China may default on silver contracts.
I looked and did not see this article posted elsewhere so I thought that I would post it here and also ask a question (or 3) about it.
Ted Butler said this in his commentary
“The threat from China that it may default on contracts that back the concentrated COMEX short position raises the stakes immensely. “
The way I read this is that JP Morgan is on the hook for massive silver short contracts on Comex. They hedged their position by getting contracts for silver from China. Now China says they may default and not deliver.
1. Do I have this right?
2. If so, does this not mean that silver should spike up in price?
3. Do you think that this is only “saber ratling” from a peeved China about all the manipulation or do you think this is real?
I don’t know why the link did not show properly – try again.
How deep does the rabbit hole go……
Thursday, September 3, 2009
Let’s put the pieces together here. Just this past weekend China announced that State Owned Enterprises (SOEs) will be allowed to default on commodity derivative contracts. Think of that. China has given the green light and authorized the defaulting on commodity derivative contracts.
This story broke over the weekend but has not gotten much mainstream media attention on this side of the pond. (North America). The only inference to it was the talk or “buzz” on the Wall Street floor that another bank was rumored to be close to defaulting. As Art Cashin of UBS Securities indicated in the video clip I posted earlier, normally when a market sells off on a rumor and the rumor turns out to be false, the market will tend to correct itself. IT DIDN’T.
The Reuters report cited 6 foreign banks that received letters indicating that the Chinese State Owned Enterprises would be given the green light to default on their derivatives.
A look at what a derivative actually is may be useful here. A Derivative is a financial instrument that is derived from some other underlying asset, index, event, value or condition. Rather than trade or exchange the underlying itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying. A simple example is a futures contract: an agreement to exchange the underlying asset at a future date. Commercial and investment banks make up the foundation of the over the counter (OTC) derivatives market. Investors use derivatives to protect against risks, such as sudden changes in price or value of the underlying asset. Others tap derivatives to take on extra risk, in the hope of extra gains.
Well China owns billions of these products and it has finally come to light they have had enough of having the value of their derivatives manipulated by the manipulation of the price of the underlying asset. They have finally woken up to the fact that these derivatives have been bundled together like junk in a manner that resembles the mortgage backed derivatives that brought down the world markets last year.
Back to Reuters. Some of the State Owned Enterprises that stated their potential intentions to default were Air China. China Eastern and Cosco. Mainly in part because they took major derivatives losses over the past year but also, concerns are arising that the derivatives that they were sold by these foreign institutions are garbage, underwater and may never see the light of day. So why continue to pay for them? So the concern in the financial world is that holders of these losing products may just walk away, not unlike a home owner with a $600,000 mortgage on a home valued at $475,000 deciding to just hand in their keys. However, read on…this has nothing to do with morgtgage backed products. This time, the concern may be over Oil.
They (Reuters) cited 6 foreign banks.Where the story gets really intriguing is that among the major derivatives providers according to Reuters but also widely known in the industry, are Goldman Sachs, UBS and JP Morgan.
Here is the looming problem. These products are worth billions. One report that a good friend of mine did showed that if Goldman Sachs for example were to take this one up the rear, they could stand to lose 15 billion dollars. (This number is by no means confirmed)
An important history lesson is needed here. “Potential default” was the concern that sparked and prompted the most recent economic crisis. These intricately weaved products along with highly speculative CDOs and CDSs began to fall apart when the bubble that was in large part significantly contributed to and created by the financial institutions that were packaging this junk started to fall apart.
Imagine the impact for a brief moment if you will, on the impact to the financial landscape if China were to say “we are walking away” from those products. I would imagine that China, being the biggest purchaser of US debt, could surely collapse the US institutions that were at one point deemed too big to fail if they decide to go ahead with this plan.
This is why I don’t take tonight’s news that China purchased 50 billion dollars of IMF bonds lightly. In fact, I take it very seriously. This is why I take the buzz on the floor over the past two days very seriously as well as I do the incredible spike in Gold today. Most importantly, I do not take lightly the recent 25% correction we have seen in the Chinese Stock Market. Can all these events be interconnected some how? Is the Chinese stock collapse giving us a hint?
The Reuters story came out on Mon Aug 31, 2009 at 7:42am EDT. I find it quite interesting that the mainstream media did not take this more seriously. Reuters reported that the above noted Chinese companies have already issued letters to the banks. The Reuters article cites 4 clear points.
• State-owned firms may default on commodity hedges – report
• Bankers dismayed, confused by report; seek more details
• Lawyers question legality of the move
• Traders suspect lurking losses may have prompted warning (Adds analysts comments)
Analysts are fearing that if these three big companies came out and spelled out their losses and dismay at these products then this might prompt other large Chinese corporations to do the same.
Let’s take a closer look at the companies that have been mentioned in these news articles out of China. They are Air China, China Eastern and Cosco. If you ask me, this conundrum might have to do with oil. I deduce from this that if there is a problem brewing it has everything to do with their Oil Derivatives business.
Here’s a brief overview of what might happen should these companies, and others, default. The banks, namely Goldman Sachs, J.P. Morgan and from other accounts possibly Deutsche Bank will find themselves LONG on oil futures with no customers on the short side of the derivatives. This will most likely lead the banks to sell the excess oil futures without a care for the price. This is no different than what happened when Bear Stearns was forced to sell off their gold futures in March of 2008 which then resulted in a sharp downturn in the price of Gold.
Spokespersons at Goldman Sachs (GS.N) and UBS (UBSN.VX) declined comment, and media officials at Morgan Stanley (MS.N) and JPMorgan (JPM.N) were not immediately available for comment. All are major global providers of commodity risk management.
We have yet to hear their commentary. A Chinese statesperson was quoted as saying “”If we were among the banks receiving that letter, we would be very angry.” You bet your bottom dollar. You don’t think the firms listed above are angry, or, are they frightened that if the Chinese State Owned entities start taking affirmative action it could theoretically bring down some of the biggest remaining names on Wall Street?
Remember Reuters initial story was titled Beijing’s derivative default stance rattles market. Read it thoroughly for more information.
Then, read the story that broke last Saturday to get a clearer perspective before the political and corporate spin started to enter the story. China warns banks on OTC hedge defaults –report.
“BEIJING, Aug 29 (Reuters) – Chinese state-owned enterprises (SOEs) may unilaterally terminate derivative contracts with six foreign banks that provide over-the-counter commodity hedging services, a leading financial magazine said.
China’s SOE regulator, the State-owned Assets Supervision and Administration Commission (SASAC), had told the financial institutions that SOEs reserved the right to default on contracts, Caijing magazine quoted an unnamed industry source as saying.”
On September 1, 2009 Reuters said that the Banks, not the commodities would be at risk if China followed through.
Yes, legal battles would ensue should this happen and we can also expect to have Chinese political figures downplay the story in an effort to avert panic. However, if they can prove that these derivatives or the underlying asset was manipulated in a manner to profit the bank that issued the product then that may even do more damage than the default themselves.
Perhaps the “buzz” on the floor is indeed true. Perhaps we are going to see action that could annihilate one of the biggest Wall Street firms ever.
If there is one thing I have learned of late is that when the Chinese speak, we must listen. Their list of allies is ever growing and they are simply fed up of having to swallow the US garbage that has turned out to be toxic and dangerous to their highly controlled and coveted state owned enterprises.
I leave you with these thoughts that I alluded to above. The Chinese market has corrected 25%. This news broke this past weekend. New York saw a sharp sell-off on Monday. Buzz of a bank default hit the floor. The rumor did not abate and the selling intensified. The selling carried over into Tuesday. Gold, a classic hedge against troubled times has broken out to the upside, China has purchased 50 billion in IMF bonds and has been questioning the US dollar now for upwards of a year. China was up 5% overnight and Gold has continued to climb this morning.
Where there is smoke there is often fire.
Hmm. I read this.
All I can say is that the possibility is there. And I’ll reiterate my position that sometime in my lifetime (I’m 43, just turned 43 yesterday), silver prices will absolutely explode.
Why am I so sure?
Because I have researched the fundementals exhaustively.There are 270,000 metric tons of mineable Ag known by the USGS. The base reserve, that is, the total Ag in the Earth’s crust, is 570,000 metric tons. But the 300K ton difference is not economically feasible for recovery. Therefore to extract it the cost of production will go way way up.
Furthermore, ~ 75% of all Ag mined is exacted along with Ni, Cu, Fe, Zn and other metals. As these base metals become more difficult to extract, the remaining Ag costs will need to increase to offset extraction costs and provide incentive.
Heck if I know. The game players are so hell bent on keeping PM’s down in price, and have been so effective at it that it might take 30 years.
Timing this thing is impossible. Absolutely impossible. I do not recommend Ag if you’re thinking that you’re going to see massive profits in the short term. I personally just don’t see it. However, having some in your SHTF portfolio might not be a bad idea.
Imagine the carnage it would cause if the Chinese went ahead with a default on silver or anything else for that matter.
The thing that really strikes me as so “dangerous” is all the IP, hardware and general know how the west has been prepared to give to China just for the sake of saving a few $s, €s, £s or what ever. wow!
I wonder if instead of defaulting, the Chinese will simply sell back the toxic waste to America threw the Fed printing more money and having China buy more short-term treasuries with the printed cash. Sounds good for gold prices. Surprised were not at 1500 after hearing all the printing going on in the Fed. The story of the schell game is spreading threw the internet like wildfire. One has to wonder just how long this B.S can go on without real trouble spreading to the markets. I wonder what they will pull out of their bag of tricks (scams) next?
kenc and Damnthematrix,
Thanks to you both for bringing this to our attention. Disturbing is the word that comes to mind. If I were in the position of the Chinese I would be angry!
Sorry to be the bearer of a cold bucket of water, but I take these Chinese threats to be nothing more than threats. If they renegged on any kind of derivatives contracts, it would tank the Chinese financial markets and send their economy into a tailspin. They would be blocked from all major global derivative exchanges and would have no way of hedging their commodities contracts by way of futures markets.
Maybe there is something I am not understanding here, but based on what I think I am understading, such action by the Chinese would be suicidal.
And I’ll reiterate my position that sometime in my lifetime (I’m 43, just turned 43 yesterday),
Hey Pete, we have the same birthday (Sept 5th) and just two years apart….small world or I mean small Matrix