By John Richardson
A SMOKING gun that points to more market-distorting high levels of speculation in China’s commodity markets? Have “circular trades” have made a comeback, where one commodity is bought merely to speculate in another commodity or even in real estate? Please consider the following evidence:
- China’s coastal iron ore inventories in early March were their highest since 2004, despite plans to rationalise steel capacity in 2017.
- Polyethylene (PE) and polypropylene (PP) imports rose very strongly in January, even though we were heading into the Lunar New Year holidays.
- Oil imports were the second highest on record February, which was reportedly mainly the result of buying by the teapot, or privately-owned, refineries. This was in spite of a government decision to cut the teapots’ import quotas for crude and remove their tax exemptions for exports of refined products.
You might believe that this will all work out fine as China’s economy continues to boom on huge public infrastructure spending, on a buoyant housing market and on rising personal income levels etc.
And you may also think that the government doesn’t mean what it says. It will thus soon become apparent that 2017 will be another year of steel capacity growth rather than contraction. Meanwhile, perhaps the teapots will win their lobbying game – and be thus allowed to continue importing crude and exporting refined products at the high levels that we saw in 2015 and 2016.
But I believe that this would be the wrong conclusion because of a changed political environment. Xi Jinping is back in control of the economy, and he realises that there isn’t any more time to lose in dealing with China’s unsustainable credit bubble.
What is likely to happen next is that we will see a further slowing in overall credit growth and a redirection of lending way from harmful speculation towards more sustainable sources of growth – e.g. the innovative products and services that China needs to escape its middle-income trap. The lending data from January-February appears to confirm this direction.
And back in late February, China’s top legislative body, the National Development and Reform Commission, began an investigation into commodities speculation because of its inflationary threat.
Interest rates have also been increased in overnight lending markets, with more rate rises quite likely on the way. Why this matters for commodities is that is in these markets where money is often borrowed to speculate in bonds and commodities. Banks now do about 65% of their borrowing in these markets, down from 90% last summer, according to data from BNP Paribas.
There is thus a risk that China will play a big role in further deflating oil and other commodity prices.