Thursday, May 12, 2011
Rubbish is seen by recyclers as commodities. TMM just think that Commodities are rubbish.
TMM’s lack of interest to participate in the upswing in commodities and particularly inenergy has proven to be well timed. Carnage continues in all things commodities and does not appear to be abating. The first leg down, as we suggested last week, was predominantly CTA driven leaving the market thinking that such moves can happily be faded as they are just “to be expected” adjustments within a macro trend, which normally plays out as long as the real money investors don’t start to liquidate as well. But whilst many in the market are scrutinizing for signs of real money joining the selling TMM think there is another major force at work that hasn’t really been noticed or discussed - The great China warehouse financing unwind.
The Chinese warehouse financing goes something like this -
Now, to TMM’s eyes there are a few problems here. First, this is fraud for the simple reason your use of proceeds isn’t what you stated. That isn’t good. Second, the entire creditworthiness of this exercise moves from being copper that should be delivered within a month, to 6 months of murky real estate/whatever you name it risk. Third, this says a lot about Chinese bank credit risk management – it’s awful.
TMM note that this commodity unwind appears to have been very closely correlated with Chinese administrative measures in property and particularly declining property sale volumes (not values). It’s easy to see why: if these guys can’t sell their dirt quickly the loan game is up and the developer has a problem. What’s more, the copper is not something the developer actually needs and what he is holding has now depreciated. So he finds himself long of dirt, long of copper at the wrong price and with a lot of short term liabilities. What’s the easiest solution? You Sell the copper and sell the dirt ASAP and try to get alternative funding. Is it just a coincidence that the Asian high yield market is bursting with supply from all manner of corporates that need dollar funding? Admittedly going from L+70 Letter of Credit funding to L+800 high yield is a tough unwind but there isn’t a lot of choice out there. Additionally, for those not big enough to do bond deals this may go some way to explaining Chinese loan growth still being laughably high – extend and pretend is a good option for these guys while they try to work out all these dirt loans they made to dirt bags. Sounds positively European re periphery debt doesn’t it?
And yes, if you are wondering “maybe Jim Chanos is right and China is a massive Ponzi scheme built upon property prices and infrastructure spending that is not NPV positive” TMM thinks you are probably right, though no doubt the government will turn on the credit taps in case of emergency and run the Hang Seng up in our faces one more time yet. So, what does this mean for metals? First, with the great China warehouse financing unwind has come a pretty brutal liquidation of hedge fund positions – and it wasn’t just CTAs. Our friends and associates in the macro space appear to have been very long and wrong in this stuff and stories of who dropped how many hundreds of basis points over the last month are a seemingly daily occurrence.
As for precious, TMM are of the opinion that silver is a pretty good indication of how likely QE3 is, and how that changes fair values for things without a coupon.