“Speculative Mania” in Chinese Markets

May 13th, 2016 by

One of the consistent themes of the markets over at least the past two years has been the fear that a “black swan” event is on the horizon for the global economy. What form this unexpectedly bad event takes is very much up for debate.

Nonetheless, the mere fact that there are several different theories about what will ultimately upset the world’s economic order lends credibility to the idea that something will do the deed eventually.

china-stockIn many cases, the sputtering economic outlook for China is at the center of these theories.

What Goes Up Must Come Down

One of the big stories of last summer was the collapse of the exuberant bull market in Chinese stocks. The benchmark stock index in Shanghai more than doubled in the span of less than a year. The country is fairly inexperienced with these kinds of mechanisms, as China’s stock market is only a fraction of the size of larger, more mature financial markets in Japan and the United States.

If you’ve caught on to how manipulated the stock markets are in New York and London, then consider that the People’s Republic of China runs an even more restrictive regime than its counterparts in the West. Negative media reports about the government or the economy are strictly prohibited. The authorities are unilaterally in favor of their citizens investing in its stock market, openly encouraging people to place their life savings into Chinese equities while making tacit promises that the market can essentially “only go up.”

China Debt ConceptBeyond these unrealistic assurances and the suppression of any critical news, the Chinese state has also aggressively pushed for looser rules that allow any average person to trade stocks on margin. The trend of spiraling debt and leverage that is bloating the country’s economy replayed in its stock markets, as well. For some time, this “extreme speculative mania” ran unabated.

Combine all of this with blatant government intervention to prop up the stocks of major Chinese companies and you have a recipe for a bubble. Not surprisingly, the fantastic performance of China’s stocks hit a wall last summer that has seen the Shanghai Composite index lose some 40% of its value, erasing $5 trillion in market value. Consequently, foreign investment also fled the country and the global economy was rocked by the volatility.

Although it has recovered slightly from its low, the Shanghai Composite is still down roughly 20% year-to-date. Now, a spike in commodities trading—but inexperienced, unwitting average citizens—is again raising the possibility of a new “black swan” from inflated Chinese markets.

Worse Than Before

The current credit-fueled gambling going on in China’s commodities trade has actually exceeded the mania of last year’s stock bubble described above. Bloomberg offers some perspective on the current bubble: “As the nation’s army of individual investors piled in, they traded enough cotton in a single day last month to make one pair of jeans for everyone on Earth and shuffled around enough soybeans for 56 billion servings of tofu.”

Commodities like iron and rebar are seeing ridiculous volumes in large measure because everyday people are swapping these contracts frivolously looking to make a buck, even trading from their work office out of boredom. We saw the same kind of proliferation of “easy credit” speculation in the U.S. during the run-up of the dot-com bubble, when teachers and clerical workers could easily buy and sell Internet stocks from their desk.

Source: Daily Mail (U.K.)

Source: Daily Mail (U.K.)

Similarly, these are risky day-trading strategies. During April, the average holding time for a contract in rebar or iron ore was a mere 3 hours! The volume of these reckless trades surged above $260 billion on April 22nd alone—bigger than the entire GDP of Ireland! Like the bust in tech stocks at the turn of the millennium, this imbalance must unravel at some point.

This all points toward another black swan for the world economy. If the recent recession and last summer’s collapse of Chinese equities were not bad enough, the signs seem to show that today’s situation is just as bad as the fateful bubble inflation from 2001 through 2008.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.