China needs a bigger hammer to beat down commodity prices

China may need a bigger mallet to hammer the nation's commodity investors and take the wind out of what Beijing believes is a speculative bubble in prices for natural resources. A raft of new measures were announced last week aimed at increasing costs for investors using the domestic commodity exchanges, the latest salvo from the authorities in their ongoing attempts to control commodity markets.
But evidence from the first week of the increased fees and margins is mixed as to how successful they have been. While the measures were broad-based and aimed at many commodities, the main interest is in coal, iron ore and steel. All of these have enjoyed stellar rallies this year and are therefore attractive to the retail investors that provide much of the liquidity on China's commodity exchanges.
The Shanghai Futures Exchange raised fees for its benchmark steel rebar contract on November 8, while warning of wild swings in some of its products. Since then steel rebar has gained in price, rising 8.6 percent from 2,799 yuan a tonne at the close on November 7 to end at 3,041 yuan on Monday. The contract has almost doubled since the start of the year.
So, little success in curbing prices for steel, but there is a bright spot insofar as volumes are down fairly sharply. While volumes initially rose after the November 8 measures, peaking at 7.075 million on November 10, by Monday they were down to 5.887 million, roughly a quarter of the 22.1 million peak so far this year, reached in late April.
The Dalian Commodity Exchange (DCE) also increased fees, raised margins and set trading limits as part of measures to cool the market - and also met with limited success. China's main iron ore contract has continued to rally since November 8, closing at 628.5 yuan a tonne on Monday, having hit a 33-month high earlier in the day. The contract is up 23.5 percent since the close on November 7, and the gain for the year so far is a staggering 166 percent.
Volumes have rebounded since the measures imposed last week, with 2.976 million contracts traded on Monday, even though they did drop initially, falling to 1.249 million on November 11 from 2.7 million on November 7. DCE coking coal futures have also shrugged off the calming measures, with the price rising to 1,644 yuan a tonne at the close on Monday, from 1,422.5 on November 8. Volumes have dropped slightly in the past week.
Thermal coal futures on the Zhengzhou Commodity Exchange have dropped since closing at 670.6 yuan a tonne on November 7, dropping to 652.4 yuan at Monday's close, but they are still 95 percent higher than they were at the end of last year. What is clear is that so far the measures imposed to cool commodity markets in November have been nowhere near as effective as similar steps taken in April.
Then, volumes fell sharply across the coal, steel and iron ore contracts, as did prices. While prices did reverse their losses fairly quickly, volumes didn't recover to nearly the same extent.
This perhaps shows that what is different this time around is that there are fewer market participants than before, and they may be more resilient to the increased costs, especially if they see fundamental reasons for prices to be rallying. China's coal output fell 12 percent in October compared to the same month a year earlier, showing that miners have been unable so far to respond to Beijing's call to lift output.
Steel production rose 4 percent in October from a year earlier, its third straight monthly increase, as steel mills continue to enjoy stronger margins despite the sharp increases in their main inputs of iron ore and coking coal. Lower domestic coal production and higher steel output will make it harder for the authorities to restrain commodity prices. While the higher costs of trading will help, adjusting the policies that have constrained coal mining but allowed for rising steel output will have a far bigger impact in cooling commodity prices.