Bloomie has a scary report with more details of China’s iron ore for cash scams:
Xiao Jiashou, known as the “steel-trading king” in Shanghai, had his assets frozen as China Minsheng Banking Corp. sues for money owed. Lenders seeking repayment are finding irregularities, including the same pile of materials used as collateral for multiple borrowings, China International Capital Corp. said.
…Premier Li Keqiang’s strategy of driving up interest rates to reduce leverage is exposing a shadow banking underbelly in the world’s second-largest economy as companies struggle to repay loans from trusts, asset managers and commodity-funding businesses. About 40 percent of the iron ore at China’s ports are part of finance deals, Mysteel Research estimates.
“The risk comes when metal prices fall by a large magnitude within a short time, driving down the value of the collateral,” Yang Changhua, a researcher with Beijing Antaike Information Development Co., said in a Feb. 19 interview. “Borrowers, forced by their bankers to repay loans or to top up collateral, will have to sell the metals, sinking market prices even further and begetting a vicious cycle.”
Correct. Sadly, Mysteel is a credible source. Brace because there’s more:
…At least a third of China’s 200,000 steel-trading firms will collapse as part of the credit crisis which started at the end of 2011, the official Xinhua news agency said Feb. 7, citing industry estimates. Nanjing Iron & Steel Co. said last month its 2018 bonds may stop trading due to losses.
Companies have taken desperate measures to survive. The PBOC is probing a loophole that allowed executives at steel traders and other companies to bridge cash shortages for their firms by exceeding credit-card limits to raise as much as 10 billion yuan in December and early January, according to three people familiar with the matter.
Commodity-financing companies typically place orders with overseas companies and then apply for a letter of credit from a foreign lender, which they use to import the material. They sell the cargo in the domestic market and invest the money in high-yield debt such as trust-fund products and bonds issued by local government financing vehicles. At the end of three months, the usual loan tenure, they redeem the debt and repay the banks.
…“Those cash-starved steel mills or trading firms don’t care whether steel or iron-ore prices are falling,” said Zhang Jizhou, a trader at Ningbo Future Import & Export Co. “Their priority is to get cash flow so they can survive.”
…“China can have lots of imports but eventually these imports will still need to be sold and absorbed in the domestic market,” said Sijin Cheng, an analyst at Barclays Plc. in Singapore. “If underlying demand doesn’t pick up it will slow that trade and we might see prices in China becoming very weak.”
The situation described fits the current mix of data of a collapsing steel price, unseasonably high steel stocks coming into the new year, but a still firm iron ore price and rising port stocks.
However, this is circumstantial evidence only and there are other interpretations we can make of the same data mix, as Mac Bank showed last week. In particular, the iron ore spot price and steel mill “days of cover” are still correlated very nicely. A breakdown of that relationship would be a first.
Nor should we conclude that if 40% of port stocks are a scam then 40% of demand is also dubious. That would be to confuse stock with flow. Aggregated port stocks tell us nothing about underlying demand.
I will add that I have never argued that the iron ore market is a bubble. It is a supply constrained market in which it is very difficult (nigh on impossible) for huge, capital intensive capacity expansions to smoothly match a demand spike. But it’s hard not to see some late stage bubbliness here.
The key point is that, whatever the real intensity of these scams, the reckoning is being brought about by tightening credit. If it persists, and I think it will for the first half at least, then the iron ore pain will follow. The iron ore scams represent the struggle to survive of some portion of marginal capacity in the Chinese steel market so the risk is that as the marginal traders and mills are creatively destroyed then iron ore demand will suddenly reset as well, just as the supply ramp heads for the moon.
How severe this ends up being for the iron ore price depends upon what Chinese regulators have in mind. If their goal is to boost steel market productivity then the fallout will be mitigated by marginal capacity being substituted by more efficient and profitable core supply as steel prices rebound over time. If their goal is larger – to genuinely rebalance the economy – then Australia’s great reckoning has arrived.
