There could be lots of reasons for this. One reason might be that the fairly subdued tone of just about everybody you speak to in markets is wrong – and that, fundamentally, China’s economy has not really slowed down by as much as people seem to think.
It wouldn’t be the first time that momentum in China’s markets has been widely and badly misjudged. For example, it was all doom and gloom in early 2013, but then, by May, thanks to an explosion of credit, markets bounced back.
“The tone does feel subdued at the moment, not disastrous, but just subdued,” commented one industry source earlier this week. “That could be partly because there is insufficient volatility for the traders to make enough money and so they are sitting on their hands, bored, with nothing else to do except feel gloomy.”
A further factor might be the 1.8m tonnes of China’s polypropylene (PP) capacity, which, on an annualised basis, was reported to be shut down in May for maintenance work. We, as yet, don’t have the domestic production data to confirm this.
But this game is, of course, all about judging the balance of probabilities in an effort to work out what is the most important factor behind any particular piece of data.
In the case of PE, if you recall, imports jumped by 26% in the first quarter of this year over the same period in 2013, according to data from Global Trade Information Services. At the same time, data from Chemease showed that year-on-year growth in local output was 8%.
At that time, we argued that hard-pressed investors were looking at inventive ways to bypass government efforts to let the air out of the credit bubble.
This can work in a number of different ways, but the key elements are as follows:
• A potential lender buys a PE cargo on normal 180 days credit from an overseas seller.
• He then immediately sells the cargo on the Dalian linear-low density PE (LLDPE) futures market, or into the physical market.
• Now he has cash to lend into the shadow banking market at interest rates of 60%.
• This gives a property developer cash to finish his project, which is no longer available via formal bank lending because of the government’s crackdown on credit.
Our blog post was very widely read and, inevitably, drew a wide variety of views.
We, of course, are now worried that something similar might have happened in PP – now that, it, too, is traded on the Dalian Commodities Exchange.
Evidence from other commodities markets suggests that something is wrong. Plastics, copper and aluminium etc. are often traded by the same people – the “circular trades” that we have described in the past.
For example, China’s northeastern port of Qingdao has halted shipments of aluminium and copper due to an investigation by authorities into the misuse of trade finance, according to this Reuters story.
“The investigation at the world’s seventh-largest port is looking into whether single cargoes of metal were used multiple times to obtain financing, according to industry sources,” wrote Reuters
“This means different banks and trading houses were holding separate titles for the same metal, they said.”
You might well say, “This kind of thing has been going on for many years in China. There is nothing new here and so it doesn’t change the underlying strong fundamentals.”
But it is the scale of what is happening right now that worries us as the end-game arrives for those tied to the old economic growth mode –i.e. the speculators and the manufacturing companies that China is prepared to let fail. These people could well be panicking.
We also worry about the complex interconnections between all these multiple uses of the same commodities cargo to obtain credit, and what might happen if and when all of this debt unravels.
This is obviously be a major macro-economic risk, regardless of whether PP is involved in this end-game.
Time for some contingency planning?