Chinese speculators have a new obsession: the commodities market. Trading in futures on everything from steel reinforcement bars and hot-rolled coils to cotton and polyvinyl chloride has soared this week, prompting exchanges in Shanghai, Dalian and Zhengzhou to boost fees or issue warnings to investors. While the underlying products may be anything but glamorous, the numbers are eye-popping: contracts on more than 223 million metric tons of rebar changed hands on Thursday, more than China’s full-year production of the material used to strengthen concrete.
“The great ball of China money is moving away from bonds and stocks to commodities,” said Zhang Guoyu, a Shanghai-based analyst at Tebon Securities Co. “We’ve seen a lot of people opening accounts for commodities futures recently.” The frenzy echoes the activity that fueled China’s stock market last year before a rout erased $5 trillion, and follows earlier bubbles in property to garlic and even certain types of tea. China’s army of investors is honing in on raw materials amid signs of a pickup in demand.
Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong, says the improvement in fundamentals and the availability of leverage to bet on commodities is making them irresistible to traders. “These guys are going nuts,” Hong said. “Leverage exaggerates the move of the way up, but also on the way down – much like what margin financing did to stocks in 2015.”
The gain in steel prices isn’t just on the futures market, with spot prices for the physical product also rallying amid a sudden shortage as construction activity accelerates. Rebar prices have risen 57 percent this year on average across China, according to Beijing Antaike Information Development Co., a state-owned consultancy. Even after output of steel increased to the highest monthly volume on record in March, rebar inventory is still falling, signaling a supply deficit.
George Soros said China’s debt-fueled economy resembles the U.S. in 2007-08, before credit markets seized up and spurred a global recession. China’s March credit-growth figures should be viewed as a warning sign, Soros said at an Asia Society event in New York on Wednesday. The broadest measure of new credit in the world’s second-biggest economy was 2.34 trillion yuan ($362 billion) last month, far exceeding the median forecast of 1.4 trillion yuan in a Bloomberg survey and signaling the government is prioritizing growth over reining in debt.
What’s happening in China “eerily resembles what happened during the financial crisis in the U.S. in 2007-08, which was similarly fueled by credit growth,” Soros said. “Most of the money that banks are supplying is needed to keep bad debts and loss-making enterprises alive.”
Soros said at the World Economic Forum in Davos in January that he’s been betting against Asian currencies because a hard landing in China is “practically unavoidable.” China’s state-run Xinhua news agency rebutted his assertion in an editorial, saying that he has made the same prediction several times in the past.
Soros said China’s banking system has more loans than deposits and has “troubles on the assets side but also increasingly troubles on the liabilities side.” “Other banks have to lend to each other and that’s an additional source of uncertainty and instability,” he said. “The problem has been deferred and it can be deferred for another year or two but it’s growing, and growing at an exponential rate.”
China’s economy gathered pace in March as the surge in new credit helped the property sector rebound. Housing values in first-tier cities have soared, with new-home prices in Shenzhen rising 62 percent in a year. While China’s real estate is in a bubble, it may be able to “feed itself for some time,” similar to the U.S. in 2005 and 2006, Soros said. “It can reach a turning point later than everyone expects,” he said. “Most of the damage occurred in later years. It’s a parabolic cycle.”
We never saw 2008 coming. We didn’t understand the August 2007 Bear Stearns conference call. Driving to work in 2006 and 2007, we had no idea what the radio ads meant when they said “no income verification” for getting a mortgage — meanwhile the guys on the shop floor were flipping expensive condos on Collins Ave in Miami. Back then our classmate figured it all out, and now he has a school named for him at Harvard.
Soros is right, as are others, about the over 3x GDP and accelerating debt. He’s also right: “It can reach a turning point later than everyone expects. It’s a parabolic cycle.” Barton Biggs was right about Japan’s crash, just 3 years too early. In a way it’s funny that the latest Chinese investment craze is commodities, since the country is so overflowing with crazy debt-fueled infrastructure capacity that there is only one way things can go, eventually. (The country was building empty cities 6 years ago and there’s only so long that can go on.)
One difference between 2008 and now is that back then private shareholders took big hits when sub-prime exploded, but in this case China controls the banks that own the bad debt, and they lend to each other to put off recognizing the bad debts and zombie companies. This would appear to be very bearish both for commodities prices and the renminbi and other Asian currencies, as well as — eventually — for any publicly traded securities of those banks. It remains to be seen whether there are hidden risks like the CDS’s of 2008.