What the world can learn from Chinese futures trading
“SO LONG AS you think about what others are thinking about, and stick to your trading strategy, you can always be successful.” This encouraging, if dubious, sliver of market wisdom was proffered on September 3rd by Zhou Chengji, a Chinese investment adviser, during a two-hour online tutorial. China is hardly alone in having a raucous community of would-be market gurus and day traders. But Mr Zhou’s focus was on an asset that makes China look rather unusual: egg futures, the only ones of their kind in the world nowadays.
For punters with strong views about whether hens will be productive this autumn and whether people will crave egg-fried noodles and the like, China is the place to be. All they need do is contact local brokerages and put down a 4,000 yuan ($585) deposit. Going long eggs (ie, betting prices will rise) was, briefly, one of the trades of the summer, with futures soaring 65% from late May to late July. Since then the market has cracked, prices tumbling more than 20%. Turnover is extraordinarily high. Investors buy and sell roughly 3m tonnes in egg futures every day, about a tenth of the total that China actually consumes in a full year. The rights to a single egg may, in effect, pass through a few dozen hands before it lands in boiling water.
All this makes it tempting to dismiss Chinese futures as a hotbed of speculative excess. Retail traders do play a much bigger role on the country’s commodity exchanges—in Shanghai, Dalian and Zhengzhou—than in Chicago or London, which have long been the world leaders in, respectively, agriculture and metals. Officials estimated that in 2016 about 85% of open positions on Chinese exchanges were held by individuals, compared with less than 15% in America, where institutions dominate trading. Nevertheless, the very immaturity of the Chinese market also reveals some enduring truths about futures that are obscured by the smoother functioning of century-old exchanges.
Start with the most basic, the need to hedge. Futures are a tool for producers to guard against prices plunging and for consumers to guard against them soaring. In the West this can look quite straightforward because market power is so concentrated. The top four steel companies accounted for about 80% of production in America in 2017 versus just 20% or so in China. Fragmented spot markets make it harder for futures to serve as a benchmark. Yet it is dangerous to operate without a pricing backstop. So China has been rushing to expand its universe of futures. In the past two years alone it has launched more than ten new contracts, from crude oil and stainless steel to apples and red dates. It will take time to establish their credibility.
If China still has much to learn about futures, there is something to be said for its trading intensity. Of the 20 most active contracts in the world last year, 14 were on Chinese exchanges, according to the Futures Industry Association, a global trade body. Some of that is because of double counting. It can also reflect the swirling pool of money trapped in China by capital controls. Nevertheless, there are limits to the potential irrationality in futures trading because ultimately the underlying commodities are due for physical delivery. Futures contracts thus converge with spot prices as they near expiry. Two other factors help explain China’s trading volume. Lot sizes are generally small (for example, five tonnes for copper futures in Shanghai, compared with 25 tonnes in London). And ordinary investors have easy access through their brokerage accounts. Institutional traders in China love the liquidity that results from this. It eliminates the risk of being unable to enter or exit a position because of a lack of trading.
如果说中国在期货方面还有很多要学的，它在交易强度上的优势值得一说。全球行业组织期货业协会（Futures Industry Association）称，去年全球最活跃的20个期货合约中，有14个来自中国的交易所。这有一部分是因为存在重复计算。这同时也能反映出，由于资本管制，大笔资金被困在国内打转。不过，期货交易中潜在的不合理是有限度的，因为标的商品最终要实物交割。因此，期货合约在即将到期时趋同于现货价格。还有两个因素有助于解释中国的交易量。中国期货的交易单位通常较小（比如上海的铜期货为5吨，而伦敦为25吨）。并且普通投资者也可以通过自己的经纪账户轻松进入期货市场。中国的机构交易员喜欢由此产生的资产流动性，它消除了因缺少交易而无法进入或退出头寸的风险。
There is another reason why institutional traders like China. They can profit with relative ease. Commodity futures illustrate how cloistering a financial system from the rest of the world leads to distortions. Darin Friedrichs of StoneX, a commodities brokerage, says that easily disprovable rumours can cause price swings; unfounded reports of a Brazilian port closure recently drove up soyabean futures. Traders relish their “import-arb” windows, when prices of Chinese futures exceed those of their global counterparts, making it worthwhile to arbitrage by buying abroad and selling onshore.
Slowly, regulators are dismantling the walls, allowing more international firms to trade in China. Futures with international counterparts such as oil and corn are starting to align more with global prices. For the adventurous, though, there are always eggs.