Recruiting in China

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SHANGHAI -- China, the world's fastest-growing major economy, is hoping to turn its voracious appetite for raw materials to its advantage by using its heft as a consumer to get better prices.

The long-range strategy, still in its infancy, calls for China to transform its young futures markets into global price setters for products ranging from oil to metals to cotton. In the shorter term, China hopes to overhaul its procurement system, better coordinating the many separate purchases it now makes in global markets, in part to avoid unwittingly bidding against itself.

China's heavy dependence on imported raw materials gives it a strong incentive to hold down prices. The country imports almost 30% of its oil, 45% of its iron ore and 44% of its requirement for 10 nonferrous metals, according to Zhu Zhixin, vice chairman of China's planning ministry and an outspoken advocate of overhauling the country's purchasing. But China's approach to the challenge shows that as it integrates itself into the global economy, it isn't willing to surrender entirely to market forces.

Futures markets allow buyers and sellers to limit their price risks by agreeing to exchange a commodity at a specified time in the future at an agreed-upon price. Chinese officials, however, view them largely as venues to control prices. "If we want to increase our competitiveness, then we must develop futures [markets] to grasp our right in setting prices for bulk commodities," Zhou Zhenqing, a member of the financial and economic committee of the National People's Congress, said earlier this month.

China is now the world's leading consumer of copper, for example, using 20% of the world supply, or almost 1? times as much as the U.S. But, rather than being set in China, global copper prices are determined on the London Metal Exchange, where traders -- based partly on their forecasts of Chinese demand -- have bid up copper prices threefold over the past four years.

Key Chinese policy makers argue that influence over the market should shift eastward as China becomes the biggest buyer of global commodities. Jiang Yang, chief executive of the Shanghai Futures Exchange, noted in a recent speech that grain futures were invented in China during the Song Dynasty some 800 years ago.

Chinese officials aren't satisfied with suppliers' explanation that unprecedented demand from China justifies unprecedented pricing. Indeed, a Chinese copper trader who racked up heavy losses in recent months -- and inadvertently sent copper prices soaring -- may have been trying to signal that Beijing thought London copper prices were far too high, by putting in massive orders to sell the metal there.

China's long-term answer to its raw-materials crunch is to build up its own futures markets. Those exchanges, one each in Shanghai, Dalian and Zhengzhou, are considered among the most modern parts of China's financial system. In recent years, they have been restructured to focus on products the country uses in vast quantities: copper, aluminum, oil, rubber, soybeans, wheat, corn and cotton.

The goal is to make them "a determining force in setting prices globally," says Wang Weiyun, the head of research at the Dalian Futures Exchange, which trades agricultural products.

A crisis in cotton led to China's strategy. In 2003 and early 2004, China National Cotton Reserve Corp. had an estimated $72 million loss after traders on the New York Board of Trade bid up cotton futures prices by 40% in just a few weeks. China's view was that traders on the world's leading cotton exchange had overreacted to a Chinese government forecast of a shortfall in the nation's cotton production. Rather than simply considering how to improve its trading performance on cotton markets overseas, China set up its own cotton-futures market.

Less than 18 months after Chinese cotton-futures trading began in June 2004, cotton volume on central China's Zhengzhou Futures Exchange sometimes tops that of the Nybot, the bellwether market for cotton. More importantly, the Chinese market is emerging as an alternative venue for pricing. "We talk about the Chinese futures [prices] every day," says Ed Jernigan, a cotton trader and analyst who runs his own firm in Nashville, Tenn.

The credibility of China's futures markets is crucial to the country's commodity strategy. That means futures prices on Chinese exchanges can't vary too much from world prices. But in a bid to expand their influence, China is urging state-owned importers to specify in long-term purchase contracts with foreign suppliers that prices reflect those set on the Chinese exchanges.

While the Chinese government can't unilaterally set prices on the exchanges, it does have influence. In China's futures markets, which are flush with speculators, government trading houses tend to be the most important players, even if they aren't always the biggest traders. Government influence is magnified by the fact that Chinese futures markets still lack some of the participants, such as hedge funds, and some of the access to information that help to keep trading active in the West. The government said this month it may open Chinese commodity exchanges to foreign traders, though under strict controls.

Overseas, meanwhile, China is trying to become a savvier trader on markets such as the LME and the Chicago Board of Trade, which trades soybeans and grains.

The country's strategy often involves simultaneous trades on foreign and Chinese exchanges using arbitrage, a tactic that seeks to exploit price differences between markets. But no trading strategy comes without risk.

Over the summer, Chinese trader Liu Qibing, working for the Chinese agency that stockpiles commodities for the government and the military, bet massively that copper prices would fall from then-record levels. Instead, they rose another 30% and left the government on the hook for hundreds of millions of dollars in potential losses. The bill for those losses starts to come due today on the LME.

Around the end of last year, as copper's price on the LME began to rise faster than on the Shanghai Futures Exchange, Mr. Liu started "shorting," or selling copper, in London and making offsetting purchases of the metal in Shanghai, traders familiar with the activity say. To profit, he had to make more money in one market than he lost in the other.

As copper started to reach new highs above $3,000 a metric ton in July and August, hedge funds started betting against him in London, where Mr. Liu's massive plays amounted to pledges to sell hundreds of thousands of tons of copper at prices far below what they are today, Dow Jones Newswires has reported.

By mid-November, copper exceeded $4,000 a ton, and it closed at a record $4,467 in London this month; yesterday, it closed at $4,426.

China's government has made no public comment about the 37-year-old Mr. Liu, and his whereabouts are unknown, but its efforts to signal that global copper supplies are ample and that prices should fall suggest it is taking responsibility for Mr. Liu's losses. As unofficial estimates of those losses topped $200 million, the State Reserve Bureau, where Mr. Liu has worked 15 years, and state-owned Chinese trading houses began an aggressive campaign aimed at wrenching the London copper price lower before today -- the delivery date for the copper Mr. Liu contracted to sell on the LME.

The campaign has included copper auctions from state stockpiles and heavy sales of copper on the Shanghai Futures Exchange. As of a result, nervous traders in London have been watching the metal's price on the Shanghai Futures Exchange more closely than ever.

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