The ructions in China have had an interesting effect on commodities prices – good for gold, crappy for copper. And more developments in this area should be expected as the market deals with growing weakness and the threat of a deflating credit bubble coming from the massive lending to various sectors in the world’s second-largest economy. Copper has been rather weak of late, but the broader CRB commodities index is actually much higher on the year. This is the biggest divergence since the eurozone debt crisis in 2011, points out Ashraf Laidi, the chief global strategist at City Index in London.
Again, the recent selling has had to do with the Chinese companies using the metal (and iron ore, too) as collateral for cheap dollar financing. So we’ve hit a weird storm here – weak yuan that makes those loans more expensive, and copper falling too, and again, that also messes with those loans. Put that together and you have a few markets moving in directions that are not beneficial to a major counterparty in several of them, for one, and resulting in the kind of activity that tends to turn into a vicious cycle.
More copper weakness, more yuan weakness, wash, rinse, repeat. Add a slowing macro economy and it’s a recipe for some more problems down the line. It’s also not good for other risk assets, even U.S. stocks, and part of the reason bonds rallied on Thursday. The growing problems there may be a reason why the Fed’s custody holdings data on Thursday afternoon showed foreign central banks dumped more Treasuries this past week than at any time – $104 billion, almost triple the previous record – as banks prepare for liquidity problems.
And it’s why things look like they’re going to be a bit ugly on Friday following more losses in Russia (down 5 percent) and in Asian markets. That’s not all, though. More defaults on trust products in China are expected. These started earlier in the year, where these big trusts that were sold to investors guaranteeing big returns backed by loans to coal producers didn’t repay investors on time. “The number of defaults are likely to accelerate in coming weeks as more Trust funds are expected to mature starting in April,” wrote Robbert van Batenburg, strategist at Newedge. He points out how intertwined these companies are in differing industries, with the common link being that they’ve all promised big returns for investors that now seem like they’re not going to come to fruition. Sound familiar? “If these problems in China escalate, a flight in gold and Treasuries is likely to ensue,” van Batenburg wrote. Well, that’s what we’re seeing again on Friday; the safe havens get the benefit while other markets suffer.
A bit of the reverse is happening in gold, which is predictably benefiting from the safe-haven allure of the yellow metal at a time when tensions are also rising between Russia and Ukraine and as a possible response from the West looms if Russia annexes the Crimean region of Ukraine (even if they want to go).