Is China going to dump their excess metal stockpiles?

February 9th, 2010

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Back in Will there be a commodity price crash?, we wrote about a curious phenomenon in China,

… as prices for base metals rebounded, so did their inventory stockpile levels. This is a tell-tale sign that much of the price rise are due to the rise in investment demand instead of real demand.

When we wrote that article, we should have used the word “speculative” instead of “investment.” Indeed, back in September last year, there were signs of base metal speculation in China, as this Bloomberg article reported (China?s Pig Farmers Amass Copper, Nickel, Sucden Says)

Private investors in China, the world?s largest metals user, have stockpiled ?substantial? quantities of copper as the government ramps up stimulus spending to spur the economy, according to Sucden Financial Ltd.

Pig farmers and other speculators may have amassed more than 50,000 metric tons, Jeremy Goldwyn, who oversees business development in Asia for London-based Sucden, wrote in an e- mailed report after a visit to China. That?s about half the level of inventories tallied by the Shanghai Futures Exchange, which stood last week at a two-year high of 97,396 tons.

Sucden?s estimate underscores the difficulty analysts face in gauging metals demand in China amid increased speculation by retail investors, whose holdings remain outside the reporting framework undertaken by exchanges. Private investors in China also had as much as 20,000 tons of nickel, Goldwyn wrote.

This is a tell-tale sign that the ‘demand’ for base metals from China is not fully substantiated by the demand from the real economy. Even the demand from the real economy are not fully substantiated by the real needs of the people. To understand what we mean by that, think of where all these credit and stimulus money has gone to in China. It has been reported that most of them had gone to fixed asset investments and infrastructure. But according to Marc Faber in a recent interview (and many eye-witness report), there’s an oversupply of apartments and commercial real estate in China i.e. vacancies are already too high. Therefore, the pace of China’s fixed asset investments have to slow down. Should that happen, you can be certain that demand for steel and cement will fall substantially. That means the demand for Australian iron ore is going to fall as well.

Now, we are hearing rumours that the Chinese are trying to offload their excess metals. As this article reported (Rogue Aluminium Shipments Suggest Chinese Metal Stockpiles are Being Re-Exported),

Something strange happened in Japan in December. Shipments of aluminum from Mozambique and Brazil showed up in the northwestern ports of Fushiki and Fukui.

Shipping aluminum to Japan isn’t weird. The nation is an important consumer. But shipping South American and African aluminum to northwest Japan is strange.

These are minor ports. Usually such imports would be unloaded on the Pacific side, at Yokohama, Osaka or Nagoya.

Where did this “rogue aluminum” come from? Traders think it might be from China.

Not only that, according to that article, there’s a divergence between the Baltic Dry Index and Chinese Shipping Index.

Next, listen to what Marc Faber has to say:

What is the implication for Australia? If you accept the theory that Australia owes much of its economic rebound from Chinese demand for Australian resources, then what follows will be very negative for the Australian economy. As we wrote in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

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  • Pete

    Good article there CIJ.

    I think this is exactly the kind of news China doesn't want in the mainstream press.

  • And we can include Australia as well.

  • Anonymous

    Hi Ed,The view that China can use its entire foreign reserve to save its economy is quite widespread. I'm having trouble looking through my collection of articles (damn, I need a better category system to sort out all these RSS feeds), but I remember a particular one that give details on how China simply CANNOT uses their entire foreign reserve as if like “cash” because some of them were already committed in deals, etc, etc. It highlights some of the “deals” in detail and explain just why that entire $2.4 trillion dollar can't be used at free will. Essentially, there were lot of restriction to it that is beyond Chinese government's control.If I can find the article, I will let you know. But I've already did an exhaustive search and couldn't find it. πŸ™ If you remember something like it, let us know too.Cheers

    In regards to the view where China’s foreign reserve will save the day (and Australia too), here is an interesting article that highlight how those reserve may not necessary as “spendable” as most people believe it to be. Perhaps it is worthwhile to break this myth by doing a bit more research into it. This will definitely put a big question mark on those who still claim “never short a country with $2.4 trillion foreign reserve”. http://www.pivotcapital.com/reports/Chinas_Inve…The part is “Credit Growth At Critical Point”This latter point raises a bigger issue: how much of its central bank?s reserves can a country actually ?spend?? Since theoretically reserves are needed to satisfy claims for the conversion of local currency into foreign exchange, as well as the transfer of foreign exchange that was acquired as a part of a liability, we have to look at the ratio of reserves to the sum of local money and gross external debt. M2 monetary aggregate in China is $8.4tn (which is higher than M2 of $8.3tn in the US) and it is currently growing at 28%. China?s gross external debt was $374bn as at end of 2008, which in Emerging Market space is second only to Russia in size. Compared to a sample of Emerging Markets, China?s reserves in relation to its liabilities are not that spectacular (chart 8), so in that sense China is technically notin a position to ?spend? its reserves.To conclude, credit growth in China has reached critical levels and its effectiveness at boosting growth is falling. External inflows into China in the past few years are a part of the ?global imbalances? that are currently being cured. These inflows are not going to fuel further capex. Finally, China has significant off-balance sheet liabilities and cannot just ?spend? its reserves on capex without undermining its external position.On the other hand, there was another article from Michael Petti that talk how massive foreign reserve != stable economy from external shocks. It uses historic cases to argue it. http://mpettis.com/2010/02/never-short-a-countr…Cheers

  • Anon

    Thought this might interest some ppl:David Einhorn Value Investing Congresshttp://blogs.reuters.com/rolfe-winkler/files/20…Talks about his recent moves and expectancy of much higher rates in US and Japan overtime.I like this passage “…But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse. So I conclude that picking one of these currencies is like choosing my favourite dental procedure.”Above not advice, just commentary, see a financial advisor for info/advice.

  • temjin

    The signs are getting more and more “mainstream” lately, at least in the financial press. I still have yet to see anything of this sort reported in the Australian mainstream news.

    Most ppls in Australia probably still have no idea about the trade imbalance, over-capacity and real estate bubble in China right now. And then they dare to claim that Australia is essentially safe because of the forever boom in China.

    The media is sure powerful in giving the wrong message, or in NOT telling the full story.

  • @temjin

    Some even vaguely know about the situation in China but shrug it off because China has US$2.4 trillion in reserves that will solve every problem. We hear this from a stock analyst of a major broking house.

  • Anon

    good points temjin. I think short term commodities are stuffed. But longer term (5 years out?) there are good fundamentals. Timing will be key. I would love to own silver and probably aluminum (rail car/electric car demand + green related metal). on any significant correction.

    I was doing some research on how the AUD responds in high inflationary environments. In the 73-74 debacle, the AUD rose during the crash – against the USD (altho this was short lived). Its something to think about if we have excessive inflation further down the road.
    Im going to make a brave call and say we have bottomed here (for now). Targets of possibly 12,000 for the DOW by years end. The EURO is rallying bigtime now that the PIGS have gone to the abattoir. Its funny how the media pumped negativity about bad pigs then completely reversed mentioning speculation as to the bailout of Greece. Gotta sell those newspapers πŸ˜‰

    Remember above not advice, only commentary, see a registered financial advisor for advice/info.

  • @Anon

    Regarding the behaviour of AUD during the 1970s, bear in mind that the AUD was floated in 8 December 1983.

  • @temjin

    The link the Pivot Capital's PDF file seems to be a broken link. Yes, we would agree with Pivot Capital. One way to look at the supply of Chinese RMBs is that they are sort of PBOC's liability to cough out USD on demand (remember, the RMB is pegged to the USD). If China prints heaps of RMB, then their contingent liability for USD increases. That'll be serious problem for China if the 'redemption' for RMB for USD far exceeds their USD reserves.

  • Anon

    Where did my brain go lol
    I meant the CAD not AUD sorry.

  • @everyone

    We've found the PDF document that Temjin talked about. Go to page 3 & 4 of Chinas Investment Boom the Great Leap Into the Unknown

  • temjin

    Hey Anon,

    I thought Germany just recently made an announcement that the rumors for bailing out Greece was not true.

    The EUR/USD pair experienced a pretty yo-yo day today. (150 pips daily movement)

    Anyway..

    @Editor

    Could you please elaborate on the part where how restrictive the PBOC would have to “spend” their reserve? I still don't quite fully understand the whole thing. Thanks! πŸ™‚

    P.S: Sorry about that messy post. The “edit” function wasn't that friendly to use when the text box is so small. πŸ˜€

  • Anon

    Hey well I mentioned it was just media speculation, have you got any links re: Germany announcement ?
    Regarding the EUR/USD I meant the push from 1.35's up was pretty strong. But today has been abit yo-yo — I agree. I thought we'd break past 1.38 but we've fallen back.

    Remember above is not advice, just commentary, for advice/info see a registered competent financial advisor πŸ˜‰

  • temjin

    $anon

    Hey, I know this is a bit off topic, but here it is.

    http://imarketnews.com/?q=node/8487

    He didn't specifically say there will be no bailout. Just denying earlier claims the package deal has been nearly done. (prepared rather) And I heard that made a rather sharp movement in the market.

    Anyway, it's for another article to discuss. πŸ™‚

  • Anon

    cheers πŸ˜‰

  • Pete

    Great comments temjin and Anon.

    I particularly like the articles you have posted temjin.

  • Pete

    That's a pretty cool article Anon.

    Personally I much prefer your “Remember above is not advice, only commentary ? seek financial advice and bankruptcy from your local financial advisor” πŸ™‚

  • @Temjin

    We will write one article on that. The explanation would be quite long.

  • Anon

    lol Pete.
    Might change soon if the government forces financial advisors to act only in the best interests of the client. Their advice would be dont listen to us? lol. I would pay for that kinda advice πŸ˜‰

  • Pete

    Haha, but where would they get employment? Imagine all the lawsuits! Every failed transaction “that wasn't in my best interests!”. Not that i'd feel a shred of sympathy for 'em.

    This quote from the article you posted is eye-opening to me. It is right along the lines of China's reserves problem Temjin posted:

    There is a basic rule of liquidity. It isn?t the same for everyone. If you own 10,000 shares of Greenlight Re, you have a liquid investment. However, if I own 5 million shares it is not liquid to me, because of both the size of the position and the signal my selling would send to the market. For this reason, the Fed cannot sell its Treasuries or Agencies without destroying the market. This means that it will be challenged to shrink the monetary base if
    inflation actually turns up.

  • Pete

    And in regards to this one:

    Over the last few years, Japanese savers have been willing to finance their government
    deficit. However, with Japan?s population aging, it?s likely that the domestic savers will
    begin using those savings to fund their retirements.

    Has anyone considered that Japan savers spending their money would boost the economy? The money will change hands, thats all. Maybe the new owners of the money will invest it? Maybe they will be forced to? Maybe the Japanese Gov. will create incentives like “huge taxes on savings” and “ban foreign investment” (to keep it local). I just thought that part had been overlooked that's all.

    In all cases, surely there is the possibility that, rather than default, Governments just take all the savings of the population? Remind anyone of gold in the GD?

  • jay

    llllllllllllllllll