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China State-Owned Trader Causes World Rubber Prices to Plunge

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The episode also highlights the challenges faced by China’s state-owned commodity traders in hedging market risks.

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Rubber prices plunged across Asia this week after news that a major state-owned trader in China, ceased trading.

China’s largest trader of rubber ceased operations after failing to honor contracts with its local and foreign business partners. Unsettling the global rubber market for the commodity.

State-owned Chongqing General Trading Chemical, allegedly misjudged bets on rubber prices, said people familiar with the matter.

The fall of CGTC, a big player in the international rubber trade, has sent shock-waves across the industry. Global rubber futures plummeted following news the company’s permanent suspension of operations.

The episode also highlights the challenges faced by China’s state-owned commodity traders in hedging market risks.

In a letter to its suppliers last Friday, CGTC said it would “suspend all operations to maximize [their] interest”. The letter added that all unexpected contracts would become invalid. All submitted banks’ bills must be recalled.

A CGTC spokeswoman said the company was “closely studying the situation,” without giving further details.

Traders who work with the company said it failed to pay for at least 100,000 tons of rubber it bought on credit. The company was also unable to fulfill contracts with its domestic clients. Including tire manufacturers and trading companies.

“This is having a huge impact on the market given CGTC’s reputation as a large and reliable player,” said a trader.

CGTC ran into a liquidity crisis after making big bets on rubber. Rubber has traded sideways despite a slowing global economy, according to the Financial Times.

The closing price of the most active rubber contract on the Shanghai futures exchange was $1,600 per ton.

Speculative Trades

Tong Changzheng, an analyst at CITIC Futures, said CGTC had paid a price for making speculative trades.

According to Mr Tong, the rubber trader would begin by purchasing raw material from abroad on letters of credit and sell it on to local traders, many of whom were speculators. CGTC then built short positions to hedge risks. When the goods arrived, CGTC paid foreign suppliers with funds partially from its trader clients.

The model worked during a period of price swings when both traders and CGTC profit from wagers in the right direction. The difference between prices of spot and futures rubber also encourages traders to enter the market.

Yet as price movements flattened and the spread narrowed this year, speculative traders were less interested in holding physical goods, thereby reducing purchases from CGTC. That created a funding shortage for the group as its heavy involvement in spot and futures market required significant amount of funds.

“CGTC shouldn’t place too much [of a] bet on the direction of commodity prices,” wrote Mr Tong of CITIC. “It needs to have buffer space when prices are moving against its expectations.”

Insiders said the incident was a result of CGTC’s aggressive strategy. A former employee of CGTC said the company would run into trouble “sooner or later” because of its “one way only” trading strategy. CGTC held significant long positions in 2016 and shorted rubber in 2017, said the person.

CITIC Securities’ Mr Tong said the gap left by CGTC might not be filled quickly because other traders were concerned about market risks. That could lead to a decline in China’s rubber imports in the short term, he added.