China and the magic financing (soy)beanstalk

Posted by Izabella Kaminskaon Jun 23 11:29.


Did you think commodity collateral shenanigans had been rumbled and stopped by China’s authorities?

Well, seems you’d be wrong.

Bloomberg is out with a cracker of a story on Thursday, suggesting the Chinese practice of using commodities to secure financing has only been transferred into another adjacent market. Soybeans.

Quite extraordinary really.

The clue, Bloomberg notes, is in the recent build-up of soybean inventories:

Now soybean stockpiles are rising to record highs as perishable foodstuffs are used to back loans, said Li Zhao, a manager at Yongan Futures Co., China’s second-largest futures broker by registered capital. “We saw such commodity financing activities spread from traditional bankable collateral material such as copper sheets to non-typical commodities,” said Judy Zhu, analyst at Standard Chartered Plc in Shanghai. “Soybeans and cotton, which have a shelf life, are normally not considered collateral material.”

The fact that Chinese companies have maneuvered their collateral financing arrangements into other markets is hardly surprising given the recent rise in Chinese lending rates. The three-month Shanghai interbank offered rate was at 6.06 per cent on Thursday, says Bloomberg, the highest level since the daily fixing was introduced in 2006. Chinese repo rates, meanwhile, have also hit fresh multi-year highs.

As to the volume of financing being accessed, soybean stocks now sit at seven million tonnes in China, which is much higher than the four or five million tonnes needed to meet demand for food processors.

As Bloomberg reports:

Loans backed by the commodity are re-lent in the “underground” market at rates of more than 6 percent per month, he said. “The importers buy the soybeans and get them in a month, and because the line of credit is often 90 days, they don’t need to pay back right away, so they can lend the money,” Li said. “Demand has increased because of the credit tightening.”

These imports — just as in the case of copper — have come despite the regional arbitrage window being closed. Indeed, as Sean Corrigan of Diapason Commodities has pointed out to us:

On the face of it, no reason to import beans since trading cheaper domestically… yet tonnage has kicked up the past two months – can we infer from this that the normal arb process has been reversed so that, rather than a shortage making imports more attractive, finance is now driving the trade, so imports lead to a domestic glut and hence lower home futures prices?

Naturally, if this malarkey continues, the true price of commodities as determined by the fundamentals is only going to become increasingly masked — something which risks exposing commodity markets to a very large correction further down the line.

Indeed, as Corrigan mused to FT Alphaville:

We’re all expecting commods to go shooting higher the moment the Chinese declare the inflation fight over and ease policy again. But, what if this means all these financing games lose their rationale, leaving us with vast mounds of unneeded material instead?

A very good point, we would say.

Related links:
The curious case of un-cancelled warrants
– FT Alphaville
China’s bonded-warehouse copper mystery
– FT Alphaville
China’s copper collateral – and covert credit – FT Alphaville

This entry was posted by Izabella Kaminska on Thursday, June 23rd, 2011 at 11:29 and is filed under Capital markets, Commodities. Tagged with , , , , , .

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