If there’s one thing that Chinese investors do well, it’s creating a speculative frenzy. Be it stocks or property, they seemingly can’t help themselves.
After last year’s stock market rout — something that saw mainland indices lose close to 50% in a little over four months after surging over 150% in the preceding year — it appears that investors are now looking for the next opportunity to make a fortune in as little time as possible.
Some have returned to the once high-flying property market, piling in at a pace so fast that some investors are losing sleep. FOMO, or the fear of missing out, has returned with a vengeance in many larger cities, producing annualised gains so high they’d be enough to make your ears pop.
Price gains have been so great in cities such as Shenzhen and Shanghai — notably financial capitals — that authorities in both centres have been forced to quash speculative forces by tightening restrictions on home purchases.
With property restrictions now in place and the stock market remaining in a funk, investors have recently turned to a more exotic asset class to make their next fortune: commodity futures.
Armed with nothing more than a pocketful of cash and a chart displaying momentum indicators, investors have been piling into commodities like never before, echoing similar scenes witnessed in stocks and property in the years before.
Driven by surging trading volumes, a sign of increased speculative activity, some of intraday price movements have to be seen to be believed.
Be it rebar, coking coal or iron ore futures, movements in excess of 3, 4 or 5% are now commonplace every day. It’s got to the stage that it’s strange, rather than normal, when the movements are anything smaller.
Chris Weston, IG Markets chief market strategist, summed up the speculative frenzy perfectly in a research note released this week.
“On Thursday (last week) 223 million contracts of rebar (steel) futures were traded, more than China’s full year steel production! These sort of volumes are not sustainable, although if you work in futures broking in China the times are good right now,” he mused.
“To put the volumes going through the market into perspective, the sorts of volumes seen on the Dalian exchange are nearly 4 times that of 2015.”
According to analysis from Vivek Dhar, a mining and energy commodities analyst at CBA, the average tenure of an iron ore futures contract on the Dalian Commodity Exchange is now under 4 hours, similar to a steel rebar futures contract on the Shanghai Futures Exchange. This compares with 40 hours for WTI crude, 60 hours for copper and 70 hours for natural gas.
“A lower average tenure suggests increased speculation and helps explain the significant volatility in China’s commodity markets recently,” says Dhar.
The excellent chart below, supplied by Westpac’s head of market strategy Robert Rennie, takes what Dhar is saying one step further, looking at the average position tenure for not only Dalian iron ore but also other key Chinese commodity futures.
The left hand side of the chart — indicating shorter periods that a position is held on average — is dominated by Chinese commodity futures.
While there are some fundamental factors that have underpinned the recent surge in bulk commodity prices — a sharp uplift in Chinese construction activity in March (which in itself raises questions over the government’s desire to push ahead with meaningful industrial reform) and low inventory levels just to name two — many believe the speculative surge has seen prices disconnect from fundamentals.
Matthew Ross and Jie Ma, analysts at Goldman Sachs, are among those who are concerned by rapid build up in speculative trading activity.
“While increased fixed-asset investment in China, a bring-forward of steel production (ahead of a government curtailment) and mining disruptions help to explain the strong rally in the iron ore price, the one driver that concerns us the most is the increased speculation in the Chinese iron ore futures market,” they wrote in a research note received by Bloomberg.
Goldman calls the rally in ion ore “unsustainable”, forecasting that the price will likely slump to $35 a tonne by the end of the year.
That sentiment is shared by Dhar who suggests increased “speculation raises the risk of prices overshooting or undershooting levels implied by fundamentals”.
In response to the surge in speculative activity, the Shanghai Futures Exchange increased transaction fees last week while the Dalian Commodity Exchange raised margin requirements and tightened rules on what it called “abnormal trading”.
While it’s early days, the measures have led to an enormous unwind in long futures positioning in recent days, something that has not only led to a sharp fall in futures pricing but also the underling spot price of steel and iron ore.
The only question now is whether it’ll be enough to stop the speculative frenzy, or just draw in more punters who are looking to sell rather than buy.
To the outsider it all looks haphazard, akin to a casino rather than a financial market. A lackadaisical approach from regulators — following an embarrassing series of measures announced last year to support stock prices — certainly isn’t helping, fostering boom-bust cycles rather than preventing them.
Until that changes, not only will Chinese financial markets not be taken seriously, it’ll continue to undermine confidence that policymakers will be able to successfully implement meaningful market reforms in the years ahead.