Thursday, May 12, 2011

Commodities are Rubbish

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.

In the short term, this dip is really hard to buy – just like China base metal demand made no sense for a long time and ran metals way higher than anyone thought possible it is similarly likely to prove a long and ugly unwind. Add to that the risk of a China rate rise or one-off reval which would blow up more warehousing deals and a bad outlook elsehere (Eurostriches, bad ISMs etc) it is very hard to love base metals at anywhere near current levels.

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.


Anonymous said...

With only subtle difference this has been yet again one more specualtive bubble based upon the same disregard for regulation,risk and fundamentals. The problem in dealing with it is we know it can go on for far longer than we have money to oppose it.Yet we can always simply sit back in the knowledge that most of the braggarts who passed us on the way up with positions in this will also pass us on the way back down. Not all ,but enough to know we didn't waste our time relying on what we know.

Anonymous said...

Funny enough, some chinese advisor was yesterday reported by Reuters saying PBoC may well cut rates around Q4.

Nemo Incognito said...

Anon, if they don't want ridiculous NPLs they may do just that. The biggest risk for being short commods is that Chinese authorities just might put the Dr Strangelove inflation trade on out of desperation or face the prospect of *gasp* privatizing their banks and *gasp* privatizing SOEs and doing their own bit of debt destruction.

If they are as gutless as the ECB it can't be ruled out lightly.

Skippy said...

Chinese policy makers are like Hong Kong or Singapore taxi drivers - they have one foot on the accelerator while the other one is on the brake.

China is cyclically over invested - if they continue to let it rip (not tighten sufficiently) they may become structually over invested.

If the rout continues, the PBOC may ease again in Q4, but that will only exacerbate the challenge over the next few years.

Excellent note today. Cheers

zenon said...

If you can show me how to borrow money by using a long position in a 6 monthh copper contract, I may be tempted to do it.

Anonymous said...

glencore ipo, rbs buying abn, aol buying time warner ... the japanese buying of the rockefeller center ... oh well. showing my age here.

TulsaGuy said...

what no one talking about China's copper imports in April down 22% compared to a year ago? Or the AUD job numbers worse than expected, indicating a hollowing out of the Aussie economy?

Anonymous said...

Some think it is business as usual in China:

Anonymous said...

Nemo your article was pretty much reproduced in The Age newspaper in Australia last weeek (even including a direct quote) without any attribution. I wanted to protest but it wasnt obvious how to do it (I'm pretty lazy). Hopefully the plagiarist reads this comment section to know he has been busted.

Anonymous said...

That bastion of objective and critical analysis, the australian news media.

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