The Next Big Futures Market May Be OUT OF THIS WORLD or in CHINA

In my post about globalizing futures, technology and logistics were highlighted as key factors to expand local commodities into a global commodities.  What I failed to mention is that these same keys may unlock potential futures markets growth beyond Earth.  That may seem extraordinary but the potential is real since according to this article on NPR, NASA is planning to grow cress, turnips and basil on the moon.  While it is interesting to think about the spread opportunities that may exist one day between global and extraterrestrial contracts, it may just be that out of this world contracts are so fabulous that they command a fixed premium.

Back to Earth now… The more realistic next big futures market may be in China. I am visiting Shenzhen this week for the 9th Annual China Derivatives Forum, where thousands have gathered to discuss openness, innovation and cooperation in the Chinese derivatives markets.  Many lessons can be learned from the US and Europe, where derivatives markets are more developed, which may help in China’s quest to develop commodity futures.

During my visit, I met with several journalists looking to highlight the importance of China in the commodities markets going forward.  Below is a summary of the most frequented questions:

Q1: How important is the development of China’s futures markets?  The development of China’s futures markets can be highly important for the continued growth of both local and global markets. With growing futures markets, there is greater incentive to produce and store since insurance against price fluctuations is available. This may consequently reduce the volatility of prices for the inputs to goods and help consumers with price certainty. However, there is greater risk-bearing for producers, so to the extent that China is a major consumer and that consumers have choices unavailable to producers, the futures markets may play a lesser role.

Q2: What needs to occur to facilitate the growth of the Chinese futures markets and to get them represented in the major indices? Greater openness, collaboration and continued innovation may be catalysts to help China’s market grow.  Futures contracts that reflect the underlying local physical markets are important to attract commercial hedgers who are in need of protection against price moves. Once there is sufficient liquidity in these contracts, independent indices can be developed only if price data is available for use in the calculation of the index levels.

Q3: For Chinese investors, how do you think they should invest in global commodity indices? Hopefully Chinese investors can enjoy the same benefits as other investors around the world, which have historically been diversification, inflation protection and the potential for equity-like risk and return.  Diversification is now more prevalent since the high inventories have fallen and commodity prices have become more sensitive to supply shocks, which have reduced correlations of individual commodities to each other and commodities to other asset classes to pre-crisis levels,

Q4: What role does China play in the global commodity market, both as a driver and as a trading platform? China is a major consumer of commodities so the demand growth is a key factor in the price formation of commodities globally. As a trading platform, China is developing quickly though their exchanges but products are still in their infancy stage of development.  This may be good news since already there have been about 10 new contracts to market in the past year including some major launches on iron ore, lumber, and crude oil. For areas where there are no great developed futures market like iron ore and lumber, there is an exciting opportunity for diversification.  For commodities that already have developed markets then the question becomes about the similarities and differences between the contracts.  Maybe the popular Brent-WTI spread will get another leg if the Chinese oil contract creates more opportunity.

Q5: How does the impact of demand growth differ between China and India? The demand growth of any consuming country has an impact on commodities.  While much attention surrounds gold demand in India, I think what is really important is the demand growth of oil from India. India is one of the top 10 oil consuming countries in the world and it has the highest projected demand growth rate.  In 2013 demand growth was 46 kb/d or 1.4% and in 2014, the projected rate is demand growth of 3.1% or the equivalent of 104 kb/d added to consumption (according to the Oil Market Report by the IEA).

Q6: What will drive commodities in 2014? The major factors set to influence commodities next year are the quantitative easing, Chinese demand growth and geopolitical tensions. While the Eurozone debt is still on the horizon, the concern seems to have subsided compared with the sentiment a year ago.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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