BEIJING, March 12 (Reuters) - China’s metal traders are betting that recently announced manufacturing tax cuts will start in May and are placing trades that pay off as prices diverge between the April and May contracts, three traders told Reuters this week.
Since the tax cuts were announced on March 5, the price spread between the April and May Shanghai Futures Exchange copper contracts has shot up tenfold from a backwardation of 40 yuan ($5.95) a tonne to over 400 yuan a tonne, the most between ShFE copper’s second and third contract months since early 2015.
Backwardation is a market structure where prompt futures are more expensive than later-dated futures.
In aluminium, another metal widely used in manufacturing, the spread between the April and May contracts rose to as high as 145 yuan a tonne from 5 yuan, the widest backwardation since December 2016.
The blow-out in the spreads was sparked by a speech by Chinese Premier Li Keqiang at the start of China’s National People’s Congress saying that the value added tax (VAT) for the manufacturing sector would be cut from 16 percent to 13 percent this year, although he did not say when.
Much of the market activity has centred on traders selling the May ShFE copper contract. Exchange data on Refinitiv Eikon shows that the number of short positions, or bets that prices will fall, for May copper increased to 83,885 contracts as of March 11 from 68,316 contracts on March 4.
The tax cut announcement had an immediate impact on ShFE prices, since China considers nonferrous metals - even the brick-shaped ingots traded on the ShFE, whether they are actually physically delivered or not - to be manufactured goods.
“The key point is that ShFE settlement prices are inclusive of VAT,” said Guy Wolf, global head of market analytics at Marex Spectron. “If you look up the exchange delivery rules, the seller is obliged to provide the VAT invoice to the buyer as well as the metal.”
Expectations that the tax cut will be made in May is essentially a “guess” rather than based on any hard evidence, the traders said. However, China’s last VAT cut was implemented on May 1, 2018.
If the speculators are correct, the May price will fall even further relative to April’s price.
“So it’s natural for speculators to buy April and sell May to avoid risk in advance or to try making a profit,” said one of the traders.
Should the tax cuts come later, traders will be able to roll over their positions to other months, making it a “risk-free” arbitrage play, the trader said.
($1 = 6.7218 Chinese yuan renminbi)
Reporting by Tom Daly; editing by Christian Schmollinger