LIU SHIYU, China’s new securities regulator, faces his first big test as markets watch how he handles a speculative bubble in commodities futures exchanges.

    Liu’s predecessor lost his job earlier this year over his mishandling of China’s months-long stock market rout.

    As with that market crash, the trick will be to stabilize volatile commodities futures markets without sterilizing them.

    “If this hedging tool is killed, steel mills, petrochemical plants, farmers and traders have no way to protect the value of their inventories,” said a fund trader who didn’t want to be named.

    “If they’re reluctant to re-stock, liquidity in spot markets will also be affected.”

    Liu was appointed in February to head the China Securities Regulatory Commission (CSRC), replacing Xiao Gang, who was widely criticized, especially for the disastrous implementation of a circuit breaker mechanism intended to stem volatility. It was deactivated within a week.

    Xiao intervened heavily in the stock index futures market, trying to drive out “malicious short-sellers” looking to profit from slumping share values, but the result was wholesale investor flight from index futures: the operation was successful but the patient died.

    Now, many of those investors have piled into commodities futures, triggering a bubble in assets from iron ore and cotton to eggs. Analysts have warned of similarities to last year’s stock market boom, which reversed into a crash last summer.

    In a statement on its website Friday, the CSRC called for China’s exchanges to strengthen market supervision and curb excessive speculation.

    “This is blowback from the stimulus package,” said Andrew Polk, director of China research at Medley Advisors in Beijing, noting many investors saw a rational buying point in depressed commodities given China’s plans for infrastructure spending.

    But Polk said he was concerned the CSRC could return to its playbook of counterproductive intervention in what is a key market.

    “This clearly represents a risk that they will try to clamp down and promote stability in ways that end up creating more volatility ... and the commodities market, where movements are heavily influenced by people’s expectations of infrastructure and real estate spending, are much more impactful on real economic growth than shares.”

    China’s commodity exchanges initially raised transaction fees for overheated futures contracts. People in the industry said this made futures trading less attractive for everyone, while the unexpected froth in prices caused some steel mills to take losses on their short positions.

    That, plus rising volatility, caused many to step back. Open interest and trading volumes for many key contracts have fallen sharply last week as money exited the market — a short-term victory for the CSRC, albeit at a cost to legitimate traders.

    “Raising transaction fees is targeted to crack down on speculative money, and it has indeed helped curb intraday speculation. But it also affected ordinary and lower-frequency traders like us,” said Zhang Xiong, senior manager at Traderblazer in Shanghai.

    On Thursday, sources said the regulators had added a layer: in addition to hiking fees to reduce speculative bets, they required major investors with no “commodities background” to reduce their positions.

    This smacks of the targeted campaign against “malicious short-sellers” in the stock market and it’s unclear whether it will be more effective.

    While there’s a risk that a purge of hedge funds might hit liquidity, traders say the CSRC has a big advantage in the commodities market: commodities are based on physical products with sale prices in the real world.

    Unlike China’s stock market, commodity futures are more closely tied to economic fundamentals. The ability to rise or fall is ultimately limited by the market realities of traded steel, cotton and eggs.

    But the CSRC has to be constantly vigilant as a pool of speculative financial firms hops from asset class to asset class at high speed. (SD-Agencies)