More On China's "Missing Commodity" Scandal: Fallout Spreads As Banks Get Involved

Tyler Durden's picture




 

While we have warned about the problem with near-infinitely rehypothecated physical/funding commodities/metals, be they gold or copper, many times in the past, and most recently here, it was only yesterday that China finally admitted it has a major problem involving not just the commodities participating in funding deals - in this case copper and aluminum - but specifically their infinite rehypothecation, which usually results in the actual underlying metal mysteriously "disappearing", as in it never was there to begin with.

And disappearing commodities is exactly what we reported yesterday the third largest Chinese port of Qingdao is being investigated for after a source at a local warehouse said that "it appears there is a discrepancy in metal that should be there and metal that is actually there... We hear the discrepancy is 80,000 tonnes of aluminium and 20,000 tonnes of copper, but we hear that the volumes will actually be higher. It's either missing or it was never there - there have been triple issuing of documentation."

This has resulted in a prompt and acute selloff of copper and other commodities as we further documents, but the problems may only now be starting and the banks, those which stand to lose the most if their "collateral" is uncovered to have never existed, are finally getting involved. As Reuters reports, worries over a probe into commodity stockpile financing at China's Qingdao port appeared to deepen on Wednesday as Standard Bank Group and a part-owned unit of Louis Dreyfus Corp warned of potential losses and copper prices fell further."

Responding to queries about the probe at Qingdao, which has not been officially confirmed, South Africa-based Standard Bank said it was "working with local authorities" to investigate potential irregularities at China's third-largest port, a major source for metal and iron ore imports.

 

"Standard Bank Group is not yet in a position to quantify any potential loss arising from these circumstances," the bank, whose Standard Bank Plc subsidiary conducts commodities trading, said in a statement.

Standard Bank is not the only one that may suffer major losses should the disappearance of rehypothecated collateral be confirmed:

Singapore-based logistics provider GKE Corporation Ltd warned shareholders that it was "assessing the potential impact" of the investigation on its GKE Metal Logistics Pte Ltd unit, a joint-venture 51 percent owned by global commodities merchant Louis Dreyfus.

While we expect many other banks to step up, for now these two are the first companies to publicly discuss the issue since the inquiry came to light on Monday, when Reuters reported the port in northeastern China had halted shipments of copper and aluminum as it launched an investigation into metal stockpiles used for collateral on loans.

To be sure Chinese authorities are in a bind: while they can't ignore the problem, a very aggressive investigation into the disappearance of collateral may result in a collapse of the entire rehypothecated house of cards, and they know it: according to Reuters, authorities at the port in northeast China have not officially confirmed an investigation, and have said exports and operations are running normally.

But earlier on Wednesday, Xinhua news agency reported that the port had said it was investigating whether iron ore warehouse receipts were fraudulently used multiple times to raise finance by different banks.

And while we have been warning about this problem for years, only now - when there is a documented case of alleged fraud - are the players finally starting to panic:

According to traders and warehousing sources, port authorities at Qingdao's Dagang wharfs have been examining whether there had been multiple issuing of receipts for single cargoes of metal tied to a trading company and linked companies.

 

The tumult has revived concerns that first surfaced in March, when China's first domestic bond default fuelled fears of further financing woes and triggered one of copper's steepest drops in years, with prices tumbling 8 percent in three days.

The immediate impact on pricing is clear, and just as we warned in March: lower.

"I think it's (copper) got more downside to go," said analyst Vivienne Lloyd at Macquarie. "That (the probe) will have the effect of making the banks extremely cautious about to whom they will issue letters of credit."

So while we are gratified that yet another event we have warned about has come to pass, what happens next is unclear.

Recall what we said in March, when we looked at the possible aftermath of a wholesale unwind of commodity funding deals:

From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price.

 

... an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry)." In other words, it would send the price of the underlying commodity lower.

Indeed as an unknown number of deals have begun unwinding, lower commodity prices is precisely what we have seen, just as predicted. But like in March, there is a footnote, one which pertains to a specific subject of Chinese funding deals: namely those which use gold, which as we showed before...

... is the metal most widely used in terms of notional to provide "metallic" funding.

We agree that this may indeed be the case for "simple" commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the "hedged" gold selling by China in the "paper", futures market.

 

And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a "conspiracy theory" is now an admitted fact by the highest echelons of the statist regime. and not to mention market regulators themselves.

 

Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 - a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course - just check out those overflowing private gold vaults in Shanghai.

 

* * *

 

This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures "hedges", i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.

 

In other words, from a purely mechanistical standpoint, the unwind of China's shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for.  This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.

So far it is unknown just what happens next: when it comes to copper and certainly gold, there has been a substantial downswing in prices. How much of that is attributed to CFDs unwinding is unclear. But the bigger question, and not just for gold prices, but for the Chinese economy is if indeed the funding deal house of cards is imploding, what happens to China's shadow banking system, which is extremely reliant on the billions in "rehypothecated" dollars emanating from non-existent metal collateral.

Because should the Qingdao port fiasco spread and be confirmed at all other venues that use commodities for funding purposes, then that may just be the straw that breaks the already weakened back of China's credit system. How the PBOC will respond to that may be just the variable that answers what happens to China's inflation, and thus to the price of the simple, unencumbered underlying physical metals in the coming weeks and days.

Stay tuned.

For those who want to learn more, please read "How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring"

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Thu, 06/05/2014 - 12:55 | 4827217 _ConanTheLibert...
_ConanTheLibertarian_'s picture

What's oh shit in Chinese?

Thu, 06/05/2014 - 12:58 | 4827225 Say What Again
Say What Again's picture

That's what happens when the "cost of carry" goes negative.

Just ask Draghi

Thu, 06/05/2014 - 13:00 | 4827235 DoChenRollingBearing
DoChenRollingBearing's picture

I am in Peru now, bearing sales are down a little vs. 2013.  Probably at least in part due to China.  Peru exports a lot of copper and iron (etc.) to China.

At 24hgold.com I see that their widgetr (bottom at home page) shows a mighty 37% premium of AGEs vs. spot price.

Yikes!

Thu, 06/05/2014 - 13:04 | 4827238 nope-1004
nope-1004's picture

If I sell you a car I don't have and you come looking for it - angry, demanding to see the car, should I be "concerned"?  LMAO.

 

Thu, 06/05/2014 - 13:06 | 4827258 pods
pods's picture

I could swear I read a story about this a year or two ago here.  Same exact shit. 

World didn't end last time?  Why is this time different?

(serious question, not poking fun)

As long as nobody actually uses that fractionally reserved copper and aluminum the band can play on.

Everything in China is at least 2-3x hypothecated.

pods

Thu, 06/05/2014 - 13:10 | 4827267 LawsofPhysics
LawsofPhysics's picture

"Everything in China is at least 2-3x hypothecated." -  Yes, but in this new game of "cleanest dirty shirt" how does that compare with the western world?

 

That's all that matters...

Thu, 06/05/2014 - 13:25 | 4827317 pods
pods's picture

Now are we talking City of London leverage or normal human leverage?

Just wanna make sure we are talking apples to apples, not apples to hand grenades.

pods

Thu, 06/05/2014 - 13:48 | 4827406 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

Rehypothecation is good to build up unbacked, toxic debt. Those creditors who had debtors who defaulted first will end up on the best side of this growing mess. They claim the commodities and later defaulters screw those who they owe money.

Is this the way things will go down in the west? He who invested in the worst investments wins out due to first dibs at the assets and bail outs are still coming strong?

Thu, 06/05/2014 - 13:56 | 4827435 Save_America1st
Save_America1st's picture

New Jim Willie interview w/ Elijah Johnson:

Banking Cabal In Charge:

https://www.youtube.com/embed/rGNCXABQiwY

Fed has printed/counterfieted 23 Trillion and given it to various world's most elite families so that they could buy up all the world's assets after they crash the system...

 

Thu, 06/05/2014 - 14:01 | 4827454 HardlyZero
HardlyZero's picture

Does negative interest rate cause any divide-by-zero errors or Excel errors in any finanance spreadsheets ?

Just asking.

This might be much more exciting than Y2K.

Get some PM before this weekend...its getting very hypothetical in the fiat echo chamber looking glass.

We hear, We see...what ?  when ?  why ?  from who ?

Start of the Great RESET ?

Thu, 06/05/2014 - 14:04 | 4827469 MillionDollarBonus_
MillionDollarBonus_'s picture

This is not even an issue! 90% of market participants are happy to settle for cash!

Thu, 06/05/2014 - 14:13 | 4827489 nope-1004
nope-1004's picture

I agree.  It's the 10% honest folk out there, littering the internet with their conspiracy theories, that we gotta watch.  The 90% engaging in Ponzinomics are where it's at!

 

Thu, 06/05/2014 - 15:08 | 4827534 Badabing
Badabing's picture

So the Chinese beat us at our own game. Forced the price of gold down with Paper while buying physical!

But this Aluminum and copper fraud is very different. Anyone who supplies the physical can call the shots on price!

The normal outcome should be the paper price goes down because no one wants to be stuck with a worthless contracts and sells at any price. While the physical price skyrockets to meet demand for the metal they didn’t have with out disrupting industry consumption.

The only way we will not see a disconnect in price is with an under the table intervention. The suppliers will get some freshly printed fiat under the table as compensation. We still will see inflation as a side effect to unwind this monster.

 

Fake inventory = a disconnect in price or inflation.      Keep in mind that his is the third largest port!

Do you think port 1 and 2 is immune ?

 

Thu, 06/05/2014 - 15:31 | 4827720 BaBaBouy
BaBaBouy's picture

JUST WAIT Until ........

The World Finds Out ALL The Purported USA GOLD Is MISSING/GONZO...

Yeah, FALLOUT...

Thu, 06/05/2014 - 15:31 | 4827733 strannick
strannick's picture

Goldman seems to think having infinite claims on finite metals is bearish for the metals.

ie. Goldman is short metals.

Thu, 06/05/2014 - 15:36 | 4827748 BaBaBouy
BaBaBouy's picture

""Goldman seems to think having infinite claims on finite metals is bearish for the metals.""

Meet The New World Of Bizzaro HFT Manipped Markets...

Thu, 06/05/2014 - 16:04 | 4827862 strannick
strannick's picture

If China needs help on conducting a fake commodities investigation, which alleivates tension in the manipulated market while not actually doing anything, the CFTC and Bart ''the couffeur'' Chilton would be a great source to try.

Thu, 06/05/2014 - 19:06 | 4828399 disabledvet
disabledvet's picture

So let me get this straight: stupendous amounts of commodities appear...get turned into a stupendous number of buildings...and the money has disappeared too.

Hmmm. This doesn't sound very unusual to me. Like stiffin your buddy for the 500 dollar bar tab.

Thu, 06/05/2014 - 14:39 | 4827562 Tall Tom
Tall Tom's picture

From the article:  From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential

 

This is mind blowing. If you believe that this will be contained to China then you have been smoking something really bad.

 

American Banks hold HUNDREDS OF TRILLIONS IN DERIVATIVES based on INTEREST RATE SWAPS...LIKE THE CNY/USD INTEREST RATE DIFFERENTIAL (a Differential IS A FUCKING DERIVATIVE.) REFERRED TO IN THE ARTICLE ABOVE.

 

This is your Black Swan Event.

 

MDB...Stop your Bullshit. (I know that it is a gag but...come on now...)

 

We are so freaking DOOMED it is not funny anymore. It is now obviously out of their control. China's God damned Shadow Banking is going to implode the World's Economy...or what is left of it.

Thu, 06/05/2014 - 17:48 | 4828162 pods
pods's picture

I recall boldy pronouncing that the "Black Swan" arrived when I looked into the MERS mortgage fiasco (on another board).

That pig is about through the python of the Fed and many people willingly refinanced to clear up the compromised chain of title.

I am never surprised now when rule breaking and rabid money printing covers up yet another black swan.  

pods

Thu, 06/05/2014 - 14:47 | 4827591 john39
john39's picture

>>Jim Willie

Interesting that Jim is openly calling the bankers out as satanists.  Absolutely true, but I doubt that most will let themselves see it.

Thu, 06/05/2014 - 15:03 | 4827640 DoChenRollingBearing
DoChenRollingBearing's picture

+ 1  That is interesting.  I was inattentive and did not take note while listening to that part of the interview.

Thu, 06/05/2014 - 13:14 | 4827274 darteaus
darteaus's picture

AND the world didn't end after: The Black Death, Holocaust, Rwanda, Nuking of Hiroshima, etc.

It's the shock of the seemingly inevitable exponential increase of human misery that most observers find staggering.  That, and the knowledge that it's all SO AVOIDABLE if only the criminal liars in positions of power would just sometimes, JUST SOMETIMES make the appearance of doing their jobs during their self enrichment at someone else's expense.

Thu, 06/05/2014 - 14:01 | 4827460 HardlyZero
HardlyZero's picture

and...these are all interesting times.

Thu, 06/05/2014 - 14:11 | 4827486 Professor Fate
Professor Fate's picture

You've got to be kidding.  Getting a valid warehouse receipt in China is about as likely as getting the truth about anything out of Obama.

Fate the Magnificent
"Push the Button, Max" 

Thu, 06/05/2014 - 13:09 | 4827265 SoilMyselfRotten
SoilMyselfRotten's picture

I'm sure there was a selloff....OF PAPER

Thu, 06/05/2014 - 13:27 | 4827320 DoChenRollingBearing
DoChenRollingBearing's picture

A friend of mine is the Latin America export manager of a US capital equipment manufacturer (machinery for chemical plants, etc.).  He told me some three months ago that sales were down ALL over LatAm except for Peru and Colombia.

But, "three gets you five" that sales are down for him now in Peru as well.

***

And there continues to be solid resistance among Peruvian locals in the mountains AGAINST Conga and other new gold mines (with good reason, the miners have historically been irresponsible re pollution and not sharing the wealth...).

With European NIRP and reports of a real decline in Q1 GDP in the USA, we probably are on the verge of our second recession (assuming acceptance of the .gov figures before).

¡Mucho Peligro!  ¡Preparanse!

Fri, 06/06/2014 - 14:40 | 4830783 Lord Koos
Lord Koos's picture

Aren't Peru and Columbia both big cocaine producers?  

Thu, 06/05/2014 - 14:11 | 4827490 lakecity55
lakecity55's picture

I just got a decent premium over some Au at Provident. Not advertising, but if you look around some are not too bad.

Thu, 06/05/2014 - 14:35 | 4827549 DoChenRollingBearing
DoChenRollingBearing's picture

 

 

Excellent!

The widget I refer to at 24hgold.com is a JV between that website and eBay.  It shows current offer price at eBay for AGEs vs. current spot price.  It is EXTREMELY volatile, but it is the only easy way I currently know to check scarcity of physical gold vs. "paper gold" price, however imperfect.

The widget has low predictive value.  For a while I tracked the premiums and other data from there in MS Excel, but found no significant predictive value.  Premiums would go UP when spot went down (easy to understand).  But, 37% is very high!  I keep an eye on the widget even though it is very imperfect.

If physical gold becomes truly scarce, that widget will be one of the very first Red Lights!

Thu, 06/05/2014 - 16:13 | 4827892 lordylord
lordylord's picture

Deleted

Thu, 06/05/2014 - 16:40 | 4827980 Coast Watcher
Coast Watcher's picture

If physical gold becomes truly scarce, what happens to silver? Hmmmmm.

Thu, 06/05/2014 - 16:44 | 4828000 DoChenRollingBearing
DoChenRollingBearing's picture

Hmmm indeed!

Thu, 06/05/2014 - 17:01 | 4828042 Al Huxley
Al Huxley's picture

...or if the general public ever starts to worry about the safety of digital money.  Gold's expensive (relative to an many peoples' income), but the $ needed to buy a couple of ounces of silver are within a lot more peoples' reach.

Thu, 06/05/2014 - 13:01 | 4827239 SamAdams
SamAdams's picture

In today's convoluted economic world, nothing works per your MBA instruction.  Supply dwindles, prices drop....  No, don't recall that one....

Thu, 06/05/2014 - 13:15 | 4827287 Deathrips
Deathrips's picture

They must be boaters....thats how I lost my shiny.

 

RIPS

Thu, 06/05/2014 - 13:57 | 4827438 scraping_by
scraping_by's picture

Careful. You might want to check out recent advances in underwater metal detectors.

Or, I might want to. Sounds like a profitable hobby.

Thu, 06/05/2014 - 16:27 | 4827946 viahj
viahj's picture

not impressed, they haven't found MH370 yet   /s

Thu, 06/05/2014 - 12:58 | 4827226 Zirpedge
Zirpedge's picture

Ni Hai Bin Du Wah

Thu, 06/05/2014 - 13:02 | 4827247 insanelysane
insanelysane's picture

Local seafood wholesaler did this in my town a few years ago.  Basically stated that they were flowing X amount of inventory each week and had cash flow financing in place.  The owner took off and the banks showed up and found the place pretty much empty.  Also had a big sale on gift certificates before running.

Thu, 06/05/2014 - 13:06 | 4827259 darteaus
darteaus's picture

The West is such a great place to do business.

I bet he paid all his payroll taxes for his illegal labor too!

Thu, 06/05/2014 - 13:05 | 4827254 darteaus
darteaus's picture

Flung Poo

Thu, 06/05/2014 - 14:22 | 4827421 HardlyZero
HardlyZero's picture

Shadow Banx Collapse >> Finance Collapse >> Markets Collapse >> Fiat Collapse.

Hopefully the fan flung poo has an airtight box around it and it doesn't escape the Chinese Fingerlock Box Confinement.

Expect Western Bank and CB firewalls to come up soon.

Incoming.

Thu, 06/05/2014 - 14:52 | 4827610 Tall Tom
Tall Tom's picture

No chance. THis cannot be contained to China as it involved the CNY/USD Interest Rate Derivatives. Our Major Banks are holding Hundreds of Trillions of Dollars in these Derivatives.

 

No firewall can be erected. Incoming without a shield. We will feel the impact and it will hit us like a Thermonuclear Bomb. Incoming is correct. The system will implode. Kiss Citigroup goodbye as they will be the sacrificial Lamb where allof the toxic derivatives will be parked since they hold a substantial amount now. (Damn I wish that it would happen to JP Morgan Chase.)

 

Thu, 06/05/2014 - 13:34 | 4827361 BanksterSlayer
BanksterSlayer's picture

So if President Xi doesn't think twice about arresting, or even hanging,  Banksters guilty of fraud ... surely heads will egg-roll over this scandal too, yes?

Thu, 06/05/2014 - 13:59 | 4827448 CPL
CPL's picture

Only morons steal from a Dragon's hoard.  Or Giants house.  Or a Bears Cave.  Or a Wolves Den.  Or the Eagles nest.  Or the Tigers wood.  Or a Lion's savanna.  Or a Scorpions hole.  Or steal from Fairy.  etc.

Anyone that's read a fable or myth anywhere on this planet would know that, they aren't suggestions.  They are the playground rules to keep it honest and things running smoothly without too many complaints in an easy format to teach a lesson without anyone getting pissed.

 

In the meanwhile, grab the popcorn, this is going to be awesome.

Thu, 06/05/2014 - 13:59 | 4827452 scraping_by
scraping_by's picture

The other recent high-profile case was Iran sending a rich banker to the gallows for embezzlement.

I'm confused. Cold War 2.0 says we're the good guys.

Thu, 06/05/2014 - 13:49 | 4827405 F0ster
F0ster's picture

"that shitty walk owner, he wouldn't even harm a fry"

 

http://www.youtube.com/watch?v=GAnGYocNP7I

Thu, 06/05/2014 - 14:49 | 4827600 rubiconsolutions
rubiconsolutions's picture

"The Law of Conservation of Energy states that matter cannot be created or destroyed, but can change its form." Apparently matter can be rehypothecated however. 

Thu, 06/05/2014 - 15:06 | 4827620 IndyPat
IndyPat's picture

And the cat can be in the box and not in the box...at the same time. Or 300 cats in a 2x2 ft box, what the hell, why not?

Just depends on who's looking...or wants to look.

Do NOT follow this link or you will be banned from the site!