Most commodities are denominated in, and therefore pegged to, the U.S. dollar but these days the Chinese yuan is starting to have as much influence on prices.
While there were fundamental triggers behind the recent spike and drop in raw materials, it's becoming clear that Chinese trading was among the main drivers. Investors in the northeastern city of Dalian have been piling back into commodities in a replay of what happened earlier this year. That's partly because they're seeking to protect their global purchasing power as the Chinese currency loses value.
The yuan has accelerated its decline since breaching the key psychological level of 6.7 per dollar in October. On Wednesday, the currency dropped to a record low in offshore trading after the People's Bank of China set the fixing at the weakest since August 2008.
So how come Chinese-traded commodities have suddenly plunged, with iron ore in Dalian down 8.8 percent from Monday's close? That's where Chinese regulators come in. The chatter among traders is that in the past couple of weeks authorities decided to stiffen enforcement of rules unveiled earlier this year to quash speculation.
That may be forcing a quick unraveling of positions. Since the start of last week, aggregate open interest in iron ore futures in Dalian has slumped by 43 percent, even as global investors become more bullish amid promises of $1 trillion in infrastructure investments under the incoming administration of President-elect Donald Trump.
It's unclear how long the Chinese clampdown will last or how much it will affect prices once the latest round is completed. Open interest is a notoriously unreliable guide to price movements. While front-month Dalian iron ore contracts have ricocheted between 282.5 yuan ($41) per ton and 656.5 yuan per ton this year, the price was barely a dollar apart between May 3, when open interest was at rock bottom, and on Oct. 19, when it hit a peak.
Ultimately, the price of commodities is guided by fundamental factors rather than the reactions of traders. Dalian's metal investors weren't chasing a speculative bubble back when iron ore prices surged in March, but getting out in front of a real increase in demand: China's crude steel output last month grew at its fastest annual pace since 2014.
Still, when the yuan weakens, the interests of Chinese retail investors looking to protect wealth and industrial companies focused on exports become markedly aligned. That looks like good news for metal prices -- whatever China's regulators do to damp trading.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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