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How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring | Zero Hedge

How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring | Zero Hedge.

A little over a month ago, we reported that following a year of record-shattering imports, China finally surpassed India as the world’s largest importer of physical gold. This was hardly a surprise to anyone who has been following our coverage of the ravenous demand for gold out of China, starting in September 2011, and tracing it all the way to the present.

 

China’s apetite for physical gold, which is further shown below focusing just on 2012 and 2013, has been estimated by Goldman to amount to over $70 billion in bilateral trade between just Hong Kong and China alone.

 

Yet while China’s gold demand is acutely familiar one question that few have answered is just what is China doing with all this physical gold, aside from filling massive brand new gold vaults of course. And a far more important question: how does China’s relentless buying of physical not send the price of gold into the stratosphere.

We will explain why below.

First, let’s answer the question what purpose does gold serve in China’s credit bubble “Minsky Moment” economy, where as we showed previously, in just the fourth quarter, some $1 trillion in bank assets (mostly NPLs and shadow loans) were created  out of thin air.

For the answer, we have to go back to our post from May of 2013 “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event”?“, in which we explained how China uses commodity financing deals to mask the flow of “hot money”, or the one force that has been pushing the Chinese Yuan ever higher, forcing the PBOC to not only expand the USDCNY trading band to 2% recently, but to send the currency tumbling in an attempt to reverse said hot money flows.

One thing deserves special notice: in 2013 the market focus fell almost exclusively on copper’s role as a core intermediary in China Funding Deals, which subsequently was “diluted” into various other commodities after China’s SAFE attempted a crack down on copper funding, which only released other commodities out of the Funding Deal woodwork. We discussed precisely this last week in “What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?”

We emphasize the word “gold” in the previous sentence because it is what the rest of this article is about.

Let’s step back for a minute for the benefit of those 99.9% of financial pundits not intimate with the highly complex concept of China Commodity Funding Deals (CCFDs), and start with a simple enough question, (and answer.)  

Just what are CCFDs?

The simple answer: a highly elaborate, if necessarily so, way to bypass official channels (i.e., all those items which comprise China’s current account calculation), and using “shadow” pathways, to arbitrage the rate differential between China and the US.

As Goldman explains, there are many ways to bring hot money into China. Commodity financing deals, overinvoicing exports, and the black market are the three main channels. While it is extremely hard to estimate the relative share of each channel in facilitating the hot money inflows, one can attempt to “ballpark” the total notional amount of low cost foreign capital that has been brought into China via commodity financing deals.

While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:

the volume of physical inventories that is involved

commodity prices

the number of circulations

A “simple” schematic involving a copper CCFDs saw shown here nearly a year ago, and was summarized as follows.

 

As we reported previously citing Goldman data, the commodities that are involved in the financing deals include copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil, rubber and, of course, gold. Below are the desired features of the underlying commodity:

  • China is heavily reliant on the seaborne market for the commodity
  • the commodity has relatively high value-to-density ratio so that the storage fee and transportation cost are relatively low
  • the commodity has a long shelf life, so that the underlying value of the commodity will not depreciate significantly during the financing deal period
  • the commodity has a very liquid paper market (future/forward/swap) in order to enable effective commodity price risk hedging.

Here we finally come to the topic of gold because gold is an obvious candidate for commodity financing deals, given it has a high value-to-density ratio, a well-developed paper market and very long “shelf life.” Curiously iron ore is not as suitable, based on most of these metrics, and yet according to recent press reports seeking to justify the record inventories of iron ore at Chinese ports, it is precisely CCFDs that have sent physical demand for iron through the proverbial (warehouse) roof.

Gold, on the other hand, is far less discussed in the mainstream press in the context of CCFDs and yet it is precisely its role in facilitating hot money flows, perhaps far more so than copper and even iron ore combined, that is so critical for China, and explains the record amount of physical gold imports by China in the past three years.

Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China as explained last year so it is not shown in trade data published by China customs.

In detail, Chinese gold financing deals includes four steps:

  1. onshore gold manufacturers pay LCs to offshore7 subsidiaries and import gold from bonded warehouses or Hong Kong to mainland China – inflating import numbers
  2. offshore subsidiaries borrow USD from offshore banks via collaterizing LCs they received
  3. onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products to bonded warehouses – inflating export numbers
  4. repeat step 1-3

This is shown in the chart below:

 

As shown above, gold financing deals should theoretically inflate China’s import and export numbers by roughly the same size. For imports, they inflate China’s total physical gold imports, but inflate exports that are mainly related to gold products, such as gold foils, plates and jewelry. Sure enough, the value of China’s imports of gold from Hong Kong has risen more than 10 fold since 2009 to roughly US$70bn by the end of 2013 while exports of gold and other products have increased by roughly the same amount (shown below). This is in line with the implication of the flow chart on Chinese gold financing deals: the deals inflate both imports and exports by roughly equal size.

Given this, that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 (less than US$5bn) to 2013 (roughly US$70bn) is most likely driven by gold financing deals.

However, a larger question remains unknown, namely that as Goldman observes, “we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.”

Recall the flowchart for copper funding deals:

  1. Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.
  2. Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.
  3. Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.
  4. Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.

In other words, the only limit on the amount of leverage, aka rehypothecation of copper, was limited only by letter of credit logistics (i.e. corrupt bank back office administrator efficiency), as there was absolutely no regulatory oversight and limitation on how many times the underlying commodity can be recirculated in a CCFD…. And gold is orders of magnitude higher!

Despite the uncertainty surrounding the actual leverage and recirculation of the physical, Goldman has made the following estimation:

We estimate, albeit roughly, that there are c.US$81-160 bn worth of outstanding FX loans associated with commodity financing deals – with the share of each commodity shown in Exhibit 23. To put it into context, the commodity-related outstanding FX borrowings are roughly 31% of China’s short-term FX loans (duration less than 1 year) .

Putting the estimated role of gold in China’s primary hot money influx pathway, at $60 billion notional, it is nearly three time greater than the well-known Copper Funding Deals, and higher than all other commodity funding deals combined!

Under what conditions would Chinese commodity financing deals take place. Goldman lists these as follows:

  • the China and ex-China interest rate differential (the primary source of revenue),
  • CNY future curve (CNY appreciation is a revenue, should the currency exposure be not hedged),
  • the cost of commodity storage (a cost),
  • the commodity market spread (the spread is the difference between the futures
  • China’s capital controls remain in place (otherwise CCFD would not be necessary).

All of these components are exogenous to the commodity market, except one – the commodity market spread. This reveals an important point that financing deals are, in general, NOT independent of commodity market fundamentals. If the commodity market moves into deficit, or if the financing demand for the commodity is greater than its finite supply of above ground inventory, the commodity market spread adjusts to disincentivize financing deals by making them unprofitable (thus making the physical inventory available to the market).

Via ‘financing deals’, the positive interest rate differential between China and ex-China turns commodities such as copper from negative carry assets (holding copper incurs storage cost and financing cost) to positive carry assets (interest rate differential revenue > storage cost and financing cost). This change in the net cost of carry affects the spreads, placing upward pressure on the physical price, and downward pressure on the futures price, all else equal, making physical-future price differentials higher than they otherwise would be.

* * *

That bolded, underlined sentence is a direct segue into the second part of this article, namely how is it possible that China imports a mindblowing 1400 tons of physical, amounting to roughly $70 billion in notional, demand which under normal conditions would send the equilibrium price soaring, and yet the price not only does not go up, but in fact drops.

The answer is simple: the gold paper market.

And here is, in Goldman’s own words, is an explanation of the missing link between the physical and paper markets. To be sure, this linkage has been proposed and speculated repeatedly by most, especially those who have been stunned by the seemingly relentless demand for physical without accompanying surge in prices, speculating that someone is aggressively selling into the paper futures markets to offset demand for physical.

Now we know for a fact. To wit from Goldman:

From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price .

Goldman concludes that “an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry).” In other words, it would send the price of the underlying commodity lower.

 

We agree that this may indeed be the case for “simple” commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the “hedged” gold selling by China in the “paper”, futures market.

And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a “conspiracy theory” is now an admitted fact by the highest echelons of the statist regime. and not to mention market regulators themselves.

Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 – a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course – just check out those overflowing private gold vaults in Shanghai.

* * *

This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures “hedges”, i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.

In other words, from a purely mechanistical standpoint, the unwind of China’s shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for.  This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.

How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring | Zero Hedge

How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring | Zero Hedge.

A little over a month ago, we reported that following a year of record-shattering imports, China finally surpassed India as the world’s largest importer of physical gold. This was hardly a surprise to anyone who has been following our coverage of the ravenous demand for gold out of China, starting in September 2011, and tracing it all the way to the present.

 

China’s apetite for physical gold, which is further shown below focusing just on 2012 and 2013, has been estimated by Goldman to amount to over $70 billion in bilateral trade between just Hong Kong and China alone.

 

Yet while China’s gold demand is acutely familiar one question that few have answered is just what is China doing with all this physical gold, aside from filling massive brand new gold vaults of course. And a far more important question: how does China’s relentless buying of physical not send the price of gold into the stratosphere.

We will explain why below.

First, let’s answer the question what purpose does gold serve in China’s credit bubble “Minsky Moment” economy, where as we showed previously, in just the fourth quarter, some $1 trillion in bank assets (mostly NPLs and shadow loans) were created  out of thin air.

For the answer, we have to go back to our post from May of 2013 “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event”?“, in which we explained how China uses commodity financing deals to mask the flow of “hot money”, or the one force that has been pushing the Chinese Yuan ever higher, forcing the PBOC to not only expand the USDCNY trading band to 2% recently, but to send the currency tumbling in an attempt to reverse said hot money flows.

One thing deserves special notice: in 2013 the market focus fell almost exclusively on copper’s role as a core intermediary in China Funding Deals, which subsequently was “diluted” into various other commodities after China’s SAFE attempted a crack down on copper funding, which only released other commodities out of the Funding Deal woodwork. We discussed precisely this last week in “What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?”

We emphasize the word “gold” in the previous sentence because it is what the rest of this article is about.

Let’s step back for a minute for the benefit of those 99.9% of financial pundits not intimate with the highly complex concept of China Commodity Funding Deals (CCFDs), and start with a simple enough question, (and answer.)  

Just what are CCFDs?

The simple answer: a highly elaborate, if necessarily so, way to bypass official channels (i.e., all those items which comprise China’s current account calculation), and using “shadow” pathways, to arbitrage the rate differential between China and the US.

As Goldman explains, there are many ways to bring hot money into China. Commodity financing deals, overinvoicing exports, and the black market are the three main channels. While it is extremely hard to estimate the relative share of each channel in facilitating the hot money inflows, one can attempt to “ballpark” the total notional amount of low cost foreign capital that has been brought into China via commodity financing deals.

While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:

the volume of physical inventories that is involved

commodity prices

the number of circulations

A “simple” schematic involving a copper CCFDs saw shown here nearly a year ago, and was summarized as follows.

 

As we reported previously citing Goldman data, the commodities that are involved in the financing deals include copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil, rubber and, of course, gold. Below are the desired features of the underlying commodity:

  • China is heavily reliant on the seaborne market for the commodity
  • the commodity has relatively high value-to-density ratio so that the storage fee and transportation cost are relatively low
  • the commodity has a long shelf life, so that the underlying value of the commodity will not depreciate significantly during the financing deal period
  • the commodity has a very liquid paper market (future/forward/swap) in order to enable effective commodity price risk hedging.

Here we finally come to the topic of gold because gold is an obvious candidate for commodity financing deals, given it has a high value-to-density ratio, a well-developed paper market and very long “shelf life.” Curiously iron ore is not as suitable, based on most of these metrics, and yet according to recent press reports seeking to justify the record inventories of iron ore at Chinese ports, it is precisely CCFDs that have sent physical demand for iron through the proverbial (warehouse) roof.

Gold, on the other hand, is far less discussed in the mainstream press in the context of CCFDs and yet it is precisely its role in facilitating hot money flows, perhaps far more so than copper and even iron ore combined, that is so critical for China, and explains the record amount of physical gold imports by China in the past three years.

Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China as explained last year so it is not shown in trade data published by China customs.

In detail, Chinese gold financing deals includes four steps:

  1. onshore gold manufacturers pay LCs to offshore7 subsidiaries and import gold from bonded warehouses or Hong Kong to mainland China – inflating import numbers
  2. offshore subsidiaries borrow USD from offshore banks via collaterizing LCs they received
  3. onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products to bonded warehouses – inflating export numbers
  4. repeat step 1-3

This is shown in the chart below:

 

As shown above, gold financing deals should theoretically inflate China’s import and export numbers by roughly the same size. For imports, they inflate China’s total physical gold imports, but inflate exports that are mainly related to gold products, such as gold foils, plates and jewelry. Sure enough, the value of China’s imports of gold from Hong Kong has risen more than 10 fold since 2009 to roughly US$70bn by the end of 2013 while exports of gold and other products have increased by roughly the same amount (shown below). This is in line with the implication of the flow chart on Chinese gold financing deals: the deals inflate both imports and exports by roughly equal size.

Given this, that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 (less than US$5bn) to 2013 (roughly US$70bn) is most likely driven by gold financing deals.

However, a larger question remains unknown, namely that as Goldman observes, “we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.”

Recall the flowchart for copper funding deals:

  1. Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.
  2. Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.
  3. Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.
  4. Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.

In other words, the only limit on the amount of leverage, aka rehypothecation of copper, was limited only by letter of credit logistics (i.e. corrupt bank back office administrator efficiency), as there was absolutely no regulatory oversight and limitation on how many times the underlying commodity can be recirculated in a CCFD…. And gold is orders of magnitude higher!

Despite the uncertainty surrounding the actual leverage and recirculation of the physical, Goldman has made the following estimation:

We estimate, albeit roughly, that there are c.US$81-160 bn worth of outstanding FX loans associated with commodity financing deals – with the share of each commodity shown in Exhibit 23. To put it into context, the commodity-related outstanding FX borrowings are roughly 31% of China’s short-term FX loans (duration less than 1 year) .

Putting the estimated role of gold in China’s primary hot money influx pathway, at $60 billion notional, it is nearly three time greater than the well-known Copper Funding Deals, and higher than all other commodity funding deals combined!

Under what conditions would Chinese commodity financing deals take place. Goldman lists these as follows:

  • the China and ex-China interest rate differential (the primary source of revenue),
  • CNY future curve (CNY appreciation is a revenue, should the currency exposure be not hedged),
  • the cost of commodity storage (a cost),
  • the commodity market spread (the spread is the difference between the futures
  • China’s capital controls remain in place (otherwise CCFD would not be necessary).

All of these components are exogenous to the commodity market, except one – the commodity market spread. This reveals an important point that financing deals are, in general, NOT independent of commodity market fundamentals. If the commodity market moves into deficit, or if the financing demand for the commodity is greater than its finite supply of above ground inventory, the commodity market spread adjusts to disincentivize financing deals by making them unprofitable (thus making the physical inventory available to the market).

Via ‘financing deals’, the positive interest rate differential between China and ex-China turns commodities such as copper from negative carry assets (holding copper incurs storage cost and financing cost) to positive carry assets (interest rate differential revenue > storage cost and financing cost). This change in the net cost of carry affects the spreads, placing upward pressure on the physical price, and downward pressure on the futures price, all else equal, making physical-future price differentials higher than they otherwise would be.

* * *

That bolded, underlined sentence is a direct segue into the second part of this article, namely how is it possible that China imports a mindblowing 1400 tons of physical, amounting to roughly $70 billion in notional, demand which under normal conditions would send the equilibrium price soaring, and yet the price not only does not go up, but in fact drops.

The answer is simple: the gold paper market.

And here is, in Goldman’s own words, is an explanation of the missing link between the physical and paper markets. To be sure, this linkage has been proposed and speculated repeatedly by most, especially those who have been stunned by the seemingly relentless demand for physical without accompanying surge in prices, speculating that someone is aggressively selling into the paper futures markets to offset demand for physical.

Now we know for a fact. To wit from Goldman:

From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price .

Goldman concludes that “an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry).” In other words, it would send the price of the underlying commodity lower.

 

We agree that this may indeed be the case for “simple” commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the “hedged” gold selling by China in the “paper”, futures market.

And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a “conspiracy theory” is now an admitted fact by the highest echelons of the statist regime. and not to mention market regulators themselves.

Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 – a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course – just check out those overflowing private gold vaults in Shanghai.

* * *

This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures “hedges”, i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.

In other words, from a purely mechanistical standpoint, the unwind of China’s shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for.  This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.

Welcome To The Currency Wars, China (Yuan Devalues Most In 20 Years) | Zero Hedge

Welcome To The Currency Wars, China (Yuan Devalues Most In 20 Years) | Zero Hedge.

The last 7 days have seen the unstoppable ‘sure-thing’ one-way bet of the decade appreciation trend of the Chinese Yuan reverse. In fact, the 0.95% sell-off is the largest since 1994 (bigger than the post-Lehman move) suggesting there is clear evidence that the PBOC is intervening.

 

The fact that this is occurring with relatively stable liquidity rates (short-term repo remains low) further strengthens the case that China just entered the currency wars per se as SocGen notes, intending to discourage arbitrage inflows. For the Chinese authorities, who do not care about the level of their stock market (since ownership is so low), and specifically want to tame a real-estate bubble, thisintentional weakening is clearly aimed at trade – exports (and maintaining growth) as they transition through their reforms. The question is, what happens when the sure-thing carry-trade goes away?

BofA notes the puzzling divergence between Yuan fixings and short-term liquidity,

The turn of the Chinese New Year brought the People’s Bank of China (PBoC) back into action – it not only restarted repo operations to withdraw liquidity, it actually did it at a much higher rate. The 7d reverse repo rate at which the PBoC injects liquidity is 75bp higher than a year ago, a move considered by the market as a 75bp rate hike over the last year. The new 14d repo (liquidity withdrawal) rate is set at 3.8%, 105bp higher than the rate when 28d repo was last conducted on 6 June 2013. Based on a simple framework, this move is equivalent to another 35bp rate hike (Rate corridor, Chinese style, 18 February 2014).

The puzzle is that both money and bond markets nearly totally ignored such an operation. The 7d repo rate is now fixed nearly 200bp lower since 10 February. Such a massive liquidity improvement in the face of the PBoC’s liquidity withdrawal is puzzling, since by 10 February most of the cash used during Chinese New Year should have flowed back into the financial system already.

The FX market move also begs the question as to why liquidity improved over the last couple of weeks. Generally, the onshore repo rate rises as the RMB weakens against fixing; a normal development because FX outflow dries up liquidity. However, the move in February turned things upside down. Look at the sharp divergence between rates and FX

Which leaves 2 possible reasons for the divergence

It is due to the seasonality of outflows, as this year could be made worse because the onshore rate was much higher before the Chinese New Year. As a result, banks might have borrowed more offshore, helping the RMB to appreciate. After the New Year, this flow reverses and pushes the RMB down. This explains why the CNY leads the CNH in spot selloff. It is also consistent with the large January FX purchase position of CNY466bn. The trouble with this explanation is that as the money flows out, the onshore rate should rise, not drop.

A more popular theory or suspicion puts the PBoC behind the move. As the PBoC buys more USD, it creates natural liquidity in the CNY, leading to much lower repo rates. This explanation is consistent with CNY leading the move, as CNY and CNH spots moved much more than forward, all suggesting a domestic investor-driven rather than foreign investor-driven endeavor. The trouble with this explanation is that the market will have difficulty proving it one way or the other without the central bank explicitly admitting it.

As SocGen notes, the latter makes more sense…

In just short seven days, the once unstoppable appreciation trend of the yuan is reversed. The USD/CNY spot has depreciated by 0.8% since 17 February and the USD/CNH has weakened by more than 1.1%. As for the causes, there is clear evidence of intervention from the People’s Bank of China. We think that the recent yuan move is intended to discourage arbitrage inflows. If short-term capital inflows abate, the depreciation will probably halt.

Ending the inexorable carry trade…

The yuan appreciated by nearly 3% against the greenback and 7% against in nominal effective exchange rate terms in 2013. Over the same period, China’s FX reserves added another $500bn, despite the repeated talk from officials that China has had enough reserves. These seemingly contradictory messages and signs, in our view, suggest that the PBoC never really wants too much yuan appreciation, especially if it is driven by short-term speculative capital inflows.

Which is crucial…

The yuan possesses the very two qualities of a carry trade currency: high onshore interest rates and a gradual but steady appreciation trend. The first quality is partly caused by the Fed’s easing policy and partly by the PBoC’s reluctance to ease domestic liquidity conditions out of concerns over debt risk. This condition is unlikely to weaken significantly in the near term. However, the PBoC is capable of altering the second condition and it seems that it is doing exactly so by reversing the appreciation trend and pushing up the volatility of the yuan.

If we are right about the reason behind the surprising deprecation of the yuan, what will follow next?

– Band-widening? Maybe, but as we have argued before, what matters is how the PBoC manages the currency. To make real difference, we think that the next step in yuan reform should be bolder: the PBoC should move from daily to weekly (or even monthly) setting of the reference rate, while at the same time widening the currency band.

– More depreciation? Probably not much more. Although the central bank does not like too much capital inflows, too much outflows will not be its choice either. The monthly FX position data are something to track for any change in the capital flow direction. A timelier indicator is the spread between CNH and CNY spot rate. If the offshore rate stays persistently weaker than the onshore one by a certain margin, that will be a sign of capital outflows. Then the PBoC will most likely choose to stabilise the yuan again.

The end-result is a concern:

Should the RMB weakening last a while longer, the cross border carry arbitrage flow which has been massive could reverse and lead to higher repo rates. Such a flattening force is a real threat, especially when the PBoC has shown no sign of lowering the repo rates in its operations.

But this certainly will not please the Japanese (trying to devalue and manufacture their own recovery) or any other beggar thy neighbor nation. Welcome to the Currency Wars China… (and we warned here, prepare for more carry unwind and a potential risk flare).

Potential asset deflation is a risk, as the carry trades diminish/unwind. Property prices are at risk – the collateral value for China’s financial systems. This is not a dire projection – it simply seeks to isolate the US QE as a key driver of China’s monetary policy and asset inflation, and highlights the magnitudes involved, and the transmission mechanism. Investors should not imbue stock-price movements and property price inflation in China with too much local flavor – this is mainly a US QE-driven story, in our view.

And lastly, as a bonus chart, we thought the correlation here was interesting…

Average:

The Chinese Dominoes Are About To Fall: Complete List Of Upcoming Trust Defaults | Zero Hedge

The Chinese Dominoes Are About To Fall: Complete List Of Upcoming Trust Defaults | Zero Hedge.

As has been widely reported on these pages in the past month, after a near-reality experience almost claimed the first material Chinese shadow banking default, the Chinese government and central bank did what they do best: a mysterious “white knight” emerged out of nowhere, and bailed out the Credit Equals Gold #1 Trust. A few days later, we reported that China Development Bank lent 2 billion yuan to coal company Shanxi Liansheng, which owes almost 30b yuan to lenders including banks, trusts and asset management firms. And while we know how “difficult” it was for China to do the wrong thing and encourage moral hazard, despite repeated assurances by one after another PBOC director that this time the central bank means business, we have good news: these two narrowly averted Trust defaults are just the beginning – it is all downhill from here.

As Bank of America reports in an analysis by David Cui, the Trust defaults are about to get hot and heavy. To wit:

We believe that during April to July the market may see many trust products threatening to default, especially those related to coal mines. By our estimate, the first real default most likely could happen in May with a Sichuan lead/zinc trust product worth Rmb140mn. This is because the product is relatively small (so the government may use it as a test case), the underlying asset is not attractive (so little chance of 3rd parties taking it over) and we also have heard very little on parties involved trying to work things out. Whether this will trigger an avalanche of future trust defaults remains to be seen and this presents a key risk to the market in our opinion.

 

… it’s still possible that many of the upcoming cases in Apr-July may get worked out one way or the other. Nevertheless, as we believe that many of the underlying assets of the trust products are insolvent, it’s a matter of time that many products will ultimately default, in our view. Various bail-outs will only delay the inevitable.

From BofA’s David Cui

12 potential defaults reported by the media

Table 1 summarizes the information on the 12 major potential defaults in the trust industry that have been reported by the media. Most of them are coal mine related and heavily concentrated in one area, Shanxi Province. So far it seems to us that most of them may get extended upon the due date. The only exception over the next few months appears to be a product issued by China Credit Trust for a lead and zinc miner in Sichuan, Nonggeshan. Even without any major default over the next few months, the process of debt restructuring can be messy and weigh heavily on market sentiment.

19 Feb 2014, Rmb109mn borrowed by Liansheng & arranged by Jilin Trust

  • Details: This Rmb109mn tranche is part of a six-tranche trust product worth a total of Rmb973mn arranged by Jilin Trust for Liansheng, a Shanxi coal miner. The other five tranches have matured since 2H 2013 and remain overdue.
  • Potential outcome: Repayment may be extended.
  • Reason: Liansheng is undergoing a debt restructuring coordinated by the Shanxi provincial government. 1) The provincial government plans to help out involved financial institutions to ensure the region’s access to ongoing financing. According to people close to the situation, the implicit guarantee practice will most likely continue with the Liansheng’s case. 2) Trust companies may have to follow banks to help the miner out. Banks have agreed to extend their mid/long term loans by three years. Top 3 banks have total debts of Rmb10.6bn to Liansheng; top 3 trust lenders, Rmb3.7bn.

(Shanghai Securities News, 2/11; Economic Information, 2/13)

21 Feb 2014, Rmb500mn borrowed by Liansheng & arranged by Shanxi Trust

  • Potential outcome: repayment may be extended.
  • Reason: Same as the Jilin Trust case.

(Caiing 1/27; China Securities Journal, 1/27; 21st Century Business Herald, 2/14)

07 Mar 2014, Rmb664mn borrowed by Liansheng & arranged by Changan Trust

  • Details: Other than the Rmb664mn product to mature on Mar 7, Changan Trust arranged another two products for Liansheng, totaling Rmb536mn which matured in Nov 2013. Both products remain overdue.
  • Potential outcome: repayment may be extended.
  • Reason: Same as the other Liansheng cases.

(Caiing 1/27; China Securities Journal, 1/27; 21st Century Business Herald, 2/14)

31 Mar 2014, Rmb196mn borrowed by Magic Property & arranged by CITIC Trust

  • Details: invested in an office building in Chongqing. The Chongqing developer ran into financial problems in mid-2013. CITIC Trust tried to auction the collateral but failed to do so because the developer has sold the collateral and also mortgaged it to a few other lenders.
  • Potential outcome: The developer and the trust company may share the repayment.
  • Reasons: 1) When CITIC Trust sold the product, it did not specify the underlying investment project. 2) The local government has intervened, fearing social unrest. A local buyer of a unit in the office building committed suicide as he/she could not obtain the title to the property due to the title dispute between the trust and the developer.

(Source: Financial Planning Weekly, 3/6/2013; Guangzhou Daily, 4/6/2013, Boxun, 5/10/2013)

14 May 2014, Rmb1.5bn borrowed by Liansheng & arranged by China Jiangxi International Trust

  • Potential outcome: repayment may be extended.
  • Reason: Same as the other three Liansheng cases.

(Caiing 1/27; China Securities Journal, 1/27; 21st Century Business Herald, 2/14)

30 May 2014, Rmb140mn borrowed by Nonggeshan & arranged by China Credit Trust

  • Details: invested in a lead and zinc mine in Sichuan.
  • Potential outcome: Likely to default.
  • Reasons: 1) Compared to coal mines of Zhenfu and Liansheng, the lead and zinc mine is a much less attractive asset: it is located in the mountains over 5,000 meters in altitude, inaccessible for 6 months of the year due to weather conditions, with low lead/zinc content; 2) According to an unnamed regulator, the central government is comfortable with trust defaults in the range of Rmb100-200mn.

(Source: 21st Century Business Herald, 31/7/2012; Caiing, 1/27)

25 Jul 2014, Rmb1.3bn borrowed by Xinbeifang & arranged by China Credit Trust

  • Details: Xinbeifang is another Shanxi coal miner.
  • Potential outcome: repayment may be extended.
  • Reason: Xinbeifang is negotiating with an SOE to sell some of its coal mine assets.

(Source: China Securities Journal, 1/15)

27 Jul 2014, Rmb319mn borrowed by Hongsheng & arranged by Huarong Trust

  • Details: Hongsheng is a Shanxi coal miner. Huarong sold another trust product for it which will mature in 4 September 2014, worth Rmb63mn.
  • Potential outcome: repayment may be extended.
  • Reason: Hongsheng may have assets to secure more financing. It issued these two trust products to replace another trust product that matured in Q3 2012. The owner also issued other trust products using his personal property assets as collateral and raised Rmb1.2bn.

(21st Century Business Herald, 20/12/2013)

7 Sept 2014: Rmb400mn borrowed by Zengdai & arranged by CCB Trust

  • Details: 1) The proceeds of the product were invested in financial markets. 2) Its 1st tranche, worth Rmb400mn, matured in Mar 2013 with a 38% loss vs. an expected return of 20-30%. Investors agreed to extend the maturity of the product to Sept 2014. 3) Its 2nd tranche, worth Rmb359mn, matured in June 2013 with a 31% loss vs. an expected return of 20-30%. Investors agreed to extend the maturity of the 2nd tranche to Dec 2014.
  • Potential outcome: The trust company and the investment company may share the losses.
  • Reasons: 1) The investment company refused to repay investors in full at the original due date so the trust company may have to chip in; 2) By Jan 2014, the 1st tranche reported a narrower loss of 24%, and the 2nd tranche, also a narrower loss of 13%; 3) Zengdai may pay on behalf of its investment company for reputation’s sake.

(Source: Securities Daily, 9/7/2013; CCB Trust)

20 Nov 2014, Rmb600mn borrowed by Liansheng & arranged by China Jiangxi Int’l Trust

  • Potential outcome: repayment may be extended.
  • Reason: Same as the other Liansheng cases.

(Caiing 1/27; China Securities Journal, 1/27; 21st Century Business Herald, 2/14)

23 Dec2014: Rmb1.1bn borrowed by Xiaoyi Dewei & arranged by China Resources Trust

  • Details: Xiaoyi Dewei is a Shanxi coal miner. The trust product originally matured in Dec 2013 but repayment was extended to Dec 2014.
  • Potential outcome: Likely to default.
  • Reason: Both the miner and the trust company refused to repay investors in full at the original due date. There has been no reporting on asset sales by Xiaoyi Dewei.

(Source: Financial Planning Weekly, 11 Nov 2013)

15 Jan 2015, Rmb1.2bn borrowed by Hongsheng’s owner & arranged by Minmetals Trust

  • Details: the collateral is the Shanxi coal miner’s personal property assets.
  • Potential outcome: May be replaced by a new trust product.
  • Reason: Same as the July 2014 Rmb319mn trust product issued by Huarong Trust.

(21st Century Business Herald, 20/12/2013)

2Q/3Q 2014 – the next peak maturing period for collective trusts

We consider the trust market the most vulnerable part of the major financing channels for companies, i.e. loan, corporate bond and trust. The quality of the borrowers in the trust market tends to among the lowest. Within the trust market, collective trust products, i.e. those sold to more than one investor, tend to be risker than single trust products, i.e. those sold to a single investor. This is because investors in single trust products tend to be more substantial in resources, thus most likely more sophisticated in their risk control.

The Wind database lists close to 12,000 collective trust products, worth Rmb1.34tr, which cover roughly half of the collective trust market (Rmb2.72tr as of the end of 2013). It has reasonably good quality data series on the issuing dates and amounts raised. However, data on maturing dates are sporadic. We estimate that the average duration of the trust products is around 2 years. Based on this assumption and the issuing dates, we have mapped out a rough maturing profile of the collective trust market. As we can see from Chart 1, 2Q and 3Q this year will be the next peak maturing period for this market.

Coal mine trusts maturity schedule

We went through the offering documents of the top 200 collective trust products by size (the smallest being Rmb400mn), worth some Rmb145bn in total. They represent roughly 10% of the trust products in the Wind database and 5% of the overall collective trust market. We identified the industries of the issuers, the regions where their businesses are located and the maturity dates of the products. Table 2 summarizes the results.

We believe that coal mine trusts are the most likely to default over the coming months because 1) coal price has dropped sharply in recent quarters; 2) most of the issuers are private enterprises; and 3) they tend to be from provinces whose governments rely heavily on resources related income, e.g., Shanxi and Inner Mongolia. On the other hand, the property market has been reasonably buoyant in recent times while LGFVs generally have access to re-financing until the implicit guarantee is removed (a whole different topic worthy another report later). Based on the maturing schedule of the top 200 collective trust products, we expect more noise about coal mine trust defaults around Apr, June and July (Chart 2).

Table 3 lists the coal mine trust products that are in our study.

For the trust market, we only have data on approximately half of the collective trust market, which in turn, accounts for about a quarter of the overall trust market. So essentially, we only covered about 1/8 of the total trust market with our analysis. Single trusts are less risky than collective trusts. Nevertheless, if the solvency issue is a systemic problem as we expect, many single trusts will ultimately default by our assessment.

Our analysis has largely zoomed in on coal mine trusts because they represent the clear and present danger given how depressed the coal market has been. However, property related trusts may come under increasing pressure as we sense that the property market may be turning south in small cities. As a result, some of those related products may threaten to default reasonably soon. Then we have the big unknown – LGFV trusts. Whether and when they may default is largely a political decision in our opinion.

China Folds On Reforms – Bails Out 2nd Shadow-Banking Default After “Last Drop Of Blood” Threats | Zero Hedge

China Folds On Reforms – Bails Out 2nd Shadow-Banking Default After “Last Drop Of Blood” Threats | Zero Hedge.

As we showed over the weekend, it is abundantly clear that for all the talk of reform, Chinese authorities have found the gap between words and deeds uncrossable. First, Chinese authorities bailed out the relatively small CEG#1 Trust (for fear of contagion); second, the PBOC injects CNY 375 bn into short-term repo to save banks from a liquidity crisis at year-end; third, total social financing rose by the largest amount on record in January (despite all the talk of deleveraging following the Plenum); and now, fourth, thanks to a CNY 2bn loan (to an entirely insolvent coal company), Chinese authorities have bailed out a 2nd wealth-management product – this time even smaller.

We noted the “technical default” of Jilin Trust last week, and despite its de minimus size, China Development Bank loaned CNY 2bn to the verge-of-bankruptcy Liansheng coal company, and thus bailed out investors in the trust –  piling on the moral hazard.

The Jilin Trust default, as we noted last week, was the second notable ‘technical’ default among Chinese wealth management products recently and caused consternation among investors:

Investors in the Jilin Trust product are demanding that CCB also take responsibility for compensating investors, 21st Century Business Herald reported on Friday.

Bankers have warned that China’s lenders are exposed to vast swathes of loans extended by their non-bank partners and sold to bank clients as off-balance-sheet wealth management products. Though banks are not legally responsible for repaying investors in such cases, they may face pressure to do so in order to maintain their reputations and uphold social stability.

“A few days ago, we went looking for CCB. CCB’s leader in Shanxi still says it’s not his responsibility. In the end, if they really don’t take responsibility, we’ll go to CCB and fight a war to the last drop of blood,” the paper quoted an unnamed product investor as saying.

Investors told the paper that all paperwork and fund transfers related to their purchase of the Jilin Trust product had occurred on CCB’s premises and CCB sales staff had verbally assured investors that the product carried no risk. They also said their willingness to invest was based on their confidence in CCB as a large state-owned bank.

And so what do the Chinese authorities do? Instead of letting a small trust face actual losses, they do what JPMorgan warned would “amplify future losses”

Via Bloomberg,

China Development Bank lent 2b yuan to coal company Shanxi Liansheng, which owes almost 30b yuan to lenders including banks, trusts and asset management firms, 21st Century Business Herald reports, citing unidentified people.

The policy bank is the co.’s largest creditor, with 4.51b yuan in outstanding loans, the report says

The loan will be used to repay maturing trust products sold to retail investors: report

Three local firms will also pay 3b yuan to buy 50 percent of Liansheng, which is based in the northern province of Shanxi, the report says, without identifying cos buying stake

Funds from the stake sale will also be used to repay maturing trust products: report

Repayment of bank loans and single trusts will be delayed

Liansheng, the largest private coal miner in Shanxi, is owned by Chinese entrepreneur Xing Libin, according to the report

Liansheng borrowed more than 5b yuan through 6 Chinese trust firms including Jilin Province Trust and Chang’an Trust, China Securities Journal reports separately, citing unidentified people.

As a reminder, this is what one analyst said of the Chinese coal industry that just got yet another bailout:

Shares of China’s biggest listed coal producers have dropped to their lowest valuations on record as falling fuel prices make it harder to repay debt.

China’s coal industry is “dead,” said Laban Yu, a Jefferies Group LLC analyst in Hong Kong with an underperform rating on all three stocks. “There are 10,000 producers in China. A lot of them are taking on debt. It gets harder and harder to service debts when coal prices keep falling.

Of course, it’s not over yet – as the following chart shows, there are a lot more “maturing” trusts to come in the next 3 months alone…

Allowing investors to be bailed out merely exacerbates the risk-taking mentality and solidifies a belief in a government back-stop (to 10%-yielding highly risky loans to an insolvent industry!!)…

As we previously noted,

…borrowers are facing rising pressures for loan repayments in an environment of overcapacity and unprofitable investments. Unable to generate cash to service their loans, they have to turn to the shadow-banking sector for credit and avoid default. The result is an explosive growth of the size of the shadow-banking sector (now conservatively estimated to account for 20-30 percent of GDP).

Understandably, the PBOC does not look upon the shadow banking sector favorably. Since shadow-banking sector gets its short-term liquidity mainly through interbanking loans, the PBOC thought that it could put a painful squeeze on this sector through reducing liquidity. Apparently, the PBOC underestimated the effects of its measure. Largely because Chinese borrowers tend to cross-guarantee each other’s debt, squeezing even a relatively small number of borrowers could produce a cascade of default. The reaction in the credit market was thus almost instant and frightening. Borrowers facing imminent default are willing to borrow at any rate while banks with money are unwilling to loan it out no matter how attractive the terms are.

Should this situation continue, China’s real economy would suffer a nasty shock. Chain default would produce a paralyzing effect on economic activities even though there is no run on the banks. Clearly, this is not a prospect the CCP’s top leadership relishes.

So the PBOC’s efforts are merely exacerbating the situation for the worst companies…

China Spurs Market Rout Blamed on Fed, Goldman Sachs AM Says – Bloomberg

China Spurs Market Rout Blamed on Fed, Goldman Sachs AM Says – Bloomberg.

By Benjamin Purvis and Candice Zachariahs  Feb 7, 2014 12:56 AM ET

China’s policy shifts are a bigger driver of the selloff in emerging markets than the Federal Reserve’s decision to dial back stimulus, according to Goldman Sachs Asset Management.

Volatility will rise toward its long-term average and that means an increase in risk premiums, said Philip Moffitt, head of fixed income in Sydney for Asia and the Pacific at Goldman Sachs Asset Management, which had $991 billion of assets under supervision worldwide as of September. The risks for different emerging economies will become more idiosyncratic and Mexico presents a buying opportunity following the rout, he said.

Markets from Turkey to South Africa and Argentina were roiled during the past month as investors sold off emerging-economy currencies, stocks and bonds, prompting emergency measures from governments and central banks. The bout of risk aversion follows the Fed’s decision to scale back asset purchases and China’s pledge to rein in leverage and give market forces a more decisive role in allocating resources.

“The selloff in emerging markets has much more to do with China than with Fed tapering,” Moffitt said yesterday in an interview in Sydney. “China’s such a big source of global demand, in particular for other emerging markets, uncertainty’s going to stay high and risk premiums should be expanding.”

Photographer: Andrew Harrer/Bloomberg

Philip Moffitt, head of fixed income in Sydney for Asia and the Pacific at Goldman… Read More

Credit Boom

The worst isn’t over for emerging markets, Mark Mobius, who oversees more than $50 billion in developing nations as an executive chairman at Templeton Emerging Markets Group, said in an interview. Prices can decline further or take time to stabilize, he said.

China’s policy makers have attempted to rein in the unprecedented credit boom they unleashed in 2008-2009 amid the global financial crisis. Money market rates in China have surged, the cost of insuring against credit default by banks has increased and payment difficulties are emerging in the country’s $6 trillion shadow-banking industry.

“They’re looking to create a market that prices credit risk, rather than having prices imposed,” Moffitt said. “In the absence of a strong mechanism for pricing credit risk, there’s likely to be a lot of uncertainty and volatility.”

The world’s second-largest economy is predicted to expand by 7.4 percent this year, the slowest pace since 1990, according to the median estimate in a Bloomberg News survey.

Diverging Outlooks

The slowdown in China comes as the U.S. economy is showing signs of a pickup, allowing the Fed to trim its monthly bond purchases to $65 billion from $85 billion. U.S. growth is expected to accelerate to 2.8 percent in 2014 from 1.9 percent last year, according to a another Bloomberg poll.

Moffitt said investing in Mexico would be his top trade at the moment because the country’s fundamental outlook is strong even though it has been affected by the global selloff.

“There’s been outflow from emerging-market assets and when you get that kind of flow people sell what they can sell, often high-quality assets,” he said. “It will benefit from the strong U.S. growth we’re expecting and there’s the prospect for rate cuts, so Mexico stands out to us on both value and fundamentals.”

To contact the reporters on this story: Benjamin Purvis in Sydney at bpurvis@bloomberg.net; Candice Zachariahs in Sydney at czachariahs2@bloomberg.net

To contact the editors responsible for this story: Katrina Nicholas at knicholas2@bloomberg.net; Garfield Reynolds at greynolds1@bloomberg.net

China’s Credit Crunch | Zero Hedge

China’s Credit Crunch | Zero Hedge.

We hear, read and listen day in and day out that it’s the Dollar that’s dead, that’s it’s the USA that will be knocked off the top of the roost and come hurtling to the ground with its neck being throttled by 1.364 billion Chinese hoards. We learn that it’s the USA that is the corrupt one and that the Federal Reserve can’t solve the financial woes of the country. The banks don’t have the money and no end of Quantitative Easing will solve the problem. But, it’s the Middle Kingdom that looks as if it’s in for a rough ride now as the credit crunch gets ready to punch the Chinese guys right in the eyeballs.

The People’s Bank of China has announced that it’s going to be delaying transfers of cash funds in both Dollars and also Yuan. Hey! I thought the Yuan was meant to be the up-and-coming world reserve currency that knew no problems and felt no crisis? It was only the Dollar that suffered, wasn’t it? The People’s Bank has invoked the need to update systems and do some maintenance. Apparently, it’s nothing to worry about and is just the ‘normal system maintenance’ that always takes place at this time of the Chinese Lunar-New Year celebrations. Transfers will be delayed right after January 30th until February 2nd for domestic transfers and it will continue until February 7th and the end of the holiday for foreign currency transfers.
Right, so there is no problem and the maintenance in the systems are going to take that long to deal with? Let’s hope they don’t get a glitch in there somehow and the entire Chinese banking system goes up in a cloud of mushrooms. There are always delays at the New Year period in China, but, the ones that have taken place in previous years haven’t had the backdrop of the previous problems with liquidity in China. That’s the whole difference in this story and that should be making the rest of us just slightly worried. The Chinese might be stealing the industrial rug from under our feet, but a world without the Chinese finances (at least what they tell us they have) would be a whole different spring roll ahead of us.

Admittedly, as many are willing to express, there is now the race that is on to be the first that predicts the fall of China. But, no need to race, that crystal-ball prediction was forecasted years ago before China even got out of its Communist pants after its long march.
But, today the financial sector in China is having liquidity problems that are getting worse. January 20th saw the interbank rates increase as much as 10%, when the PBOC stepped in. That was an increase from 3% the previous week. It is now at more stable (although still high) levels of 4.65%.

The POBC has urged banks in China to deal better with liquidity in particular at this time of year and to rely less on short-term funding.
But, the holiday-period is a frightening time for the banks as their liquidity drops and therefore trust between the banks gets worse as cash is depleted. The system maintenance comes at a wonderful time. The Chinese are taking a leaf out of the books of the best spin-doctors around and telling the world exactly what isn’t true, but what will be good to hear. Telling us all ‘hey, we’re up it without a paddle’ just isn’t going to instil confidence in the market is it? Welcome to the world of marketing in China.

Lies, lies and wool over your eyes. Until the penny drops, that is.

Originally posted: China’s Credit Crunch

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Is The China Bank Run Beginning? Farmers Co-Op Unable To Pay Depositors | Zero Hedge

Is The China Bank Run Beginning? Farmers Co-Op Unable To Pay Depositors | Zero Hedge.

While most of the attention in the Chinese shadow banking system is focused on the Credit Equals Gold #1 Trust’s default, as we first brought to investors’ attention here, and the PBOC has thrown nearly CNY 400 billion at the market in the last few days, there appears to be a bigger problem brewing. As China’s CNR reports, depositors in some of Yancheng City’s largest farmers’ co-operative mutual fund societies (“banks”) have been unable to withdraw “hundreds of millions” in deposits in the last few weeks. “Everyone wants to borrow and no one wants to save,” warned one ‘salesperson’, “and loan repayments are difficult to recover.” There is “no money” and the doors are locked.

The locked doors of one farmers’ co-op…

Via China CNR,

Shadow Banking has grown remarkably…

…in recent years, opened dozens of Yancheng local “farmers mutual funds Society”, these cooperatives approved the establishment by the competent local agriculture, and received by the local Civil Affairs Bureau issued a “certificate of registration of private non-enterprise units.”

As savers are promised big returns…

Deposit-taking and lending by cooperatives operated operation, and to promise savers, depositors after maturity deposits not only can get the interest, you can also get bonuses.

But recently things have turned around…

However, beginning in early 2013, Yancheng City Pavilion Lakes region continue to have a number of co-op money people to empty, many savers deposits can not be cashed, thus many people’s lives into a corner.

Dong-farmers in Salt Lake Pavilion mutual funds club, a duty officer’s office, told reporters, because many people take money, put out loans difficult to recover, leading to funding strand breaks.

Rough Google Translation:

Salesperson: …the money has been slowly falling and in the end is difficult to ask for money, right? And now there is no money coming in, now people don’t want to save money, and take all the money.

Reporter: But it’s their money, they should be able to…

Salesperson: I know I should [given them money]; however, when the turn started, their is no money, we get cut off and lenders and borrowers took off…

One depositor blames the government (for false promises):

The bank has a deposit-taking his staff, he would say that he is a government action that has the government’s official seal, to give you some interest, as well as the appropriate dividends, because we believe that the government, so we fully believe him , we put the money lost inside, who thought in November, Xi Chu who told us that something was wrong.

But don’t worry – this should all be settled by 2016…

Yu Long Zhang: we put all of his certificates of deposit are received out. You are only responsible for the loan out of the money back to the people against. The people’s money has been invested in other projects go, we have to be tracked to ensure no loss of capital assets, can dispose of his assets disposed of, can recover quickly come back.

Reporter: There is a specific timetable yet?

Yu Long Zhuang: 2014 cashing out the entire program.

Reporter: When did all of these things can be properly resolved?

Yu Long Zhuang: the latest is 2015, 2015, all settled.

So, for the Chinese, their bank deposits have suddenly become highly risky 2 year bonds…

China Liquidity Fears Ease As PBOC Injects 255 Billion CNY – Most Since Feb 2013 | Zero Hedge

China Liquidity Fears Ease As PBOC Injects 255 Billion CNY – Most Since Feb 2013 | Zero Hedge.

Despite all the reform policy imperatives to constrict credit and normalize and liberalize policy and rates, the PBOC just provided the largest liquidity injection to its banking system in a year – 255bn CNY. While this is not entirely unusual for a year-end, when Chinese banks have to confess their illiquidity sins and cover mismatches (and are always helped by the PBOC); this year, short-term money-market rates are triple that of last year and there is a very real chance of a very real default within the shadow banking system. Of course, the sell-side are desperately writing cover that this is all priced in and even if the PBOC “lets some Trusts go” then they will come to the rescue and any crisis will be “contained.” However, no one knows who will be saved and therein lies the safety-first rub – now where have we heard “contained” before?

  • *PBOC TO CONDUCT 75B YUAN OF 7-DAY REVERSE REPOS: TRADER
  • *PBOC TO CONDUCT 180B YUAN OF 21-DAY REVERSE REPOS: TRADER
  • *PBOC OFFERS 7-DAY REVERSE REPO AT 4.1% YIELD: TRADER
  • *PBOC OFFERS 21-DAY REVERSE REPO AT 4.7% YIELD: TRADER

China Repo (lower) and Reverse Repo liquidity provision…(biggest liquidity provision in a year)

Crucially, the PBOC will have to withdraw this liquidty (obviously as the repo matures) if it is merely year-end window-dressing (as is obvious in the chart above with the large downward red bars in each Feb).

For now short-term repo rates are lower

1d: -85bps at 3.48%
7d: -135bps at 5.25%
14d: -34bps at 5.57%

But of course, the big banks always bid first and scoop up the supply – just as we saw yesterday – its the smaller banks that are the most in distress and 7-day repo went through a 8, 9, and 10% rates – these are triple those of the peak rates during last year’s new-year liquidty crunch.

And as much as banks will contend – just as the China itself admitted tonight:

Credit default risks with Chinese companies are emerging because of rising borrowing costs and tight liquidity conditions, said the official China Securities Journal in a front page editorial. The government needs policy flexibility to prevent any systematic financial risks.

This problem – described as “contained” by one sell-side shop reminds us of the “it could never happen here” mentality in the 2008 US shadown banking system. Critically, when the PBOC suggests it may let some banks go (to prove its mettle and resolve to fight out of control credut creation); investors will sell first and think later about which are safe and which are not. A ‘default’ – which looks increasingly likely – may just be the test of just how ‘planned’ and ‘controlled’ the Chinese banking system can really be…

We have on little question… for now the only Wealth Management Trust product that is publicly on the verge of default is CEQ#1 and that is only a 3 billion CNY position – so why did the PBOC feel the need to provide more than 80 times that amount of liquidity to the banking system unless it was epically worried about contagion and the total size of the Trust market.

Of course, the knne-jerk reaction is positive (well it is 255 Billion CNY of magic money) but between the BoJ starting its two-day meeting and John Hilsenrath confirming that Taper is here to stay – JPY weakness (and USD strength) are dragging stocks higher with S&P futures +7.5 from Friday’s close.

 

Fun-DURR-mentals?

 

Charts: Bloomberg

“China Expected To Announce It Has More Than Doubled Its Gold Reserves”, Shanghai Daily | Zero Hedge

“China Expected To Announce It Has More Than Doubled Its Gold Reserves”, Shanghai Daily | Zero Hedge.

The topic of China’s below the radar accumulation of gold is nothing new: first revealed here in September 2011 as part of a Wikileaks intercept, watchers of Chinese gold imports have been stunned by the ravenous pace with which Chinese customers have been gobbling up both domestic and foreign gold production month after month. One needs merely to glance at the net imports of gold just through Hong Kong to get a sense of just how much gold has flowed into the country which has now surpassed India as the largest buyer of gold.

But the biggest question mark since 2009, when China gave its last official gold holdings update, has been how much gold has the People’s Bank of China accumulated. One thing is certain: it is well more than the official number of just ovef 1000 tons.

Recall the confidential memo revealed through Wikileaks:

According to China’s National Foreign Exchanges Administration China ‘s gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the U.S. and European countries. The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold’s function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.

In other words, between 2009 and 2011, China’s gold reserves had increased according to internal data. One can assume they have increased substantially since then, however the PBOC, judiciously, has refused to provide an updated amount of its gold holdings for five years in a row: after all why buy at higher prices (if the world knows that the PBOC is buying at any price), when it can buy cheaply?

However, the period of stealth – and cheap – accumulation may be ending. At least according to the largest English-language portal in East China: Shanghai Daily.

The website, which cites an analysis by Jeffrey Nichols of American Precious Metals Advisors, reports that the Chinese central bank is about to announce its gold holdings have nearly tripled from 1054 tons to 2710 tons.

From Shanghai Daily:

China may soon announce an increase in its official gold reserve from 1,054 tons to 2,710 tons, Jeffrey Nichols, managing director of American Precious Metals Advisors, said.

 

The People’s Bank of China has not reported any increase in official gold holdings since 2009, when the central bank said the official reserve was at 1,054 tons, which accounted for only about 1 percent of its multi-trillion foreign exchange reserves.

 

The PBOC has been “surreptitiously” adding to its official gold reserves. It has bought a total of 654 tons in 2009 through 2011, another 388 tons in 2012, and more than 622 tons last year, mostly from domestic mine production and secondary supplies, Nichols said in a commentary posted on NicholsOnGold.com yesterday.

 

Central bank purchases comprise the smallest fraction of global gold demand — less than 10 percent.

 

“If China announces an increase in gold reserves, there would be an immediate drag-up force in the gold market,” Albert Cheng, managing director of the industrial association World Gold Council for the Far East, told Shanghai Daily.

 

China is the biggest gold consumer and producer in the world.

 

Combined demand in China in the first three quarters amounted to 821 tons and the demand for the whole last year is expected to exceed 1,000 tons, according to the council’s earlier statements.

Oh well: the period of quiet accumulation was fun while it lasted.

That said, we for one would be happy if Nichols is wrong, and if the PBOC were not to announce any time soon it has become the fourth (or third, or second) largest official holder of gold in the world. Because unlike clueless, momentum-chasing traders everywhere, it is always better to buy lower than higher: a concept which the entire Western “developed” markets and the HFT algos and sophisticated “hedge fund” investors that trade them, have either forgotten or never grasped to begin with.

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