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Noticing that real gold costs more than paper, India expects $500 soon
By David M. Lenard
Asia Times, Hong Kong
Thursday, November 17, 2005
http://www.atimes.com/atimes/China_Business/GK17Cb05.html
HUA HIN, Thailand -- Confusion reigned in world copper markets this
week after reports emerged that a Chinese copper trader based in
London, Liu Qibing, had disappeared after building gigantic short
positions in the metal, said to range from 100,000 to 600,000 tons.
Adding to the mystery were strenuous denials by Liu's purported
employer, China's State Reserve Bureau (SRB), that Liu actually
worked for the agency. Another official told a Western journalist
that it was "not clear" whether such a person even existed.
The case was reminiscent of two epic financial scandals of the mid-
1990s: the downfall of Barings Bank, brought about by rogue trader
Nick Leeson's US$800 million worth of losses in Nikkei index futures;
and the debacle brought about at Japan's Sumitomo Corporation by
Yasuo "Mr Five Percent" Hamanaka, who effectively tried to corner the
world copper market by manipulating the eponymous portion of it that
his group controlled.
One difference between Hamanaka and Liu is clear, however: Hamanaka
attempted to keep copper prices high, while Liu placed a huge bet
that they would go down.
Copper prices have soared 30% this year so far. But based on his
knowledge of Chinese government plans to sell off part of China's
copper reserves in a bid to ameliorate the effects of high copper
prices on the domestic economy, Liu apparently decided that prices of
the metal would fall, and tried to take advantage of this by selling
vast amounts of copper he did not actually possess for December
delivery.
This was done in the expectation of buying the metal back in
December, at the lowered price, and pocketing the difference.
Such "short selling" practices are routine in commodity markets, and
not illegal; but they are risky, since if the expected price decline
fails to materialize, the commodity must be delivered at a loss.
Sadly for Liu, copper prices did not fall: they rose, reaching a
record high of US$4,175 a ton on Tuesday on the London Metal Exchange
(LME).
In the current case, many nonferrous metal experts doubt that the SRB
even has enough metal on hand to fulfill the contracts, which would
require the agency to deliver hundreds of thousands of tons of copper
to LME warehouses by December 21, according to media reports.
China maintains large reserves of the reddish-brown metal, which is
regarded as strategic due to its ubiquity in electrical and
electronic items, including military hardware. But the actual size of
Beijing's reserve is unclear, and the apparent reluctance of the
Chinese government to take responsibility for Liu's contracts only
increased the suspicion that Beijing actually lacks the metal to make
good on his commitments.
"It is not known for sure how much copper the State Reserve Bureau
holds," said the Independent's Jeremy Warner, "but it may be rather
less than the estimated 200,000 tons Mr Liu has sold." Of course, if
China needed to purchase the metal on the open market to cover Liu's
position, it could do so; but such purchases would compound the loss,
since expectations of just such purchases have only driven prices
higher.
The conflicting reports about Liu from Chinese sources suggest that
top government circles have not yet decided what to do about the
case. In the meantime, there are still three fundamental questions
about him which have not been clearly answered.
First, does he even exist? It seems fairly certain that he does,
despite bizarre official statements suggesting the contrary, such as
the SRB official who told Agence France-Presse that he was "not
clear" whether such a person existed.
A trader surnamed Zhou, from Zhejiang Nanhua Futures, confirmed Liu's
existence, as did another SRB source, who told Reuters that Liu
was "on leave." Unless the SRB has a policy of granting leave to non-
existent employees, it would seem reasonable to infer that there is
such a person.
Given that Liu exists, the next question is whether he was, or is,
actually employed by the SRB. This also seems likely, since both the
SRB itself and the aforementioned Zhou confirmed it, saying, "He is a
trader and definitely an official of the [SRB]."
But in other statements, SRB officials have repeatedly tried to
disavow Liu. One official told AFP by telephone: "We do not have such
a person working for us." And China Futures Association chairman
Chang Qing, who is also chairman of Jinpeng International Futures,
told the agency, "I've asked the SRB [about this] issue and they told
me that they don't have any official with the name of Liu Qibing. The
man in the center of the market rumor is not with the State Reserve
Bureau ... they have never heard of this person and I've never heard
of this person."
But as more information about Liu gradually emerged, this position
became increasingly untenable. The Financial Times said Liu's profile
on the Bloomberg machines used for commodity trading listed him as a
government trader.
In the same article, the Times quoted "participants in the Chinese
copper market" as saying Liu had about 10 years of experience in
metals trading; one trader even describing him as "a very serious and
likeable guy." The most recent statements from the SRB have
apparently acknowledged his status as a head of physical and futures
trading.
The last question -- and the crucial one in deciding who will end up
holding the bag for the rogue copper trader -- is whether he was
acting with the SRB's approval. The SRB has so far refused to accept
the responsibility for his trades, with one official saying, "The
[short sales] done by him are his, not ours."
But metals trading experts scoffed at this, noting that the Chinese
government maintains strict capital controls, which include
restrictions on which companies and traders are allowed to conduct
business on overseas financial markets, including commodity markets.
One futures trader said: "There is no way he was acting on his
own ... he was the one doing the trading, but I doubt he was actually
taking the decisions." A mining analyst with London-based Numis
Securities, John Meyer, told the Guardian that he did not think "for
a minute" that Liu was acting on his own behalf rather than for the
SRB. And an analyst in Shanghai told the Financial Times: "In order
to make those trades, he would have had to show evidence that he was
backed by the organization's balance sheet."
The Chinese government now faces two unpalatable alternatives. It can
take responsibility for Liu's shorts and deliver on the contracts.
This will cost an uncertain but large amount of money (US dollar
amounts in the hundreds of millions have been bandied about), and
possibly drain the country's strategic copper reserves in the
process. Or it can continue its current line of "Liu who?" and leave
the errant trader's customers, which presumably include Western
banks, commodity traders and third-country industrial copper users,
high and dry.
The repercussions of taking the second route could be serious, and
transcend the copper market. Obviously, foreign commodity dealers
will become reluctant to deal with Chinese customers if they fear
that the Chinese government will allow its agencies to walk away from
loss-making deals. Although this obviously does not mean that vendors
will stop selling commodities to China -- which has become the
world's biggest customer in many commodity markets -- it does mean
that they might demand a risk premium from Chinese customers in
general, and the SRB in particular.
Just the possibility that China might shirk the responsibility for
the Liu affair caused consternation in the LME and has raised
eyebrows in the financial world. The Guardian quoted one Hong Kong
trader as saying: "Right now, if the copper market is like a highway,
there's a student driver out there driving a tank, and everyone else
just wants to get out of the way." Another observer suggested that
SRB officials are desperate to avoid being blamed for the emerging
fiasco by higher-ups in Beijing: "How would you like to tell the
State Council you have hundreds of millions in losses?" one trader
with a Western firm told Reuters.
Is it entirely implausible that Liu could have deceived his overseers
at the SRB?
Not really: financial malfeasance is frequent in China, and so is an
unwillingness of officials to report setbacks to their superiors.
Furthermore, the regulation of Chinese financial markets is anything
but strong, and if Singapore and Japan, which are much better
regulated overall, could not avert the Barings and Sumitomo scandals,
it is not hard to see how Liu, far from official oversight in London,
could have conned SRB officials and possibly the LME as well.
Still, a few "grassy knoll" rumblings could be discerned from the
commodity markets crowd. China is a huge consumer of copper and has
been jawboning for months about the need for lower prices, as Chinese
copper users complained to the government about high prices. This has
led some to suggest that the Liu affair was an orchestrated attempt
to force down copper prices which backfired on the government.
In this scenario, the knowledge of Liu's huge short sales by other
traders could have helped to create a self-fulfilling prophecy of
lower prices in the market. In favor of this theory is the undisputed
fact that the SRB, which has not historically taken an overt
commercial role, recently started openly selling copper on the spot
and futures markets. Metals analyst Neil Buxton of GFMS Metal
Consulting told the Independent: "There have also been attempts to
talk the markets down that have been proved to be unproductive ...
users of copper have been complaining to the government all year that
their profit margins have come under extreme pressure from the rising
price of copper."
Certainly, there was evidence that China intended to continue its
recent spate of copper-selling activities, for whatever reason: a
November 16 Xinhua story pledged that the SRB "will soon release
about 80,000 tons of copper". The same story, in what could be
interpreted as a further effort to talk down prices, noted soaring
production at Chinese copper smelteries and cited an HSBC study
predicting a 450,000 tons per annum global supply surplus developing
by 2007, which would cause a drop in prices to $2,646 per ton by that
date.
Whatever the outcome for copper prices and the parties involved in
the Liu transaction, there is a general perception that the incident
will slow down China's financial reforms, particularly the planned
reforms of the futures market, since "futures" include precisely the
kind of short sales evidently abused by Liu.
This is especially so since similar problems have occurred before:
the copper flap followed a derivatives trading scandal in 2004 at
China Aviation Oil, a Singapore-listed company that racked up $550
million in trading losses on oil swaps; and an abrupt reining in of
the futures market in the mid-1990s after a scandal in the market for
government bond futures. With Chinese companies increasingly eager to
hedge their futures and foreign exchange positions on overseas
financial markets, the timing of the copper affair must be unwelcome,
to say the least.
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