From commodities to Bitcoin, Chinese speculators are looking to escape the weakening yuan

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Following an enormous rout in stocks in 2015, skyrocketing house prices in the nation’s largest cities and a lack of investment options elsewhere, Chinese speculators flocked to commodity futures markets in 2016, trading record volumes during the year.

According to Bloomberg, citing data from the China Futures Association, combined aggregate trading volume on the Shanghai Futures Exchange, Dalian Commodity Exchange and Zhengzhou Commodity Exchange jumped to 4.1 billion contracts in 2016, up 27% from the levels of a year earlier.

Turnover across all three bourses jumped by a mammoth 30% to a record 177.4 trillion yuan, equivalent to $US25.5 trillion, the Association data showed.

Bloomberg sums up the frenzy:

Chinese investors, flush with credit and hunting for returns, piled into commodities futures last year, spurred by bets that the government’s efforts to cut industrial capacity would lead to shortages of raw materials. They charged into markets several times in 2016 and bought everything from iron ore to cotton, driving up prices and stoking fears of a bubble.

And charge in they did — particularly in May and again in the latter parts of the year — leading regulators to step in to quell the feverish frenzy.

These periods coincided with some jaw-dropping price gains in the likes of iron ore and coking coal, raising questions among many analysts about the fundamentals underpinning the moves.

Some, like Goldman Sachs’ commodities research team of Hui Shan, Amber Cai and Christian Lelong, suggested that weakness in the yuan, and a lack of alternate US dollar denominated assets, contributed to the surge in speculative trading activity.

Looking specifically at iron ore markets, the Goldman team suggested about 60% of the price rally in October last year was explained by renewed weakness in the Chinese yuan, which was driven by rising expectations of higher US interest rates.

“With ample onshore money supply chasing a limited menu of accessible dollar-linked assets, continued CNY depreciation means that iron ore prices may stay above what the fundamental demand and supply suggest in coming months,” they wrote in early November – not a bad call as the benchmark spot price for 62% fines rocketed above $US80 a tonne for the first time since 2014.

It was a similar story for other commodity futures, with fundamental factors that started the rally in prices earlier in the year replaced by swirling levels of speculation as investors chased prices higher.

And, despite the best efforts of policymakers to quash rampant speculation, it’s clear that it’s still prevalent in both commodity and other asset classes.

According to analysis from the Commonwealth Bank, the average hold time for positions in rebar and iron ore futures contracts traded on the Shanghai and Dalian exchanges was less than 24 hours at the end of 2016, significantly lower than the levels seen earlier in the year when prices were falling rather than rising.

To Vivek Dhar, a mining and energy commodities analyst at the Commonwealth Bank, the elevated levels of speculation will add to upside price risks and increased volatility in the year ahead should they be allowed to persist.

“Without intervention, speculative trading will likely be another risk to higher prices in 2017, particularly if China deploys further stimulus,” he said in late December.

“Price volatility would likely continue next year if speculative trading is left unchecked – both to the upside and downside depending on prevailing sentiment.”

Mirroring the frenzy seen in commodity futures, there’s now evidence that Chinese speculators have now moved into the Bitcoin market, once again fuelled by concern over the potential for further yuan weakness.

The cryptocurrency rose by as much as 6.9% on Wednesday to $1094.69 per coin, bringing its gain to a massive 15% so far this year.

And that was fallowing a mammoth 123% gain in 2016.

Much of the buying interest has come from China.

According to a recent Business Insider Intelligence briefing, citing data from Cryptocompare, in the first 24 hours of the new year, over 5 million bitcoins were bought in Chinese yuan, equating to $US3.8 billion.

In comparison, just 53,000 bitcoins were bought in US dollars.

It’s clear that Chinese investors are concerned about the outlook for the Chinese yuan given the speculative-driven moves seen in recent months.

At this point, however, that concern has yet to impact more developed financial markets.

It will be interesting to see if that lasts, particularly given the events that occurred at the start of 2016.

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