China's preparing to expand its futures markets.
Futures exchanges exist worldwide, though just a few main futures exchanges set the benchmark prices for most commodities globally.
China, along with other growing emerging markets, will drive marginal demand for commodities and other goods ahead.
Any expansion of Chinese futures markets will likely take time and be incremental in nature—giving stock markets plenty of time to price in developments.
Tiananmen Square was recently alight with celebrations marking the 60th birthday of the People's Republic of China. Hardly a time to party if you don't like communism (we don't). Still, we're encouraged by the occasional signs China's communist roots can give way to a slow adoption of free(r) markets—like China's preparation to expand its futures markets.
Futures are contracts traded on exchanges that allow contract holders to buy or sell a commodity at a fixed price at some point in the future. Futures exchanges exist worldwide—Mexico, Malaysia, Thailand, Turkey, Dubai, etc.—helping buyers and sellers clear trades on many different commodities each day. Yet despite the numerous futures exchanges, just a few of the biggest—in New York, Chicago, and London—largely set the benchmark prices for most commodities globally.
China's heavy appetite for raw materials and energy makes it a sizeable end market for commodities. Chinese oil and iron ore imports rose to a record in July—and demand may rise higher, fueled by stimulus spending and a recovering economy. China, along with other growing emerging markets, will drive marginal demand for commodities and other goods ahead. There's no doubt China's large demand influences prices to an extent, but commodity pricing—especially when dealing with futures contracts—can be subject to great volatility and potentially cost the state billions.
So it's no surprise then the state is turning its attention to the futures market. China's hoping to expand its futures exchanges—and thus the visibility of what its companies and investors deem fair commodity prices—can help increase transparency about supply and demand. In turn, this could improve the price discovery process and help traders on the major exchanges more accurately price futures contracts (rather than bid up prices based on misinformation or baseless speculation on future Chinese demand, for example).
Overall, a step toward Chinese market liberalization is a positive one. Improved transparency in Chinese futures markets can add stability and efficiency to commodities trading. However, any expansion of Chinese futures markets will likely take time and be incremental in nature. It's unlikely the Chinese futures exchanges will supplant the 161-year-old Chicago Board of Trade (CBT) or 132-year old London Metal Exchange (LME). And even if they did, so what? An exchange is just that—a free market place.
The LME is the world's largest, but the Brits don't influence metal prices by dint of their geographic proximity to the physical exchange. Traders will continue to buy and sell commodities where it's easiest and cheapest—a more robust Chinese futures market will simply help open a window to this important end market.