We just see another bubble building up in China, aka the domestic commodity market. On April 21st, led by bellwether Rebar Steel futures, other 7 commodities were lifted to the up limit (5% to 7%), including iron ore, HRC steel, met coal, asphalt, methanol, cotton, and egg (yes, it’s egg! No one has idea why even eggs go up together with other commodities). The endless money just flood everywhere in the domestic commodity market, especially for those lagged behind, and fundamentals do not matter here. The case of Rebar major contract RB1610 (settle in Oct 2016) can tell you how crazy the market is. On April 21st, RB1610’s trading volume is 22M contracts (equal to 220M tn of rebar steel), but China only produces 200M tn rebar in 2015 (China total steel production is around 850M tn per year). So the Chinese trades one year production volume for the underlying commodity in a single day, for a specific contract (Oct 2016) only!
Below is the YTD performace of the major commodities trading in the China domestic futures market.
The bulls talk about inflation trade, while the bears talk about deteriorating fundamentals. Apparently, both side speak in different languages, and in the short term, the side with stronger fire power (money) wins. The Shanghai Chaos Fund, which was famous for shorting big in copper in 2015, is reported to lose around $80M a day on April 20th as it holds 120k contracts short position in Rebar. One of its flagship funds, Chaos Value I which invests in A share and commodities, has declined 19% YTD.
We all know China created $1 tn credit in Q1 to stimuluate the economy, and apparently part of the money flows into the commodity market (the infamous A share equity market is deemed as “bear market” now and the speculators don’t even bother to trade there). As indicated by the chart below, the total China domestic commodity daily trading amount is RMB1.4tn per day in 2016 (YTD), compared to RMB1.1tn per day in 2015, a 27% increase. On Apirl 20th, its trading amount hits RMB2.9 tn, compared to the A share market’s RMB0.5tn amount.
Trading amount in Chinese domestic commodity market (value in RMB100M)
Seeing the great “opportunities” of the fantasty commodity bull markets, Chinese retails investors rush to the brokers to open new accounts. It’s reported that the new accounts number in April is double or triple of the normal days. Does it smell the same as 2015’s A share market?
But wait, the leverage in the commodities market (easily 10x) is much higher than that in the A share market (normally 2-4x). If the investors still remember the lesson in 2015, they should pay extra attention now. When the music stops, the collapse of price can be faster and steeper than the pace of going up. 2009 already showed us a real example in the Rebar market.
White line: Rebar price in 2009 (lhs), Purple line: Rebar price in 2016 (rhs)
Is the Rebar rally sustainable? The A share equity investors gives their own answer. The orange line (below) is China’s rebar price and the purple line is the share price of Baosteel, the flagship Chinese steel company.
Apparently the equity investors don’t believe the rally is sustainable. However, the funny thing is the North American equity investors are chasing the most leveraged commodities equity names (green line is US Steel and blue line is Teck Resources). They must hope the comodity rally can continue and hold at high level for a while. So we will see who is right, the Chinese commodity speculators or North American equity investors.
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