Calling the bottom in Commodities was the one call every trader and fund manager only dreamt of getting right this year. Given how depressed prices have been over the last few years, it was always going to be the career defining moment for anyone. Following the rhetoric of most sell side houses and strategists, everyone thought they had until later this year to catch the rally given the oversupply that plagued most markets. However, it seems the adage from the old floor trading days still holds true today, “better to be lucky than smart!”
From its opaque policy to the accuracy of its economic numbers to its momentum based day traders abundant with cheap liquidity, China has single handedly caused all of us to age prematurely this year. At the start of the year, they devalued the Yuan aggressively causing a collapse in their local stocks markets that spread to developed markets as investors got spooked that the slowdown could be worse than projected to the market. The subsequent margin calls caused shock waves in all asset classes causing liquidation across the board. Words of global deflation echoed on the trading floors. Towards the middle of Q1’16, China then decided to stabilise the markets through credit growth. Sure, let’s take on more debt to spur growth. A broad measure of credit that spans commercial banks to unofficial shadow lenders totalled 2.34 trillion Yuan ($361 bullion) in March. This caused a u-turn in the price of risky assets including Commodities as investors took it as a signal that demand was coming.
In the past Chinese led stimulus has led to Commodity demand growth via infrastructure related demand, but that was the old economy. Given its more consumer oriented growth, its policies are more selective. When you have too much credit and not enough opportunities, what happens? It fuels illogical price moves. Reminiscent of last year, full time employees in their twenties bored of their day jobs were dabbling in commodity futures now, hoping to making a quick buck and retire early. Outside of the moves, it was the sheer volume of trading in Dalian, Zhengzhou and Shanghai that confounded everyone. Daily average of about $78 billion in February to a peak of $261 billion in April exceeded the gross domestic product of Ireland alone! It was neither physical nor fundamental. It was pure greed and speculation. The average holding period for rebar and iron-ore futures in China was only 2.4 hours compared with 25.8 hours for brent on ICE Futures Europe, according to a May 4 report. Individuals with a bank account and official identity card were able open a futures trading account at a brokerage within 40 minutes, with no initial balance required. On that note, another adage comes to mind, “the market can be irrational for a whole lot longer than one can be liquid.”
The initial move in select Commodities may have been fundamental to a very slight extent. Steel demand did pick up early in the year, which it tends to do so seasonally. Most producers had de-stocked given abundant inventories and shocking margins. The initial demand led rally got out of control when steel prices rallied 54% in 2016 taking iron-ore above $70/t for the first time since Jan 2015. Chinese steel margins have now rallied from 15% to above 70%, leaving producers salivating. Crude steel production has now soared to 70.65 million tonnes in March. Déjà vu anyone? Market moves can defy logic but Economics 101 always holds true; when prices rise, supply side responds.
All the way from the Dutch tulip craze of 1637 to America’s dot com bubble at the turn of the century, history has shown how greed forms the basis of human behaviour, prevalent in some cultures more than others. Philosophy aside, for those stimulus bulls out there, here is a riddle for you: If China really is boosting its demand, why is the economic data still so weak? April indicators showed retail sales coming in at 10.1% vs. 10.5% expected, and Industrial Production year over year at 6% vs. 6.5%. The trend has been same since 2012, downwards.
China’s reforms should focus on curbing the excess liquidity that spurs speculation distorting asset prices than trying to give into the fix its economy relies upon. Perhaps the nation would be better served if it embraced the teachings of their wiser Confucius ancestors than to give into their gambling instincts.
