Chinese commodity futures turmoil casts doubt on possible trading links
Price fluctuations reveal that the mainland market is still too much of a speculative gamble for Hong Kong and overseas investors, analysts say
With the launch of the Shenzhen-Hong Kong Stock Connect approaching, some observers now expect the next step in Hong Kong’s financial links to the mainland could come through commodities trading.
Earlier this month, Charles Li Xiaojia, the chief executive of Hong Kong Exchanges and Clearing, said the bourse was likely to explore similar schemes for metals, bonds and initial share sales.
However, despite the idea being highlighted in the Hong Kong stock exchange’s 2016-18 strategic plan, the recent turmoil in the mainland’s commodities futures market could now set back those plans.
As prices fluctuated, analysts said it underlined just how immature and speculative the market was in the mainland. The aim of a commodities connect, as with the Shenzhen and Shanghai share trading links, is to essentially attract more overseas investors. But the fluctuations would have spooked them, the analysts said.
The wild trading of November 11 began shortly after the night session opened, with the price of purified terephthalic acid, a petroleum-based chemical product, soaring 7 per cent, the maximum increase allowed. But within 10 seconds, traders said, the price then plunged nearly 14 per cent.
There then followed similar swings in the prices of other commodities, including steel rebar, tin, zinc and agricultural products such as cotton and rubber. Not a single commodity escaped the frenetic trading.
The wild trade continued on the following Monday, with many commodity futures rebounding strongly and hitting their price ceilings, only to be followed by a widespread sell-off on November 15.
Fan Qingtian, an analyst at Nanhua Futures, said the extreme volatility “reflects accumulated risk after a period of wild rallies, driven by increased demand for certain products and primarily by capital inflows”.
The renewed frenzy in mainland commodities actually began at the start of the year, prompting wild swings in futures prices, particularly those of the so-called ferrous complex of steel, iron ore, coking coal and coke, and rubber and cotton.
Coke, which cost 558 yuan (HK$630) a tonne in January, has since soared to a recent high of 2,276 yuan.
Thermal coal futures rose 25 per cent in the first week of this month, raising their gains so far this year to 121 per cent, following restrictions on output.
“It’s the first time I have seen coke futures rise for 16 sessions in a row,” said investor Wang Zuo. “I have been in the market for 20 years and have never seen anything like this.”
The surge in futures prices has also triggered sharp rises in physical prices. Iron ore rose about 25 per cent in the past week to its highest level in more than two years. Its price atTianjin port hit its highest since October 2014 on Monday, according to the Steel Index, an information provider.
The wild rallies have also seen increased capital pouring into the market. Turnover in Dalian iron ore contracts in the first two weeks of this month were 34 per cent higher than a year ago, according to the Steel Index.
The National Development and Reform Commission said last month the country had reached its target for capacity cuts. It blamed the shortages of coking coal and coke for the price rises, which have a knock-on effect on steel and iron ore.
However, analysts found few clues to explain the price gains.
Ye Yanwu, a research director at Chaos Ternary Futures, said the shortage of coking coal and coke offered fundamental support for their rally and that of steel and iron ore.
“It’s primarily caused by significant capital inflows, given the excessive liquidity and limited amount of investment opportunities in the market,” Fan said.
Qiu Huiming, the general manager of Shanghai Minghong Investment Management, attributed it partly to “unprecedented leverage used by speculators”.
“When volatility rises, high leverage leads to forced liquidation of positions, which further aggravates the volatility,” Qiu said.
While official data is unavailable on how high the leverage is, it is obviously enough to prompt the authorities into tightening mode.
Earlier this month, regulators banned futures brokers from providing margin financing, and three major futures exchanges all raised transaction fees and deposit requirements in the same week, to deter speculation in the market.
Six months earlier, the stock exchanges took similar action after short-term retail investors piled into the market, driving up the prices of all commodities and stoking fears of a bubble.
Analysts said the latest tightening would not be the last if fundamental problems were not solved.
Similar to the stock market, the mainland’s futures market is dominated by retail investors. In the United States, 48 per cent of futures contracts are generally held by funds and other institutions, according to statistics from the Commodity Futures Trading Commission.
In contrast, data from the Dalian Commodity Exchange shows retail investors hold more than 60 per cent of futures products on the mainland.
However, what was unusual about this year’s fluctuation was that the market was flooded with many first-time investors, who had switched from stocks and stock index futures after last summer’s equities crash, said Lv Jie, a deputy general manager of research at Guoxin Futures.
“These first-time investors are very sensitive, and that’s led to more volatility,” he said.
Lv also said the commodities market was still “too small to absorb the volatility caused by big capital inflows” with deposits on futures traded at about 400 billion yuan, compared with 50 trillion yuan in the stock market.
While analysts said regulation was a must for any financial market, they said too frequent and unpredictable interventions could hurt its development.
“To some extent, the intervention from the exchanges aggravated volatility, instead of smoothing it,” Fan said. “We need better regulatory measures to prevent trading becoming further overheated.”