Friday, September 11, 2009

Which Derivatives Will China Renege?

News hit the wire late August-early September that China may renege on their commodity derivative contracts with unnamed six foreign banks.

Derivative deals hit a rough patch (9/1/09, People's Daily Online)

"Chinese State-owned enterprises (SOEs) may unilaterally terminate derivative contracts with six foreign banks that provide over-the-counter commodity hedging services, Chinese business magazine Caijing reported, citing unnamed sources.

"The report said that the State-owned Assets Supervision and Administration Commission (SASAC), China's SOE watchdog, has informed the financial institutions in written letters that SOEs reserved the right to default on those derivative contracts."

The derivatives in question are reported in the U.S. to be oil hedges. They certainly could include oil derivatives, but consider this peculiar phenomenon: it was gold, silver, and gold/silver miners that jumped big on the news.

Further checking this article, I found this paragraph [emphasis is mine]:

"The Caijing report, quoting an unidentified SASAC official, said that almost every SOE involved in foreign exchange or trade had some exposure to derivatives such as crude oil, non-ferrous metals, agricultural commodities, iron ore and coal, although only 31 SOEs were licensed to do so."

What are "non-ferrous metals"? According to GlobalSpec, "Nonferrous metals and nonferrous alloys are not based on iron and include alloys of aluminum, copper, titanium, zinc, nickel, cobalt, tungsten, precious metals, and refractory metals."

Long positions in oil, if they entered near high must be painful (as U.S. university endowments should know very well); also painful would be short positions in gold and silver, which they may have entered into to hedge their domestic operation (China is a large gold producer).

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