China – The domestic credit dragon.
Hang Seng (17.979)  Shanghai B (199,00)  USD/CNY (6,8315)

I have spend some time researching the rising Chinese commodity import as it has been discussed during the last 2 months. Naturally very interesting in respect of the commodity prices, but the conclusions affect all asset classes in China, including equities.
Many have heard that imports of physical commodities are so huge that they can’t be transported away from the ports. Some of the stories are true, but as always regarding China, we will never find the final answer. Based on different information sources, then around 1/3 of all commodities imported to China are bought and kept for speculative reasons.
The speculative commodity buying continues.

The higher demand for commodities is partly explained by the spending on infrastructure and urban development. But it almost seems evident that Chinese corporations have bought, and are buying commodities, for speculative purposes as well. It most likely started because the forward prices were much higher than the spot price by end of Q1 (the likely reason was rising investments in commodity ETF’s by private individuals). One could argue, well done, because the companies simply used the steepness of the commodity forward curve. So the companies bought spot and sold forward. The curve flattened, meaning the speculation gave money. But why continue to buy commodities? The answer is, as a pure speculation in higher prices.
Corporations around the world suffer from much tighter credit conditions, so how can Chinese companies generate liquidity enough to be long and warehouse physical commodities? Simply by bank financing, as Chinese banks actually finance physical commodity positions against the same commodities as collateral.
In respect of lending and credit markets, is the difference between the old economies and China how the lending is allocated. The old economies suffer from the same Japanese problems like in the 1990’s, where the banks could access unlimited liquidity at de facto zero interest. In China the Communist Party every year decides how large the lending increase should be, and then the banks have to deliver the lending growth. For the whole 2009 RMB 5 billion was planed, but the end-of-June figures show that so far in 2009 the lending already reached RMB 7 billion.
Be aware of the new asset bubble.

Partly the credit expansion has benefitted different areas, but now we circle back to the commodity syndrome. Since January, everybody has reported about the corporate SME segment suffering from credit constrains, against large and state owned enterprises getting overloaded with credit supply. Corporations are now participating in the grey credit market as active lenders, apparently at pretty high interest rates.
The worst is, that these hot and cheap credit money have found their way from bank lending to corporations and further into the stock market in China mainland and Hong Kong (the Hang Seng move from 15.000 to 19.000 in April and May). This is risky business and should under normal circumstances lead to a collapse, or minimum a very dramatic sell off in equity markets.
The people in the Communist Party are fully aware of what is happening, and I think that they are willing to run the risk of a new asset bubble in the name of creating a wealth feeling.
Despite of the bull market for Chinese stocks I argue for a 10 % correction in Chinese stocks due to the above reasons, and then a new evaluation is needed.

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