China Looks To “Stabilize” Free Markets; Sellers Turn To US, Hong Kong ETFs

Either China has a lot to learn about “free markets” or those who believe in the concept of supply and demand need to catch a clue as to where the future is headed.

Does China need a lesson in “free market” mechanics or do those who believe in freedom need to see the writing on the wall?

There are those who believe supply and demand encompasses a mathematical logic that eclipses just markets and determines how people behave and societies make decisions. When something becomes short in supply – water in California, for instance – the price rises. This, in turn, leads to solutions such as lowered consumption and innovative methods to develop more supply are typically developed. When a government or a human force creates a pricing mechanism below the “natural” supply and demand price, the system of checks and balances is disturbed and, eventually, this has more severe consequences when markets correct, finding their true value level.

One can argue the Chinese market is experiencing such a value adjustment, finding its own level where buyers and sellers both agree “fair value” can be found.

Enter China, which has outright banned short selling and, according to ValueWalk sources with direct familiarity of the matter, is engaging in a witch hunt for anyone who dares sell stock.

China’s freely traded ETFs see short interest

Markets, like water, typically find their own level. Hence, China’s bears are flocking to U.S. and Hong Kong ETFs, Shuli Ren in Barron’s Asia observes.  She notes that the Chinese central planners have accused short sellers of creating havoc on a market that, judging by the Shanghai Composite Index, more than doubled in less than a year. Some might call this a mean reversion statistical play when a market gets ahead of itself to such a degree, but whatever it is, China is dissatisfied with this “free market” philosophy, instead preferring the controlled market approach where investors don’t lose money and markets are a dream world of tranquility.

So long as the concept of “freedom” is alive and well, and self-expression can be found in one’s investment thesis, markets tend to find their own level. That level may not always be accurate and sometimes involves volatility, but there is a daily point where buyers and sellers meet in the middle. It happens in currency black markets when a government decides to declare a value to their currency that is not supported by a market reality. It happens when water isn’t subsidized in cost and prices rise – impacting commodities and inflation in the process. And it happens in China, as “free” investors sell ETFs that track China.

Specific China ETFs traded outside China

Ren in particular is tracking Deutsche X-trackers Harvest CSI 500 China A-Shares Small Cap ETF, which is the most shorted ETF with 53 percent of the total exposure net short. She is also watching the Market Vectors ChinaAMC Chinext ETF, the second most shorted ETF, with nearly 35 percent net short exposure – a ratio that looks close to that of a long / short hedge fund ratio. But in a crunch, liquidity matters and the “hot commodity” is the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF, with a borrowing cost three times higher its previously mentioned sister fund, the Harvest CSI 500.

Is supply going the way of the dinosaur?

While the Chinese market situation is likely to sort itself out, China might want to consider that if it builds an international reputation for not allowing the buying / selling relationship to properly work, it will not find balance with world markets and China’s quest to for worldwide leadership, the key inside track to watch, may be thrown off balance.

But, on the other hand, perhaps it is the concept of free markets that are being challenged. Perhaps the trend with a powerful force of momentum is for “active market management” to become more the norm and supply and demand economics becomes a concept for the dustbin of history.

Responding to China’s moves to stabilize their markets, International Monetary Fund chief Christine Legarde backed efforts to “stabilize” the markets. “The fact that they (Chinese authorities) want to maintain a level of liquidity as well that is commensurate with an orderly process is also quite good,” she was quoted as saying. Then Lagarde touched the third rail insider topic that, in part, is said to be driving international investment in China and benchmarking its emergence as a world economic powerhouse. “We are very comforted by that determination (of Chinese authorities) to deliver on the reforms, which will be conducive, one day, when the times comes, once all the signals are checked positively, to the renminbi being included in the special drawing rights basket,” she said.

It is inclusion in the SDR currency basket that financial insiders are watching, a topic that isn’t often publically discussed but one that signals a milestone in a shifting world power landscape.

Despite efforts to “stabilize” markets, China’s Shanghai Composite Index was down 2.2 percent in trading today.