Wednesday, June 10, 2009

The China Syndrome

Another day, another low-volume traipse within established ranges. That sentence sums up yesterday's action in equities and currencies rather succinctly, don'tcha think? To be sure, there's still plenty of action in rates space-any day when red Eurodollars rally 25 bps can hardly be called "quiet" or "uninteresting", that's for sure.

But from Macro Man's perch, perhaps the most interesting market at the moment is commodities. The rise in crude over the last few weeks has been little short of inexorable. While the rally in prompt (front-contract) crude for much of May was mostly a curve trade, narrowing the steep contango in crude, over the last couple of weeks the belly/back end of the oil curve has exploded higher. Dec '12 is up a full $10 over the last 10 trading days, for example.

What's driving this? To a degree it's a dollar phenomenon, the same sort of "invoice currency" effect that we observed last year. Moreover, the rise in crude specifically and commodities generally has exhumed the momentum jockeys, who have started buying simply because the price is going up. But ultimately, it seems to Macro Man, the bedrock of the commodity bull story is down to the Chinese growth "miracle." Call it the China syndrome.

On the face of it, now looks like a great time to position long commodities for a China-driven bull run. After all, the PMI only ticked above 50 a few months ago. Perhaps more importantly, Chinese imports have not rebounded much at all in value terms. The chart below shows the nominal dollar value of Chinese imports since the beginning of 2003.
Drilling down beneath the surface, however, we see a picture that is much less unequivocally bullish for commodities. While overall imports have barely started to recover in value terms, many commodity imports have absolutely skyrockjeted in volume terms. And at the end of the day, the inputs to China's industrial and investment complex are based on volume, not value.

Macro Man ran a study looking at the import volume of four different industrial commodities, comparing it with the trend of 2003 through mid-2008, a period in which Chinese growth averaged 11%. (Data for coal imports only begins in December 2004.) The results were remarkable.

Starting with coal, for example, we see a modest upward trend in coal volume imports, which is surely what you'd expect from an indutrial country like China. To be sure, the noise aroudn the trend was fairly substantial, even in the good times. But note how the last few months have seen import volumes blow through the trend and exceed prior highs by a very sunstantial amount.
We observe a similar phenomenon in iron ore, where the prior trend was stronger (a steeper slope) and less noisy. Again, import volumes have blown through where they "should" be had China continued along its 11% growth pace. Not coincidentally, there have been plenty of anecdotal reports recently suggesting that Chinese iron ore stockpiles are bursting at the gills and that there is a lengthy queue of ships waiting to deposit more on China's shores.
Copper is also quite interesting. Unlike the prior two commodities, even during the good tiems there was no discernible trend in imports. You can see the peaks and valleys induced by prior policy actions from the central authorities. But again, the message is quite clear: China has recently imported much more copper than they ever did during the boom times.

And finally, crude oil. This may be the most remarkable chart of all. While crude hogs most of the headlines in the commodity space, on the basis of this study at least China's behaviour has had relatively little impact on price. Unlike the other commodities, import voloumes have yet to reach last year's highs, and they have only now reached the trend of the salad days.
May trade data is scheduled for release tonight, and it will be fascinating to see how imports evolved- both in value and volume terms. From Macro Man's perspective, China has been been fairly shrewd in all of this, building large stockpiles of important industrial inputs at knock-down prices.

The flip-side, of course, is that even if China manages to maintain its recent growth path over the next few quarters, its recent commodity buying spree might mean that it buys much less from the rest of the world than one might normally expect, perhaps with the exception of crude oil (the only commodity where Macro Man retains a long exposure.)

For now, the China syndrome giveth....but if Macro Man were long high-beta plays on Chinese growth, he'd be concerned that at some point, the China syndrome may taketh away.


Anonymous said...

a few comments on rates, feedback is welcomed. from last autumn onwards people have been long USTs to park their cash, now a lot of that money seems to have left the long USTs trade and is somewhere... but where? just a bullish argument for the current development in rates, higher rates do not necessarily need to be bearish...

spagetti said...

higher rates are used as a bullish argument for stocks; money migrating from govies to equities, is a proof of an equity bull market

i see something wrong with this circular logic.

rather, money migrated from bonds to equities making equities vulnerable

H(oratio) said...

Thanks, good graphs and explains much.
How about them. How about them 6 pence moves on a 48 hour graph? Is that the Global Investors purchase money being converted this time?

Professional Gringo said...


Obama administration spokesman "Baghdad Bob" Gibbs was queried about China's GDP yesterday and said "Keep your enemies close, and always know what the crazy chick with armpit hamsters is saying."

So we have that going for us.

The E wave critters have some convincing arguments on some nice up channels..4 hour charts on cable and some others.

Unconvincing open to the European markets in regard to fair value on the majors, and their ability to move things forward against the Usd. No news really this week.

It's just boring right now. Break out the blender and make rum drinks for lunch?

SFOT said...

Nice long on crude MM. Looks like trend is continuing. I'm happy to be long gamma here in short end.

Nemo Incognito said...

Crude's a good bet - especially given those China car sales. Wow.

All the anecdotal stuff on Chinese credit expansion is bananas, real estate companies are going nuts buying land again and everyone thinks it can last more or less indefinintely. Its like being in the US in 2006, when the music stops their banks are going to be screwed (again).

Anonymous said...

MM strong commentary the last week or so, esp today and friday, thanks. You know I agree with you re EURGBP med term mainly cos € has to suffer, but I think GBP is way overdone on this rally against main crosses. Expect cable to sink once the yards for BGI are done, Brown shmaown.
Re crude I think US demand destruction should outweigh Chinese increases at the margin so I think the front end of WTI is also overdone too.
I think the risk rally is starting to run out of steam, but am only chipping away for now.
Cheers, JL

Anonymous said...

Where do you source your data from? Do you use EcoWin?

Macro Man said...

Either Datastream or Bloomberg. In this case, it was Bloomberg.

SD said...

MM - don't 'bout the knee, but the writing is back to pro shape! Great posts the last few days, thanks.
What's been the interesting question for me is whether China is stockpiling because its timing the market or are they rolling less of their USD into USTs and Agencies and instead buying a mountain of stuff as a broader diversification program? What's your take?

Macro Man said...

JL, SD, thanks for your kind words. As noted last Monday, after six weeks of keeping one eye max on the market, I am now fully re-engaged> Part of this process has indeed been physical...I can now spend more time under a desk without the knee joint becoming very, very stiff. In any event, it is nice to hear that you feel this re-engagement has been associated with an uptick in the quality of the posts. I guess I'd be a tad concerned if there wasn't!

Re: £, I concur that it is a "two steps forward, one step back" process of normalization in EUR/GBP, best played IMO with a short (or at least not overly long) vol directional type strategy....spreads, RKOs, etc.

As for China, I think some of the activity has been conscious stockpiling, and some of it has been guys being given a huge dollop of cash and deciding to buy raw materials in the absence of anything more constructive to do with it. Either way, colour me sceptical that it can continue for much longer.

Anonymous said...

see how sticky the s&p is on 50x levels.
its a very obvious thing known w/in the mkts (due to gamma trading on option strikes), but recently its been super strong. just cool to observe.


Anonymous said...

i finally figured it out!
think about it --mm
uso, tbt unstoppable - 'true' money flow
xlf trades with a lid... why???... because hedgies or big options buyers are gamma trading their out of the money xlf calls - which they bought months ago...
all this means is that when the gamma trading reaches saturation (i think soon) we will be set up for a mega move higher due to xlf leading the charge.

call it 1000 1050

count it

Macro Man said...

..or.....maybe it's because XLF is (still) chock full of turds?

I don't think USO tells you much other than what Mom and Pop are doing. It's such a colossally bad investment vehicle that I'd really prefer to think that professional investors stay the hell away.

In any event, volume in USO has been mediocre at best in this rally, so I don't think it's a retail phenomenon.

Anonymous said...

Just thought you'd like to know in case you already didn't, shurely shome mishtake in the absence of a syndication fee:
Laters, JL

Macro Man said...

Yeah, it's with permission. Because I don't advertise or taker any revenue out of the site, I am OK with people republishing content with proper attribution.

It might take away a bit from the visitor figures for this site, but as you know, you gotta come here to experience the comment-section banter...

Anonymous said...

if its the only conduit w with i can trade the underlying, then eff it... even though it charges a % more and gets drilled on contract rolls.

it still pumps out green p&l

and these professionals you speak of... i would love to meet one


Martin said...

Hey MM - great stuff, as often is the case. Might I modestly suggest though that you invest in a spell checker? Hope the knee is mending on schedule. Do not neglect the PT.

Macro Man said...

Martin, one of the reasons that there are more spelling errors than usual is that immediately after writing, I generally launch into some PT exercises without proofreading. Mea culpa!

Anonymous said...

what is your source, MM ,for all this import volume data into China ?

Stephen Kirchner said...

Helps explain how Australia posted a 2.7% q/q and 3.5% y/y increase in export volumes in the first quarter.

Anonymous said...

it is also important to note that for iron, there is also some substitution of domestic ore: domestic is of quality and more expensive at the moment - imports should decline once this price gap narrows

it also makes you wonder about that trade balance...


TedM said...

two points to be made with regard to your bullish tone in crude. 1)Last yr one of the most fundamentally bullish aspects of the rally was the fact that OPEC was producing at what was basically full capacity. This year they are not there and either through cheating or a legitimate price increase it is possible to see them put more supply into the market and dampen things 2)While china's consumption looks impressive on paper bear in mind that they are still a relatively small consumer when you consider there bpd consumption vs the US. In fact I read a stat that basically said china's bpd consumption only amounts to a fraction of what the state of California takes down. While their consumption, along with that of the rest of the EM world, is growing, it is no where near where OECD consumption is and therefore even if the EM markets resume their growth path you will need to see a global recovery to see the type of demand stats we need to sustain these levels in the long run

TedM said...
This comment has been removed by the author.
TedM said...

2 things points here 1) OPEC. Unlike the commodity rally last year they still have capacity and my guess is that we will see more supply coming at these levels (either officially or through cheating). While its not been the case lately at some point the supply demand fundamentals will catch up and take us lower in crude 2) While china's consumption has been steady throughout the slowdown their consumption relative to developed countries is still small. I cannot remember the exact number but I believe that China's bpd consumption figures are still less than California's let alone the rest of the country or OCED. Point being that unlike other commodities (some of thebase metals, iron ore, coal) Chinese consumption habits do not have that great an impact on global prices

Anonymous said...

"Helps explain how Australia posted a 2.7% q/q and 3.5% y/y increase in export volumes in the first quarter."

Idiotic methodology offers a much better explanation.

"The volume measures of exports of bulk commodities recorded for the latest quarters in the ABS Balance of Payments and National Accounts Statistics are calculated by multiplying the quantities of such exports, as reported by exporters in tonnes or some other unit of quantity, by the average price of such commodities, as reported by exporters in the reference year. For the March quarter 2009 volume estimates, 2006-07 is the reference year for prices. The reference year prices are updated annually, in the September quarter accounts. For example, the September quarter 2009 accounts will use average prices reported in 2007-08. This methodology assures that movements in the volume of bulk exports from one quarter to the next reflect only changes in actual volumes and are not influenced by changes in prices."

Anonymous said...

this is cash in the bank.

start counting the chips now

Arun said...

TSY always seem to hit year high peaks in the second half of june.. happened in 2006, 2007 , 2008 too.. not saying sell off in rates will reverse, just pointing out the observation

Thomas said...

Quote: "on the basis of this study at least China's behaviour has had relatively little impact on price"

But there is a strong uptick at the end of the graph.

As oil producers have reduced their output to reflect the much lower demand, it should influence prices when Chinese demand suddenly bounces back to pre-crisis leven, no?

Anonymous said...


On Chinese import charts, what is the units on Y axis.?
Tonnes? Percentage? etc..


Macro Man said...

It depends on the commodity. I believe for most of them it is million tons, but there might be an exception on of these four. I probably should have labeled the y axis at the time, but I forgot to do it and can't be bothered to look up the answer on a Sunday evening.

bill markle said...

The comment may be a little late to this discussion, but my Chinese government contacts in economic development departments confirm that the government, acting at the provincial and city levels, is acting as "buyer of last resort" for manufacturers.

Tom said...

Good and important post, except for the odd conclusion that China's stockpiling is "shrewd". This is a classic case of a superbull running up the prices on the things that he's accumulating, and then being convinced by the price gains that he was right to buy and should buy more quickly. You could call it an understandable beginner's error if this superbull hadn't done precisely the same thing just last year with oil - China didn't stop stockpiling till the price they were paying broke past $120. And then it fell below $35.