“Metals Traders On Red Alert” – Chinese Commodity Bubble 2.0 Just Imploded

Industrial metals commodity prices plunged by the most since March in the last 2 days as China’s exchanges (once again) clamped down on speculation by tightening trading rules. As Bloomberg reports, for the second time this year, trading has exploded on the nation’s exchanges, pushing prices of everything from zinc to coal to multi-year highs and sending authorities scrambling to deflate the bubble before it bursts.

Metals brokers described panic earlier this month as the frenzy spread to markets in London and New York, prompting wild swings in prices that show no signs of abating.

“I can recall only two other occasions in my career where there was such panic and devastating price action in copper but this market today is far less transparent,”

 

While billions of yuan have poured in from herd-like Chinese retail investors who show little regard for market fundamentals, brokers and traders say even more is coming from an expanding army of deep-pocketed hedge funds. They’re chasing better returns in commodities as stocks and real estate fade, often using algorithms and trading late into the night, when markets in London and New York are most active.

 

“There is no doubt that the price moves and the bigger volumes worldwide are being driven by the Chinese, and by professional speculators and financial players,” said Tiger Shi, managing partner at brokerage BANDS Financial Ltd., which counts several of those funds as clients. “The western hedge funds and institutional investors don’t really know what’s going on. Often they were used to trading macro factors or Fed policy, but now they find they have fewer advantages.”

And it was never going to end well…

Zinc Futures have plunged over 10% in the last 2 days (after surging over 27% since the start of November).

 

Steel Rebar is tumbling…

 

And Iron Ore futures have collapsed more… twice…

Think it's the Trump-Trade? Think again. Fundamentally, as Bloomberg highlights, there is massive oversupply. Iron ore port inventories in China are near the highest since September 2014 and are up 19 percent this year, according to Shanghai Steelhome Information Technology Co. Top producer Vale SA reiterated its output guidance of 360 million to 380 million tons for 2017 on Tuesday and expects to produce 400 million to 420 million tons the year after.

So what is it? What had driven this panic-buying in industrial commodities? Simple – another Chinese speculative bubble…

Iron ore and steel futures trimmed their second monthly advance as bourses in Dalian and Shanghai moved to deflate a boom driven partly by speculative trading.

 

The Dalian Commodity Exchange raised margin requirements and the Shanghai Futures Exchange capped some positions. These measures have taken some speculative steam out of the market, according to Justin Smirk, a senior economist at Westpac Banking Corp.

As the Chinese commodity bubble of March/April is back and trading volumes explode relative to open interest…

NOTE: SHFE updated their Zinc "control measures" once again tonight, capping new positions at 1500 lots.

 

 

Thank to hot money flows…

“Commodities market volatility is liquidity driven, as money from commercial bank wealth management products and private banking accounts flow into the market seeking higher return,”

And an increase in algos…

The use of algorithmic trading, in which computers execute multiple orders in milliseconds, is turbo-charging volume and volatility, according to Fu Peng, a portfolio manager at Lianzhan Global Macro Fund Management Co. About a third of activity on Chinese exchanges is executed by automated commands, which generates more volume and greater momentum on global markets, Shi estimates.

 

“The machine component in the market is now so much bigger as is the onshore retail and fund involvement on the Shanghai Futures Exchange and OTC options.”

Similar to the last frenzy in April, the government-owned exchanges have stepped in to cool trading by raising fees and margins, or cutting the number of new positions allowed daily. In the latest move, the Shanghai Futures volume and turnover have since come off their highs but prices are still swinging.

So with the China Commoditty Echo Bubble now bursting, the big question is, where does the hot money flow next? As Socgen shows, Chinese 'gamblers' have chased stocks (and lost), dumped capital (Yuan loss), piled into commodities (in March/April) and lost, rotated into housing (until the government choked that off), and then sent bond yields to record lows…

As Fu at Lianzhan Global Macro Fund noted:

“The nation’s supply-side reforms had a big impact on the market balance, and that’s the fundamentals behind the trading,”

 

But at the same time, we’ve got too much money there. There have been no returns from investment in industries. The stock market is neither dead nor alive. Investment in real estate also got curbed. So all the money is rushing into commodities.”

But now, Chinese housing is at record highs, Chinese stocks are falling, Chinese bonds are falling, and Chinese commodities are tumbling… the only thing with momentum for the hot money to chase in the currency… and we suspect (by recent liquidity withdrawals) that The PBOC has had enough of that.

“The massive and unprecedented surge in Chinese trading volume in base metals over the past month — but especially since the election — has put LME metals traders on red alert,” Tai Wong, director of commodity products trading at BMO Capital Markets in New York.


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