Rebel Traders – Analysis Without The Hype

We know that China has been putting a lot of efforts into obtaining cheap iron ore for its steel mills. Hence a surge in industrial production in China, notably of steel.

The problem (again), is that the steel is sold on the market by traders who have entered into future contracts at prices much higher than the current market price (and the market price in itself gives an idea of the tepid recovery taking place, even in China).

As it is, the Steel mills have been charging extremely high prices on their production, while the local demand is weak, and international demand almost non-existing.

As often repeated in these chronicles, Q4 will be the time of truth, for steel as well, as overcapacity is starting to hit the steel production.

Steel traders have urged large mills to cut their prices to reflect the market conditions, Caijing learned from a trader’s conference on Sept. 20.

Steel prices have fallen since August and many traders have lost money on products purchased under contract at higher than current market prices.

The contract price of cold-rolled steel for October delivery from Baosteel, for example, is 6,300 yuan per ton, compared with a market price of about 5,600 yuan per ton, Liu Changqing, chairman of Beijing Lange Baiziwan Steel Market, said.

Liu Yong, general manager of Anhui Huishang Metal Co., said his company bought 90 percent of the steel for a new project though the local markets.

Large steel mills should base their prices on what’s happening in the market or it will be “hard for mills and traders to reach a consensus,” Xu Jianlong, head of Jiangsu’s steel commerce chamber, said.

Meanwhile, steel mills should guarantee traders a discount on the market price, Xu said.

A large proportion of the steel produced by large mills is sold by traders, who resell it on the local markets.

Li Jianshe, marketing manager with steelmaker Magang Group, said steelmakers always consider their own interests first when the market deteriorates.

Meanwhile, the fourth quarter will be the most difficult time of year for domestic steel mills because weak demand will be unable to absorb fast-growing output and inventories, according to the China Iron and Steel Association.

Prime steel output grew for seven consecutive months to August, reaching a record 52.3 million tons in the month, far above the 40.4 million tons in February. In early August, prices stalled abruptly after a four-month rebound as ballooning output began to outpace demand.

We have been in a mixed mood on the markets since the beginning of the week. Positive stats (German confidence, for instance) were mixed with less positive news about retail spending on Friday and a lower PPI yesterday.

Whereas the markets’ pullback was limited yesterday and saw some form of bounce at mid-level in the market… Asia seems to pull the markets back down today.

The main reason: doubts on the capacity of China to pull itself out of the recession by itself and doubts on the capacity of Asian governments to support their economies without increasing debt, and a serious issue with the large Chinese stimulus and the government’s need to curtail it.

Now, for Asia, it is true that it seems to be acting as a vanguard on the markets, by pulling back rather stiffly. But then, I had indicated a number of factors, both on the economic front and on the market front which may explain this pullback. In addition, the markets are anticipating a tightening of the monetary policy by China.

Namely, we have 31 Bn of new shares entering the Shanghai market. We also have several other events taking place which bode ill for the overvalued Shanghai stocks.

So recovery, there could well be. But is it sustainable without selling massive amounts of junk to the US or Europe?

The four largest Chinese banks reported that despite a massive surge in lending, they still booked a loss in H1.

China’s four largest listed banks are expected to see their first-half net profit reduced by narrower net interest margins and higher loan-loss provision requirements, despite having extended record loans over the period, analysts surveyed by Caijing said.Commercial banks loaned 7.4 trillion yuan in the first six months, and the scale of lending could moderate profit declines for some of these banks, analysts said.

An official at Central Huijin Investment Co. Ltd., the controlling shareholder of Industrial and Commercial Bank of China (SSE:601398, HKEX:1398), China Construction Bank Corp. (SSE:601939, HKEX:0939) and Bank of China (SSE:601988, HKEX:3988), told Caijing the investment firm was satisfied with the three lenders’ first-half net profits.

Bank of China booked first-quarter net profit of 18.57 billion yuan, down 14.41 percent year-on-year, while China Construction Bank’s net profit fell 18.2 percent to 26.3 billion yuan. Bank of Communications Co. Ltd. (SSE: 601328, HKEX: 3328) booked growth of just 0.8 percent in first-quarter net profit to 7.9 billion yuan.

Bucking the trend, ICBC recorded a 6.2 percent rise in net profit to 35.1 billion yuan, supported by one-time forex gains and bond disposals.

Commercial banks had a combined provision coverage ratio of 134.3 percent at the end of June, up 17.9 percentage points from the beginning of the year, according to the China Banking Regulatory Commission.

The regulator has ordered banks to meet a new minimum provision coverage ratio of 150 percent within the year.

The increased provision coverage ratio will put added pressure on lenders, which will have to allocate some of their net profit to these provisions, an insider from a large bank’s risk management department said.

Bank of Communications is scheduled to release its interim report on Aug. 19, ICBC on Aug. 20, China Construction Bank on Aug. 21 and Bank of China on Aug. 27. 1 yuan = 14 U.S. cents

The doubts on the continued recovery of China are accentuated wit the news that coal inventories have again increased in Chinese ports – which points to a resumption of production with no exit for the production.

» Inventories in China’s largest coal port in Qinhuangdao reached 5.45 million tons by August 17, up 599,000 tons from two days earlier.» The inventories have rebounded to late July levels.
» Industry analysts say the rising inventories are mainly due to the increasing rail transportation of coal and production resumption of many smaller mines.» Coal prices have remained stale despite the rising inventories.

In addition to the multiple signs of warning, we had announced a few weeks ago, on the grounds of a study by Andy Xie that the tightening of the Chinese monetary policy would begin by Q4. The pullback or fall in Shanghai’s market is probably anticipating this move. Remains to see if it will be sufficient to take out all the steam of the Chinese markets.

Another analyst, Fiona Lake, seems to confirm the hike in Q4:

We expect a 50bp hike in the reserve requirement ratio (RRR) in Q4 of this year and three 27bp hikes in the 1-year lending rate through 2010 Tightening to start in earnest in Q4 Signs are emerging that the Chinese authorities are starting the process of moving away from the incredibly easy monetary policy stance in place at present. In July, the People’s Bank of China (PBOC) initiated a moderate liquidity withdrawal and mild window guidance.

In our view, the Q3 GDP data is likely to provide enough evidence for the Chinese authorities to start that process, and shift into meaningful tightening in 2010 on the back of stronger growth and higher inflation. Specifically, we expect a 50bp hike in the RRR in Q4 and a further 150bp increase in the RRR through 2010 bringing the RRR back to its highs in mid 2008 (note that the RRR was not reduced aggressively through the easing cycle). Turning to interest rates, we expect the 1-year lending rate to rise from 5.31% at present to 6.12% by the end of next year, in three 27bp clips.