By John Richardson
IT is the interconnections that matter and the trouble is that few people seem to have adequately thought about the interconnections between the various dysfunctional parts of the Chinese economy.
- A lot of the main players in copper financing are also involved in the property market, according to this FT Alphaville blog post.
- Some traders in chemicals and polymers have also been involved in the property sector. Overseas chemicals and polymer cargoes have sometimes been bought not because of their underlying value, but because of the cheap US dollar-based credit that these shipments have generated. The chemicals have then either been sold immediately or put into storage, and the finance used to speculate on property.
- In copper, traders have estimated that up to half of China’s imports have been used as collateral to raise cheap US dollar loans.
- Nobody has a clue about how the scale in the chemicals sector. More research is, therefore, needed.
- Copper prices have fallen during the early months of 2014 because of the clampdown on dodgy trade financing practices in general and wider economic reforms aimed at moving the economy away from its investment-focused growth model. A key method of reform has involved making speculation on the value of the Yuan much more risky.
- If copper prices continue to decline real-estate prices might, thus, follow.
- How might this mechanism work? Copper traders have taken out long positions in the hope that rising, rather than falling, copper prices will pay for their real-estate investments. If copper prices instead fall, more and more traders may decide to cut their losses and dump their domestically-held inventories. This would, of course, push copper prices down even more and could also lead to the failure of real-estate projects that were tied-in to the success of long positions in copper.
- The same negative feedback loop might affect chemicals-real estate deals.
- If property prices start to slip, or even if only the excess air is taken out of the real estate market, this would be a big deal for China and the global economy. The reason is that 16% of China’s GDP was derived from real estate in 2013.
And so a crucial question, therefore, that we need to try and answer is,: Where are copper prices heading?
Last Friday, copper prices rose to a two-week high on the NYMEX because Li Keqiang, the Chinese Premier, was quoted as saying that economic growth should be maintained at a “reasonable pace”.
This was taken as a signal that the government is ready to launch another economic stimulus programme.
But whilst the “economic stimulus” scenario is a great way for commodity and equities traders to make a quick bit of money, it doesn’t stand up to serious scrutiny.
First of all, any stimulus that is launched could be relatively modest compared with that of 2008-2009 – and, quite likely, also, with that of July 2013.
Any new money also seems likely to be part of ongoing economic reforms – i.e. it will be directed at priority areas such as environmental protection and new and innovative small business ventures that take China up the manufacturing value chain.
By their very nature, some of these projects might fail, whilst the successful ones will take a while to deliver significant benefits to growth.
Thus, whilst any announcements of economic stimulus could well lead to rally in copper and other commodity markets, including chemicals, when the dust has settled, people will begin to realise that this time is different.
Hence, copper, which has been buoyed in recent years by all the spending on big, wasteful industrial and infrastructure projects, may in the longer term continue to head south.
“Despite Friday’s gains, copper prices are down 11% so far this year amid worries that China’s slowdown will further curb growth of the country’s demand,” wrote the Wall Street Journal in this article on last week’s rally in copper prices.
“Chinese demand for copper is expected to rise 5% this year from the previous one, down from a 10% rise in 2013.
Five percent growth might, on paper, still seem good.
But the problem with investment bubbles is that in order to keep them stable, you have to pump ever-more air into them. Reducing the supply of air has serious negative short and medium-term consequences. This is what is happening now in China .