Monday, February 24, 2014

China’s raw materials bubble bursts

Steel, iron ore futures in China tanked on bloated (all-time high) inventories and apparent lending curbs by Chinese banks.

Source: CME

It seems that banks and regulators have been spooked by falling industrial demand, lower prices, and speculative activities of commodity traders. Anecdotal evidence suggests that many commodity importers have been using their inventories as collateral to bet on the yuan appreciation against the dollar. In fact some have borrowed dollars converted them to yuan and held the money in "high yielding" accounts. Some simply used the forwards market to take advantage of the rate differential between the two currencies. As long as the government stuck to its policy of gradual appreciation, it was "free money".  Moreover, some traders supposedly used the same iron ore and steel inventory with multiple counterparties at the same time (equivalent to taking out multiple mortgages on the same house at once).

With banks cutting back lending in this sector and the yuan actually declining recently, that gravy train has stopped. Traders are being forced to dump inventory. That is sending prices lower and even pressuring some mills to close.

Lending curbs have also been extended to other sectors related to property development, such as cement. All this points to tighter credit, weaker demand, and slower industrial activity going forward.
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