As we have reported since May 2013, when we explained the role of Commodity (and particularly copper [9]as well as gold [10]) Funding Deals in Chinese "trade" and especially in the laundering of hot money flows, and most recently when we followed up on the first revelations that unknown amounts of physical commodities [11]had been corzined in China's port of Qingdao, one of the key uses of monetary commodities in China is for purposes of "trade", and especially to artificially boost exports by way of fake trade invoicing. Non-existant exports which, it goes without saying, end up boosting China's already slumping GDP. Well, like a recovering junkie addicted to fabricated data, China finally admitted it has a problem when overnight it "uncovered almost $10 billion in fraudulent trade nationwide as part of an investigation begun in April last year, including many irregularities in the port of Qingdao, the country’s currency regulator said today."
Bloomberg reports [12]what we have been saying for years, and many have been suspecting for far longer, namely that companies “faked, forged and illegally re-used” documents for exports and imports, Wu Ruilin, a deputy head of the State Administration of Foreign Exchange’s inspection department, said at a briefing in Beijing. The trades have “increased pressure from hot money inflows and provided an illegal channel for criminals to move funds,” Wu said, adding that those involved in such fraud would be severely punished.
“Some companies used the trade channel to bring in hot money,” said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd. SAFE’s investigation “will likely further cool down hot money inflows and commodity imports could slow as banks will likely conduct more careful checks on documentation.”
And while it is commendable that China's program economy is pretending that it is cracking down on data fraud (recall the "sum of the GDP parts never equaling the whole [13]" as just one example of outright data fabrication in China), the problem with the data set is how it is intertwined with all other data, because merely cutting down on hot money flows has major impacts not only on China's "optical" growth, as it reduces the contribution to net trade once fake export invoices are eliminated, but it also impacts the "bean count" for current account data in the US and other places where Chinese hot money transits to and from.
But while the end impact of the crackdown is still to be determined, one thing is clear: $10 billion is just the start.
SAFE identified the fake trade invoicing as part of a crackdown on the practice in 24 cities and provinces, Wu said. The news raised speculation that metals supplies may increase as stockpiles tied up in financing deals come back on the market.
Which is something we warned about back in March [10]. The bigger program is that as Goldman calculated, should the entire CFD-sector unwind, the impact could be devastating if it migrates away from the "only" $100 billion in FX loans tied to CFDs, and impact the broader FX loan space, which at last check was a whopping $1 trillion, and whose unwind would generate a wholesale market and bank crash in China, and perhaps serve as the catalyst to start China's outright QE.
[14]
[15]
Not surprisingly, in the aftermath of the announcement industrial metals fell and the yuan weakened, with copper sliding as much as 0.5% and all main metals on the London Metal Exchange declining.
Finally, another side effect of the crackdown on CFDs is that, as also reported previously [10], inventories of copper in warehouses linked to exchanges such as the LME and Comex will rise over the next six months in part because of fewer financing deals in China, Goldman Sachs Group Inc. said in a Sept. 23 report.
Which brings us to the original question we asked in March: while for the bulk of commodities an unwind of FX loans in the commodity space means lower prices, by the odd nature of the physical/forward exposure in gold, it may well happen that the unwind of paper hedges would have far greater impact to the upside than any selling of physical gold would have pushing the price to the downside (more here [10]).
[16]
We look forward to finding out the answer first hand quite soon.
