5-24-18

When Hong Kong Exchanges and Clearing (HKEX) bought the London Metals exchange in 2012 all the speculation about about the effects on gold trading.  The primary reason for buying the LME was to obtain its warehouses and ensure a free flow of metals to points east.

What it also did was give them control over what type and kind of futures contracts could be traded on their exchanges.  No longer would the west control this very important part of the precious and industrial metal supply chain.

Now we’re seeing the next evolution of the power of owning the exchange.   After successfully launching a yuan-denominated gold futures contract last year, the LME is now preparing to issue a range of yuan-denominated metals futures.

In other words… Boom.

First Rule: Do No Harm

When China bought the LME the usual suspects in the contrarian investing community talked about the coming apocalypse for the bullion banks.  It never happened. In fact, China was in a position to help them cap the price of gold and extend the gold bear market for the past six years while it and its strategic partners, namely Russia, accumulated vast quantities of the world’s most important metal.

The Chinese were smart. Take over the LME and, for a while, change nothing. Don’t upset the apple cart and allow markets to operate mostly normally.  Now their ownership of the LME is not an issue.

Until now.  First gold trading in Yuan. Now the rest of the metals.

We’ve all been breathlessly focused on how strong the so-called ‘petroyuan’ oil futures contract has been for the Shanghai Exchange.  It has captured more than 12% of the total oil futures market in just under two months.  That’s incredible.

It tells us there was substantial demand for this product because many in the world were tired of being exposed to U.S. dollar currency risk to buy oil.  Now that business is gone.

Moreover, the more successful the contract becomes the more belligerent the foreign policy rhetoric from the Trump administration on trade and sanctions becomes.

Parallel Escalation

There’s a reason why this Sturm and Drang is coming from the Trump administration on trade and tariffs now.  Trump needs wins on this front for the mid-terms and to counter the very real changes to the world’s financial structure China and Russia are spearheading.

He needs to press what advantages we still have to maintain our position in the world.

However, things like the petroyuan contract, ailing emerging markets enbracing cryptocurrencies (Venezuela and now Argentina), NATO allies siding with Iran (Turkey, the EU) are threatening to unravel everything Trump is trying to accomplish.

So, why is this announcement by the LME such a big event?

The effects are legion:

1. It removes yet another important source of dollar demand from the global financial market.
2. It creates more demand for the Yuan which will feed China’s need to expand its money supply if it’s to liquefy its trade.
3. It helps countries circumvent sanctions by removing its need to hedge in dollars for trade with China.
4. It provides Europe and Russia a new way to avoid tariffs and resist sanctions.
5. It insulates emerging markets from a potential spike in the U.S. dollar as China will allow the Yuan to fall versus the dollar while keeping its overall REER — Real Effective Exchange Rate — relatively stable.

This leads to one conclusion.  This is massive assistance to emerging market companies with big dollar-denominated liabilities.  These are the catalysts to take shake up the world completely.

They will better handle any dollar liquidity crisis by separating its supply-chain management for buying metals in earned yuan while using dollars earned to service dollar-denominated debt.

I’m becoming convinced that Trump is pursuing this kind of trade policy to punish the world for taking advantage of past administrations destruction of the U.S. capital base through Byzantine WTO regulations and lopsided trade deals.

The problem with this approach is that with China’s strategic acquisitions and movements, it can respond with what look like small, inconsequential moves that have out sized repercussions.

China sees what I’m seeing with what’s happening, a massive dollar liquidity crisis and it needs to put in place alternative to keep global trade from collapsing.

And if it is going to rise to challenge the U.S.’s unipolar world, it cannot let that happen.  And the free flow of strategic commodity metals in the face of strong U.S. tariffs is the means by which to ensure that happens.

The Critical Shift

The reason why the petroyuan contract was so immediately successful is because China provided traders with a direct path to convertibility into gold.  It de-risked listing because profits wouldn’t be trapped behind China’s capital controls.

This convertibility wouldn’t be worth anything if China didn’t have a steady source of gold streaming in via the LME, however.

China is the world’s largest oil importer. With Trump’s threats to cut everyone off from dollar-funding markets over Iran making the switch, sans real risk, from dollars to yuan was an easy choice to make.

Now let’s bring Europe, Russia and the rest of the world into that realm to coordinate the attacks on the U.S.’s dominance of global financial markets.

The chaos unleashed by the confluence of Italy’s new coalition, a strengthening dollar and trade wars is putting insane pressure on those emerging markets vulnerable to a dollar shock.  Turkey’s lira and debt are under extreme pressure while President Erdogan defies NATO and U.S. foreign policy over Syria, Israel and Iran.

Trump’s near inhuman treatment of Venezuelans over President Maduro’s defiance is frankly, shocking.  This is not an endorsement of either Maduro or Erdogan, but simply a statement of how vicious U.S. foreign policy is right now.

And both Turks and Iranians are taking notes as to what their future holds if they submit to this pressure.  Erdogan, while a lunatic, is right to stay his central bank’s hand on raising interest rates IMF-style.

They are staring massive corporate debt defaults if the Lira continues to spiral down. And that will absolutely blow back on the banks carrying that debt, all $222 billion of it.

This is simply yet another attempt at regime change through hyperinflation that we’ve already tried on Venezuela which didn’t work.

Iraq just thoroughly rebuked U.S. intervention. So did Lebanon.

And Turkey is next on the list, with elections brought forward by Erdogan a year for early in June.  Iran is publicly gaining support as it stands firm.  And Russia is acting like everyone’s friend making deals and honoring them without ever firing a shot or even issuing a threat.

All of this ties back to China’s tacit financial support of these nations currently being attacked by U.S. power brokers through the financial markets trade policy.  As these countries survive the worst of these attacks, as the near-term crises fade, these markets will adjust to a different landscape.

A landscape where the U.S. bullies and no one listens.

https://tomluongo.me/2018/05/24/petroyuan-is-only-the-beginning-pop-goes-the-metals-market/