The other day I was listening to this great podcast called MacroVoices. It is hosted by Erik Townsend - a hedge fund manger who manages to line up some terrific guests (click picture below to be taken to Erik’s site):
Recently Erik interviewed the renown China watcher Simon Hunt. One particular passage struck me, so I took the time to transcribe the exchange:
QUESTION - ERIK TOWNSEND: In Australia I met a fellow who is actually an engineer on one of the big ships that delivers coal and iron ore to China. We were talking about the significance of those exports to the Australian economy and he looked to me and said,
“Eric - it’s in the harbour.”
I said, “what?”
And he described to me a scene that he has seen dozens upon dozens of times. They pull into port in China. They unload thousands of tons of coal and iron ore, that cost millions of dollars. As they are pulling away from the pier they observe the Chinese literally bull dozing it into the harbour. Just stock piling all of these commodities apparently for later use.
What’s going on? Why in the world is China stock piling raw commodities, literally to the point where they are bull dozing them into the harbour because they have no where else to store them?
ANSWER - SIMON HUNT: I can add to that, in other metals too, China has been deliberately stock piling, putting material into unreported locations. The sums are very large. In some cases enormous.
I think there are several reasons for this.
First of all they are an importer of key commodities that drive their economy. Should relationships with America deteriorate any further, it is quite possible that America could turn off one or more of the sea port routes. So if you are a planning nation, which China is, you have plan B. Plan B is that we have to have these contingency plans. So I think what has been going on, and is ongoing, it’s not just coal and the iron ore or whatever, it’s actually the finished metals as well, which are basically bought through the SRB (the State Reserve Bureau) and my guess, and it’s only a guess, they will be significantly larger buyers over the next two years than they have been over the past two years.
Another point, China does not want dollars. Their stock piling metals, buying natural resources, is part of the dollar diversification program.
Finally, the Chinese financial system would very much like to see higher commodity prices because the severity of their non-performing loans in that sector, both to producers, fabricators, importers, traders, etc. is simply enormous.
So yeah, they have built big resource reserves, and they are going to get bigger.
I am not sure how much I buy Erik’s Australian pal’s story that the Chinese are literally dumping the imports into the harbour. They can’t just ship it to a warehouse somewhere? Certainly there has to be a better solution than storing it at the bottom of the ocean.
Yet I am sympathetic to Simon’s idea that the Chinese are stock piling natural resource reserves. His line about China being a planned economy and the necessity of having a plan B really resonated with me. Put yourself in China’s shoes for a moment. Regardless of what you think of Donald Trump or his chances of winning, it would be imprudent to not plan for the possibility of a Trump White House. Simon Hunt was probably being overly dramatic when he discussed “closed sea routes,” but China has to entertain that possibility. And it’s not like relations between China and the United States have been rosy under the Obama and Xi administrations. Tensions are increasing between the two powers on a daily basis.
It makes sense for China to stock pile natural resources. If I was in charge of their economy, I know I would. But that’s not really anything new. They have been doing this for years. All you need to do is look at the pace of Chinese crude oil imports to get an idea of the trend:
With the recent inclusion of the Chinese Yuan in the SDR basket, China has moved from a currency loosely pegged to the US dollar to one managed against a basket of currencies. Years of this symbiotic relationship between the US and China has resulted in China possessing stacks and stacks of US dollars. Any transition into other assets will most likely include a fair amount of natural resource buying.
The breakdown of this long term relationship will obviously cause some volatility. This is already evident with the recent decline in the Yuan which is getting a little more hairy. Today we hit a new low (high in the CNH rate).
I don’t know how this Yuan/US dollar unwind will play out. I am not sure if it is just starting, or almost over. Just be careful assuming commodities will go down. If the shit really hits the fan, the Chinese just might come for the commodities in a big way.
Thanks for reading,