Chinese government doing illegal trading?

By: ispeculatornew
Date posted: 03.04.2010 (5:00 am) | Write a Comment  (0 Comments)

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In the past, we discussed sovereign wealth funds and how they are now having a significant impact on capital markets all around the world. One of the main differences is that these funds often do not disclose what they are doing. There are some exceptions though as they do have to comply with exchange regulations where they trade. In the US, that means reporting important holdings of US stocks. Interestingly enough, China Investment Corp, the Chinese government’s wealth fund, is now getting involved in some ETF’s, specifically in some commodity ETF’s. It recently confirmed it now was the 4th largest holder of USO, a crude-oil ETF. It also made important purchases of GLD, the very known Gold ETF. Is anyone monitoring their activities and specifically the timing of their transactions?

So what is the problem?

Well, the thing is that when buying stocks, it is illegal to do insider trading right? Why? Because it gives an unfair advantage when someone knows information that will impact significantly the stock price. The same rules should apply to commodities, except they don’t.

Imagine being the Chinese government. You know that you are about to announce some major purchases of gold and that these purchases will put upward movement on the price of gold futures. You could simply buy gold in the few days before announcing the gold purchase. Once the announcement is made, you simply start selling those ETF’s and get some profit. From what I understand, this is not currently illegal but it certainly gives governments and such funds an unfair advantage.

Hedge or speculation?

Of course, the counter argument by these funds is that they are using these ETF’s not to make money but simply to hedge their pricing risk when buying commodities. And that point could be defended. After all, China is a mass buyer of commodities and price increases can hurt the country greatly. Having long positions in ETF’s would act as a good hedge to profit from those prices increases.So yes, it would make sense.

Where do you draw the line though? It is obvious that the Chinese fund could gain a lot financially by knowing important news that will affect commodity prices. It would be very tempting for managers to add a few millions in profits thanks to this information, especially since it is not “technically illegal” and also because there are no organisations that could currently regulate such trading.

Any thoughts??

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