CSRC: commodity futures speculation not moving spot prices

Eye-watering one-day moves on China spot commodity markets due to “supply and demand”

Shenzhen, China

The head of China's securities regulator rejected criticism that excessive speculative participation in the futures market was "amplifying" wild one-day moves in the underlying spot price. Iron ore spot prices increased by a record 19% in just one day's trading on March 6, for example.

"Judging from the changes of commodity prices this year, futures prices are mostly lower than spot, therefore, futures did not amplify the spot price movements," said the vice-chairman of China Securities Regulatory Commission (CSRC), Fang Xinghai, at a derivatives forum in Shenzhen on 3 December.

"Since early this year, some commodity prices have increased rapidly with huge volatility, attracting attention from society. There are different factors for these moves, including short-term supply/demand imbalance in the domestic market, as well as foreign exchange volatility, and of course speculations," he said, citing the US Interagency Task Force on Commodity Markets, led by the Commodity and Futures Trading Commission, which investigated a possible link between the futures markets and the rise in crude oil prices in the US between 2003 to 2008.

Fang said the US investigation also found the price increase was caused by imbalanced supply and demand, not the futures market.

But a key distinction between China and other markets is the extent of retail activity. A rough rule of thumb is that typically, for example, equity markets are 80% institutional, with the rest being private investors. In China, however, the opposite is true: Reuters estimates that retail money accounts for up to 85% of the trading on the onshore stock market.

Equity index futures trading was effectively banned in August 2015, when the Chinese government raised margin requirements and tightened position limits in order to support the ailing domestic stock market, and a large number of retail investors switched instead to the commodity futures market.

This resulting increase in retail activity was seen in March 2016: as base metals commodity prices rose, activity also jumped on the futures market. Trading volumes of rebar futures (a type of steel used in construction) increased 75.3% compared with February, while open interest only increased 1.26%, according to data from Shanghai Futures Exchange.

A comparison of daily volume and open interest is sometimes taken as a proxy for speculative versus hedging activity; open interest excludes all intraday trading, most of which is presumed to be speculative, while hedging positions are generally held for longer. The Singapore Exchange, which is generally perceived to have more corporate activity, has greater open interest than trading volumes. In July, for example, iron swap volumes averaged 118.8 million tonnes daily, while open interest averaged 186.7 million tonnes.

But Fang said that worrying about the heavy speculative interest in Chinese commodities was "unnecessary".

"Because of the effectiveness of the trading mechanism of the futures market, its price signal moves ahead of the spot market, which can accelerate the price adjustment of the spot market and shorten the adjustment time,"
Fang Xinghai, China Securities Regulatory Commission

"Trading volume was very large for some commodities this year; there was concern that speculating in the futures market would intensify the increase of the spot market. But this is an unnecessary concern because if speculators spike up futures prices despite  the price movement in the spot market, they will lose money when it comes to delivery. Spot prices are determined by demand and supply as well as monetary and credit policies, not by speculators," he said.

Among the supply and demand factors are a number of moves by the Chinese government to reduce industrial overcapacity; many steel factories have been forced to cut their production. Also, Tangshan, China's largest steel-producing city, announced plans to restrict steel production as part of a bid to reduce its carbon dioxide output by 50% ahead of the 2016 Tangshan International Horticultural Exposition, which took place between April and October.

The plan further caused market concern about short supply and moved up prices of iron ore, rebar, coke, coking coal and thermal coal earlier this year, particularly as there was also an expectation that real estate activities would pick up after a new round of credit easing to support the economy and the currency. To curb the market from overheating, the three main bourses, Dalian Commodity Exchange, Shanghai Futures Exchange and Zhengzhou Commodity Exchange, increased margins and transaction fees for many commodity futures, including soybean, soybean meal, corn, rebar, iron ore, coking coal, cotton and rapeseed, in May 2016.

According to Fang, instead of the futures markets amplifying changes in the spot prices, they were instead performing their intended price-signalling role.

"Because of the effectiveness of the trading mechanism of the futures market, its price signal moves ahead of the spot market, which can accelerate the price adjustment of the spot market and shorten the adjustment time," Fang said.

He also encouraged exchanges to launch more hedging tools, such as crude oil futures and sugar and soybean meal options, and said the CSRC would work to promote the establishment of futures laws to improve the operation of futures exchanges and the futures market and prevent violations such as price manipulation.

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