Zero Hedge did a great article over the weekend regarding China and the “vicious circle” that could be created with commodity price weakness. It used to be copper was used as “collateral” for carry, now it is iron ore. The “game” has been one of re re re hypothecation where say iron ore is deposited and letters of credit are issued off of the deposit and the “re” part is because in many instances several letters of credit are issued for the same ore.
This is a problem, a big one! Many financial writers speak to the levered status of the U.S. and Europe but miss the house of cards that is China. I believe that we will see before the year is up, Chinese defaults that actually end up as defaults. I say this because there have already been in 2 default situations (2 separate coal companies) where a “bailout” saved the day. Zero Hedge in the above article speculates that the PBOC may step up and do more “QE” so to speak of their own to prevent defaults. I say “maybe.”
I have written before that my opinion on China is different from what is common. I believe that China has “played” the game in order to build out their infrastructure. Infrastructure as in roads, bridges, plants, equipment and even cities where only ghosts currently inhabit. They have stockpiled more raw material than they need in many areas and this is viewed as a potential risk to a cascading downward spiral for commodities and their prices. This may be but China has also made deals all over the world to secure even more raw materials in the future…that will be paid for in dollars. I believe that China did not “allow” this credit bubble to expand to the current extremely dangerous levels by accident. I think that they knew full well where this would go and how it will end.
Think about what they’ve done. They have allowed the U.S. (the West in general) to go into too much debt. In fact, they have facilitated it. While they were “helping” us, they have positioned themselves for the next generations. I believe that they fully understand that the credit markets will go “boom” (they may even be the ones to pull the trigger?)…but, what remains after a financial collapse? What remains are stockpiles of raw materials that will be “used” in the future. The roads, plants, equipment and empty cities will all eventually be used.
Another “clue” for me about China is the fact that they have been hoarding gold. I would say that it is safe to say that they now have more gold than any other country. They are also now producing more gold than any other country on the planet! Do they view gold as a “commodity?” Have they stockpiled gold to “use” in the future? No and no. I think that gold is a big part of their “national strategy” so to speak. They fully understand that gold IS money and will be the last man standing as the global credit bubble bursts. Think about it, if the global markets were to just seize up one day and everything just stopped as in a “snapshot” photo where all the participants only “have what they have”…what would you as a nation want? You would “want” what they have newly built and stockpiled!
You have heard the above opinion before as I written about it several times but wanted to use that as a segue to a conversation I had last Thursday with Harvey Organ. Harvey has a theory which I agree with and had thought about this time last year. China is a “silver” country. They used silver for many years (between fiat blow up episodes) and had accumulated some 300 million ounces at the time of Mao back in 1949. The Yuan was originally a silver coin which was named after a Chinese general and is synonymous with the Renmimbi. The U.S. which no longer minted any silver in its coins since 1965 had a stockpile of possibly 2 billion ounces after the dismantling of the Manhattan project, by approximately 2003 all of that silver was gone. Harvey speculates that we approached the Chinese to “lease” their silver and is probably one of the reasons that they received “favored nation status” for trade. The Chinese agreed but understood that the pressure on silver prices was from their stock being bled onto the market as supply…but, they also understood that they could purchase gold at suppressed prices.
Harvey believes that the “lease” arrangement took place in 2003 which is exactly 10 years prior to April 2013, if the leases were 10 years in length it would explain last April’s carpet bombing of prices. If you recall, the COMEX silver open interest stayed quite high in 2012 and into 2013 and only after April did it begin to shrink in earnest. I wrote several times in 2012 and early 2013 that I believed the high open interest were of Chinese origin, who could have sustained such large losses from $45 down to $25 on a levered basis? Then suddenly the open interest fried up. The open interest has again neared 150,000 contracts which are odd because gold’s open interest has not risen. Harvey believes that “something” has really gone wrong behind the scenes as China is openly being aggressive with Japan and S. Korea which are both U.S. allies and protectorates. This is at a time where they also sold $48 billion worth of treasuries in a month. He and I both believe that “proxies” for China are where the resurgent open interest in silver is coming from…because they know. Our speculation is that China knows that their silver is gone…and will claim as much as they can from the COMEX inventories…however in the meantime they have been scooping up as much gold as they could and in far larger “dollar quantities” than the silver that they originally leased.
I have always said that the Chinese are a very smart people, if they were approached to lease their silver and then immediately following, silver became “plentiful” on the market place, then they knew where it was coming from. They used “this loss” as a way to accumulate gold by “going along with the game.” Silver and gold have acted very differently, not so much in price but in volume and especially in open interest. If we are correct about the use of “proxies,” the end of the game is whenever China chooses it to be. Far less than $5 billion could blow the lid off of COMEX silver. $5 billion is far less than chump change to China.
So they get some of their silver back in this manner but not all of it, who cares? I say “who cares?” because in the meantime they have built out infrastructure and probably accumulated more gold than the U.S “supposedly has.” Were China to “pull the plug” on the global paper Ponzi scheme and then immediately revalue gold multiples higher…they win the game. They will have won the game for generations to come! Speculation on our part? Of course it is but I bet that it is not very far from the reality.