There’s something unique about China that fuels rapid boom-bust cycles in financial markets

Contained liquidity. VCG/VCG via Getty Images
  • Most Chinese investors don’t have the luxury of choosing where to deploy their cash around the world given capital controls implemented by regulators.
  • This means capital, and speculative activity, tends to shift from asset class to asset class in China.
  • Chinese stocks have been hosed in recent month, coinciding with a sharp pickup in property prices. There’s also evidence of increased speculative activity in commodity futures.

Unlike many people around the world, most Chinese investors don’t have the luxury of choosing where to deploy their capital around the world.

The introduction of tighter capital controls by currency regulators at the People’s Bank of China in early 2017 has meant that investors have little choice but to invest in domestic assets, something that has seen capital, and speculation, shift continuously from one asset class to another.

While there have been many stories so far this year in regards to Chinese financial markets, none has been as well documented as the plunge in stocks.

The benchmark Shanghai Composite Index has shed over 30% since late January, leaving it languishing at the lowest level in four years. Other major Chinese indices have also tanked, losing similar or greater amounts than the Composite.

It’s a very different story to what was seen throughout most of 2017 and earlier this year when Chinese stocks were charging higher, something that just happened to coincide with a slowdown in the property market.

However, now the tables have turned with new property prices in China jumping by the most in two years in August, according to data from China’s National Bureau of Statistics, hinting that capital may be flowing out of stocks and back into the housing market.


It may not just be the property market that’s recently benefit from this latest merry-go-round for Chinese capital flows.

As the stock market has plunged, Chinese commodity futures have been soaring with steel and bulk commodity contracts recently hitting either multi-month or multi-year highs on the Shanghai Futures and Dalian Commodity Exchanges.

While fundamental factors have undeniably been a factor, it appears that speculative money, potentially from the stock market, may also be finding its way into commodities.

Here’s two interesting charts from RBC Capital Markets that make for interesting viewing.

The first shows the Shanghai Composite Index overlaid against the amount of outstanding margin debt used to invest in stocks.


Both the index and amount of margin debt borrowed have, unsurprisingly, fallen in unison this year.

And with leverage in the stock market falling, the average hold period for Dalian iron ore futures contracts has also fallen sharply, indicating an increase in speculative activity in iron ore contracts.


Similar moves have been seen in the past, including in the first half of 2016 — again, another period when Chinese stocks were hammered.

With limited choices on where to invest, one suspects similar shift in speculative activity will continue to dominate movements in Chinese assets until policymakers feel confident enough to relax capital outflow restrictions.

With the Chinese yuan already under pressure, one also suspects that won’t be happening anytime soon.