China feels it is at the mercy of international commodity suppliers rather than the master of those markets even though it is often the largest buyer for many commodities. As a result, the government is looking to position futures exchanges to rival the London Metal Exchange, New York’s Mercantile Exchange and the Chicago Board of Trade, enabling (in their opinion) Chinese buyers to inform the world what their expectations are on price, according to an article in the Wall Street Journal.
There is no doubt that considering China’s position as a major buyer and producer of many commodities, including oil, metals and agricultural products it should have more vibrant futures markets. We only have to look at the attention that the Shanghai Futures Exchange gets in setting world copper prices to see that the interplay of supply and demand in China influences price movements globally. The authorities are looking at contracts for oil, tin, lead, and even sea freight containers while at the same time further consolidating the activities of the many exchanges that exist across the country to create a more coherent internationally recognized marketplace.
The WSJ says Beijing believes hosting the three big futures markets will enhance the country’s economic security by essentially advertising what the world’s biggest customer for many commodities considers a fair price. Chinese leaders are concerned that their nation’s enormous economic expansion is becoming an excuse for foreign suppliers to inflate commodity costs. So they hope to use their three futures exchanges, Shanghai Futures Exchange, Dalian Commodity Exchange and Zhengzhou Commodity Exchange to fight back. For suppliers to the market a more transparent market price may reduce the guesswork in understanding where the price should be and hence reduce volatility, or so it is hoped. There is something in this, it was clear from the arbitrage window which opened up this year between SHFE and LME copper prices that demand in China was running ahead of the rest of the world. As physical metal moved to meet that demand, the window closed and a more balanced position now prevails. The SHFE premium cannot be blamed for causing global copper prices to rise it merely reflected the divergent demand positions between China and the west. Such transparency in metals not currently served by futures contracts would be a good development.
The biggest advantage may be to Chinese manufacturers having access to more liquid forward markets in which they can hedge their commodity risks. Liquidity will in part come from greater speculative activity and that will be a challenge to control. Certain markets already have a large speculative element such as Zhengzhou’s sugar contract where steep rises in sugar prices are widely blamed more on some 300,000 active futures investors than sound fundamentals. At present, most futures activity originates from the large state organizations but as access is opened up, more players would come in creating a challenge to ensure adequate controls are in place. It is rumored a new oil futures contract on the SHFE will mirror the Nymex contract for sweet crude. Generally speaking though how excessive speculative activity will be controlled in a country like China awash with cash will be interesting to see, particularly in a country which both seems to embrace and despise capitalist free markets.