2015-10-14

China's Volatility Machine: Copper Edition

ZeroHedge: The Biggest Threat To Glencore's Survival: The Unwind Of China's Copper "Carry Trade"
The great mystery of metals is the amount used to finance the Chinese carry trade, or collateral used to borrow cheap dollars to buy yuan-backed high-interest-carrying notes. The Bank for International Settlements says this trade may be $1 trillion to $2 trillion, tying up tens of millions of metric tons of iron ore, aluminum and other metals. About a year of global copper consumption (22 million mt) equals just 5% to 10% of the estimate.
The irony is the situation is better for commodities, slightly, if most of the inventory is fake.

Here's a simplified breakdown of what's going on:

1. Borrow buys commodities because banks won't lend without good collateral
2. Leverage up commodities holdings with debt from multiple banks
3. Invest in real estate, credit guarantees, high interest lending, or RMB bonds that yield more than the interest rate on the loan
4. Investments start declining in value; cut losses and reverse the trade
5. Falling commodity prices weaken emerging markets
6. Demand for Chinese goods falls
7. Yuan depreciation pressure increases, go back to number 4.

There are a lot of steps in between, including potential NPLs for the banks, but the macro level is bad enough. If commodities are as large a financial asset as suspected, the post-2008 global recovery may have been almost entirely the result of the debt binge in China, which propped up commodity prices and emerging markets. The decline from 2011 until today is merely the end of the expansion, the prelude to the ultimate denouement as the commodity-backed carry trades fail and stockpiles are dumped onto world markets. Thus as I say above, the more Chinese defrauded their own banks by rehypothecating commodity inventory, the better it will be for commodity producers. Except that it still will be bad news for the Chinese economy, which will hurt commodity demand and emerging markets...

Related: China's Volatility Machine

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