The extraordinary run-up in commodities over recent weeks has led to fears that a flood of Chinese investors has floated materials prices away from their moorings in reality.
Daily trading volumes of iron-ore futures in Dalian regularly exceed the value of the country's iron-ore imports, according to Goldman Sachs. Enough cotton was traded in Zhengzhou in one day last month -- 41 million bales -- to make a pair of jeans for everyone on the planet. When higher trading fees and shorter hours start pulling all that dumb money back out of the markets, surely prices will crash back down to earth?
Believe it or not, that's the optimistic scenario. The more worrying prospect is that speculators aren't chasing momentum, but getting out in front of a real increase in demand.
High levels of speculative interest shouldn't automatically be taken as a sign that prices are out of whack. Quite the opposite -- liquid markets are meant to improve, not distort price discovery. And such speculation isn't unique to China. There were about 1.7 million gold futures and options contracts outstanding on Chicago's Comex exchange last month. That's equivalent to 171 million troy ounces, 5,300 metric tons, or 20 months of global mined gold production at 2015 rates of about 3,200 tons a year.
There's plenty of evidence, too, that the surge in the prices of construction-linked commodities is real. Spot prices aren't immune to the gyrations of the futures market, given the potential arbitrage between the two -- but it's striking that spot prices for steel rebar and iron ore have risen further this year than those in the futures market:
Or check cement prices, a measure that Gadfly highlighted in March as a potential test of real Chinese commodities demand. There's no futures market in Chinese cement and the figures are assembled by checks on the market by China's National Bureau of Statistics, so building cement should give a much less frothy picture of where the country's construction activity is headed. Three of the five biggest price rises the index has seen since it started to be compiled two years ago have occurred in the last three weeks:
Credit Suisse is also seeing a genuine pickup in activity. ``Infrastructure project execution is underway, feeding through to demand,'' the bank's analysts argued in a May 3 note to clients.
Why should that be more worrying than a markets bubble?
If China's demand for construction materials is really increasing at the rate implied by futures prices, it can only be because a lot of building activity is underway. While one widely watched industrial activity measure weakened Tuesday, that picture is still entirely consistent with first-quarter economic data showing rising real estate and construction activity, driven by a worrying increase in debt levels.
Outsiders who've experienced the bursting of two major asset price bubbles over the past few decades should think hard about the one they'd prefer to see take place in China.
If futures markets have lost touch with reality, we're in for a replay of the 2000-2001 dotcom crash. The main players who will lose out will be professional investors who've hedged their exposures, and amateur traders who will likely cash out before they go too deep underwater.
The alternative is that futures markets have read China's economy right, and the bubble being fueled by all that debt is in bricks and mortar and the borrowings of unproductive state-owned enterprises.
If that bubble bursts, we'll be looking at something more like the 2007-2009 subprime crash: households with mortgages worth more than the value of their homes, writedowns to banks' loan portfolios, and credit being eaten up in keeping zombie companies alive rather that in fueling the growth of new ones.
Put that way, the idea that traders in Dalian have just got a bit overexcited seems positively comforting.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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