Commodities

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Wondering what will blow up in China next? For all the concern about excessive debt, bubbles are likely to keep inflating for a while. The latest exhibit: commodity futures. 

Iron-ore contracts traded in the northeastern city of Dalian are starting to look eerily like Chinese stock market indexes did in early 2015, on their run-up to a midyear peak that then turned to bust.

Looks Familiar?
Iron-ore futures contracts traded in Dalian have been behaving similarly to Shenzhen stocks last year
Source: Bloomberg
*Data are indexed for comparability. Dalian iron-ore contract prices from Dec. 10, 2015, to April 27, 2016, and Shenzhen prices for the same period a year earlier.

Anyone tempted to believe that the gains are driven by fundamentals should look at what happened this week. China's iron-ore futures contract dropped by the daily limit to 450.5 yuan ($69) on Tuesday after the Dalian exchange almost doubled trading fees, the latest of a raft of measures to curb speculation. It plunged further to close at 434.5 yuan on Wednesday, still up about 40 percent for the year.

Daily volumes are now so large that they sometimes exceed the value of China's annual iron-ore imports, according to Goldman Sachs.

Deja Vu
Volumes of iron-ore contracts traded in Dalian have more than doubled, similar to stock markets last year
Source: Bloomberg
*Data are indexed for comparability. Dalian iron-ore contract volumes from Dec. 31, 2015, to April 22, 2016, and Shenzhen volumes for the same period a year earlier.

Fueling the rally are a sudden interest by Chinese investors in commodities after their best two-month run since 2012, and the availability of margin finance.

The events mirror almost step by step the rise and fall of the local stock markets last year. The Shanghai and Shenzhen stock exchanges also began to raise trading fees while the bull market was still raging but it wasn't until regulators clamped down on margin trading that the bubble popped. 

It appears regulators are being more cautious this time and have started moving to bring onshore commodity prices back in line. Besides boosting trading fees and margin requirements, exchanges have also issued warnings to investors. The coming weeks will provide a sense of how successful these efforts are.

The Dalian commodity rally is having a profound impact on global prices, even though many contracts relate mostly to the domestic market. China consumes about half the world's metals, so an overseas trader who's not paying attention to what's happening in Dalian is unlikely to stay solvent for long.

Take a look at the correlation between prices for copper on the Shanghai Futures Exchange and the London Metal Exchange, for instance:

Separated at Birth
Copper prices in Shanghai and London move more or less in tandem.
Source: Bloomberg data
Note: Figures have been rebased. April 8, 2015=100. Contracts are Generic 1st Shanghai copper futures and LME 3-month rolling forwards.

Or examine the prices for Chinese steel rebar and the global benchmark index for iron ore, its main raw material:

Metal Mirror
Steel and iron ore aren't even the same commodity, but their movements are becoming increasingly aligned.
Source: Bloomberg data
Note: Figures have been rebased. April 8, 2015=100. Pricing is for Generic 1st Shanghai Futures Exchange rebar and Metal Bulletin 62% iron ore CFR Qingdao.

The share price of Brazil's Vale, the biggest iron ore-miner, is up 28 percent since Chinese rebar prices started their 41 percent bull run on March 4.

Even if a sudden pop in the ironclad bubble developing in Dalian doesn't impact the world directly, sentiment toward China, and especially suspicions about regulatory intervention, could take their toll. When the Shanghai and Shenzhen stock markets collapsed last year and regulators went scurrying to stop the hemorrhage, foreign investors pulled money out of the country and many locals followed.

It's little surprise that history is being repeated. China's aggregate financing totaled 2.34 trillion yuan in March as the government opens the credit taps in an attempt to stabilize economic growth. With authorities simultaneously tightening capital controls to prevent depletion of foreign-exchange reserves, all that liquidity has to go somewhere. An incipient property bubble is already building again in some big cities, not long after the government was focused on trying to cool the market. More stop-start booms and busts in the country's asset markets can be expected.

Pay attention to those seemingly innocuous rebar contracts in Dalian: They could be where the next Chinese cracks appear.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Christopher Langner in Singapore at clangner@bloomberg.net
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net