is that for any producer trying to plan for the remainder of 2012, the Dalian is a hindrance rather than aid.

From their perspective, it is therefore probably good news that the launch of a Dalian contract in RMB-priced homopolymer polypropylene (PP) has reportedly been delayed by a year.

Pity the traders, though: If the PP contract has been delayed, they will have less to occupy themselves with when physical markets go quiet – which they will definitely do in a few weeks when economic realities once again become clear.

Our hearts go out to them……

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