Hedging Rollovers: Risks And Returns In Chinese Commodity Markets

AuthorLark Y. Grier
Pages05

Lark Y. Grier is a JD/MA student at American University, where she is studying International Trade Law and International Political Economies. She also serves as the International Trade Liaison to HYBAS International, an import-export firm with headquarters in Houston, TX and offices in Trinidad, Dubai and Washington, DC. She focuses her trade practice on International trade services, trade facilitation and supply-chain consultation.
In 2006, the Chinese economy experienced unprecedented growth. China's gross domestic product (GDP) comprised 30 percent of the global increase in GDP. The purchasing-power of China's currency exceeded that of the United States by more than 15 percent and in 2007, economic indicators estimated a three percent increase in GDP.1 While the U.S. economy is still the world's largest, accounting for 20 per cent of the global GDP, China's growth, at a rate of 11% in 2007 far sur passed a U.S. growth of two percent and a nine percent growth rate for India.2
Many experts say that the remarkable growth of markets in emerging countries, such as China, India and Russia, is largely attributed to high commodity prices. While high commodity prices are helpful to producers and exporters, they hurt consumers. In the long- term, these prices are not sustainable, unless they are supported by sufficient increase in demand.3Trade surpluses surpassing $1 trillion have sustained China's growth and provided a strong buffer against credit disruptions.4However, projections show that emerging markets will begin to suffer from the effects of rollover risks as the settlement dates for their long-term debts approach. With respect to China, investors fear the following risks: loss of liquidity, in both foreign exchange and commodity markets; decrease in returns on investment in commodities; and decrease in commodity prices.
A rollover (often called "rollover hedging" when done speculatively) is a technique through which investors can extend a contract for the sale of a commodity by continually extend-ing a futures contract, thereby tendering a new contract for the same commodity, with a later settlement date.5 Stated differently, the investor (also known as the hedger) enters into a contract which he later closes, while simultaneously opening the same position on a contract for the same good, where payment is due at a deferred time.6This procedure allows investors to take advantage of fluctuating prices, giving them the opportunity to extend a contract for a specified commodity until the market for that commodity renders a lower price. Unfortunately, this procedure also reduces the liquidity of commodity markets by limiting the cash transactions and presenting risks for sellers, especially those of agricultural commodities.
Despite the use of rollovers in securing profitable investments in China, the country's government has yet to develop legislation to deal with the use and misuse of rollovers in capital markets. Similarly, their laws regulating foreign exchange markets are fairly new and are continuously expanding to address new issues as they arise. Given the vitality of China's foreign exchange markets, regulations on the use of rollovers would ensure settlement of large transactions, lending itself to the economy's growth. While the country is continually expanding the laws and procedures which govern foreign exchange transactions, these provisions...

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