China’s commodity exchanges

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China is seeking to gain a role in global commodity pricing commensurate with its demand for raw materials and boost use of the Yuan as an international currency of exchange.

  • China’s ferrous futures markets influential but volatile
  • New crude contract has chance of success

Historically closed to the outside, China is gradually opening up its derivatives trade to foreign investors. The government’s aims are twofold: to improve the interconnectivity between Chinese and international commodity markets, and thus gain more influence over the price China pays for its commodities, and to promote the use of the Yuan in global trade as an alternative to the US dollar.

To this end, the Shanghai Futures Exchange (SHFE) launched in March a crude oil futures contract open to the international community. Iron ore futures, already well established domestically, are expected to be opened to foreign investors later this year. However, shifting a meaningful volume of international trade onto Chinese trading platforms may prove challenging.

US dollars are the “lingua franca” of international commodity trade, and international players may display significant inertia when it comes to using futures contracts prices in Yuan.

As with all new crude futures contracts, there are doubts over whether China’s will attract sufficient liquidity to make it a useful trading tool. There are also fears of speculative trading behavior causing large and unpredictable price swings, as well as the potential for government intervention. These factors could impede the uptake of Chinese derivatives by the international community.

Irrational exuberance

China’s steel and iron ore futures are widely considered to be a key indicator of Chinese steel market sentiment and have exerted growing influence on physical prices over the past two to three years. This is not surprising given China imports more than 1 billion mt of iron ore annually and produces half of the world’s steel.

Rebar futures were launched on the SHFE in early 2009 and the rebar futures contract is now the most actively traded metals futures contract in the world. With “lot” sizes of just 10 mt, it enabled small players to participate easily. However, in many Chinese futures contracts, including rebar, all the liquidity is concentrated in one month, typically several months out to avoid the risk of physical delivery.

Owing to the lack of a liquid and well-defined forward curve, they are often seen as an indicator of market sentiment more than as a tool to hedge physical price risk for delivery in the month ahead.

In addition, while large financial players, trading houses and steel companies in China are major users of derivatives, hundreds of thousands of wealthy individuals also participate in rebar and iron ore futures. These participants are purely financial players; many entered the market after the abrupt falls in China’s stock markets in 2015.

Many observers consider China’s rebar and iron ore futures contracts a speculator’s haven; a place for day- traders and punters with no physical exposure to gamble hot money, as suggested by the high ratio of volume to open interest. The market can also be extremely reactive to Chinese government policy announcements, or global events such as fears of a trade war with the US.

It means that sentiment can play a greater role in influencing prices than supply and demand fundamentals might suggest. This was seen in early March 2016 when global ferrous markets were stunned by Shanghai rebar futures rising 10% over a couple of days, while the S&P Global Platts 62% Fe iron ore benchmark experienced one of its biggest day-on-day jumps of around $11/mt.

The excitement was attributed to comments made in Beijing at the National People’s Congress – the annual meeting of China’s Parliament – about steel production cuts, along with positive noises about the state of the economy. A week later, few could remember what had provoked the price surges.

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