Chinese Markets' Rational Exuberance

(Bloomberg Gadfly) -- Those crazy Chinese speculators are at it again.

Dalian iron ore futures hit the highest level in three years last week. Silver futures in Shanghai are up 29 percent from a year earlier. Thermal coal in Zhengzhou has gained 15 percent since the start of the year.

Such disorderly mass activity was bound to attract the attention of Beijing -- and sure enough, China's top economic planners at the National Development and Reform Commission, or NDRC, have been quizzing traders about whether commodity speculation is distorting prices, people with knowledge of the matter told Bloomberg News

Let's set aside for a moment the fact that actual speculation, as measured by open interest in Dalian futures contracts, has grown at a fairly consistent 30 percent annual pace for several years now.   

Instead, think about how much better off the world would have been if extraordinary popular delusions hadn't overwhelmed Chinese investors 12 months ago.

When a closely watched index of Chinese import iron ore prices jumped 19 percent in one day (on March 7, 2016), seasoned observers dismissed the market activity as a blip. The symptoms of excess were everywhere: Trading volumes in Dalian iron ore by March 9 reached 7.5 million contracts, equivalent to about nine months' worth of Chinese imports of the metal.

How did that bull stampede turn out? Not so badly, actually:

Far from slumping once the speculative fever broke, Dalian iron ore prices are now up about 79 percent from that March madness level. That suggests China's taxi drivers and shoeshine boys hadn't lost touch with reality when they piled into the market. In truth, they were a better guide to what was really going on than the wiser heads who pronounced them delusional.

In retrospect, it's clear that 12 months ago, markets were doing precisely what they're supposed to do: Delivering signals about changes in the economy to ensure that supply and demand don't get too far out of whack. Iron ore prices were up because steelmakers' raw-material needs were up: Of the six highest months for steel output, four were March, April, May and June of 2016. 

That's reason for the NDRC to tread carefully in trying to regulate the country's futures markets. If there's one reason for wrenching moves in Chinese raw-material prices, it's that the economy as a whole is overly dependent on the centralized decision-making of powerful economic planners like the NDRC. Reports that Beijing may reinstate limits on coal-mine operating days this year appear to be one of the main reasons behind that recent jump in Zhengzhou thermal coal prices, for instance.

It's hardly surprising that a one-party state tends to focus on the madness of crowds. The Chinese authorities would do well to reflect on their wisdom, too.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

1. If that sounds a large number, consider that open interest in copper contracts on the 119-year-old Chicago Mercantile Exchange is up about percent over the past year.

To contact the author of this story: David Fickling in Sydney at dfickling@bloomberg.net.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net.