China Faces "Vicious Circle" As Commodity Collateral Collapses

As we warned last week, stockpiles of iron-ore have reached record levels in China as end-demand slumps but, as Bloomberg notes, this is potentially creating massive dislocations in other markets. Record imports of iron ore and copper, driven by traders who use them as loan collateral, risk repeating the vicious cycle of repayment difficulties and falling prices already seen in the steel-trading market. A stunning 40 percent of the iron ore at China’s ports are part of finance deals (having replaced copper after China's last shadow-banking crackdown) and with the glut, prices drop (driving down the value of collateral on loans) and "borrowers, forced by their bankers to repay loans or to top up collateral, will have to sell the metals, sinking market prices even further and begetting a vicious cycle."

As we noted last week, Bloomberg reports China’s record imports of iron ore and copper, driven by traders who use them as loan collateral, risk repeating the vicious cycle of repayment difficulties and falling prices already seen in the steel-trading market.

Iron Ore stockpiles ar record highs…

But Lenders seeking repayment are finding irregularities, including the same pile of materials used as collateral for multiple borrowings, China International Capital Corp. said.

Xiao Jiashou, known as the “steel-trading king” in Shanghai, had his assets frozen as China Minsheng Banking Corp. sues for money owed.

…

About 40 percent of the iron ore at China’s ports are part of finance deals, Mysteel Research estimates.

“The risk comes when metal prices fall by a large magnitude within a short time, driving down the value of the collateral,” Yang Changhua, a researcher with Beijing Antaike Information Development Co., said in a Feb. 19 interview. “Borrowers, forced by their bankers to repay loans or to top up collateral, will have to sell the metals, sinking market prices even further and begetting a vicious cycle.”

And those prices are tumbling:

Steel reinforcement-bar futures in Shanghai have fallen 19 percent in the past year, while iron ore delivered to China’s Tianjin port dropped 22 percent

And non-performing loans are therefore – exploding (as we noted here)…

Traders began having trouble repaying loans when steel prices in China slumped 38 percent in the seven months through August 2012 as the economy slowed. In the southern city of Foshan alone, local banks have given 100 billion yuan in credit to steel traders, Caijing magazine reported this week, citing a local banker it didn’t name. Loans to the sector helped drive non-performing loans in Yunnan province to 5.86 percent as of November 2013…

At China Citic Bank Corp., bad assets surged from 2011 to 2013 mainly because of non-performing loans to the steel-trade industry, Moneyweek magazine reported on Feb. 17, citing bank President Zhu Xiaohuang. The lender said on Dec. 12 that it plans to write off 5.2 billion yuan of bad debt for 2013.

At least a third of China’s 200,000 steel-trading firms will collapse as part of the credit crisis which started at the end of 2011, the official Xinhua news agency said Feb. 7, citing industry estimates. Nanjing Iron & Steel Co. said last month its 2018 bonds may stop trading due to losses.

Everyone should also know that like a metastatic cancer, the amount of non-performing, bad loans within the Chinese financial system is growing at an exponential pace.

But no matter how much the PBOC cracks down, only one thing matters:

“Those cash-starved steel mills or trading firms don’t care whether steel or iron-ore prices are falling,” said Zhang Jizhou, a trader at Ningbo Future Import & Export Co. “Their priority is to get cash flow so they can survive.”

So the shadow-banking system filled the gap as prime lenders disappeared…

Which means, howevere well intended, the PBOC is exacerbating the situation that many have drawn ugly comaprisons to the subprime-lending bubble in the US.

Simply put, the 'clever' people in China – having had their copper financind taken away, have shifted to steel – as the following diagram explains (just replace Copper warrants with Iron Ore…)

Which will end just as disastrously… unless of course, China once again unleashes the ghost cities building spree. Which it inevitably will: after all it has become all too clear that not one nation – neither Developing nor Emerging – will dare deviate from the current status quo course of unsustainable, superglued house of cards "muddle-through" until external, and internal, instability finally forces events into a world where everyone now has their head in the proverbial sand.

The big question is then, does China re-ignite huge inflation in an attempt to save its vicious-circle-facing economy or does the "pig in the python" get expelled first as fast-money carry leaves en masse and crushes collateral values…