That's one of my favorite expressions to describe an overheated market. I uttered it today not to describe the U.S. stock market -- though I still think we're a little toppy here and I'd look for the S&P 500 to test 2000 again by the end of earnings season.
No, today I was looking at a chart of iron ore prices. The ferrous rock's rally has been dramatic since bottoming in December 2015. For the year, iron ore prices have risen about 55% after spiking through the $70/tonne level on Friday.
Iron ore prices seem to have been following the dramatic rise in futures prices for steel rebar, which have also risen more than 50% year to date. Rebar -- short for reinforcement bar -- is the steel rod-like material used to reinforce concrete. If you walk by a construction site, you've seen rebar sticking out of concrete as the layers are allowed to harden. It's just tempered steel; it's really not a high-value-added product.
So, why is rebar so hot? Certainly there have been signs of a recovery in the building trade in China. Goldman Sachs (GS) noted this morning in a note on Caterpillar (CAT) and Joy Global (JOY) that "the breadth of the China construction recovery is broadening." It is clear the People's Bank of China has been pumping easy credit into the domestic economy in 2016, and that is translating into increased demand.
Physical demand and futures pricing can be two very different things, though. The activity in China's three futures markets -- Shanghai, Dalian and Zhengzhou -- has been extraordinarily high, and seemingly characteristic of a bubble forming. To me, this is going to end badly.
Last Thursday, according to Reuters, the benchmark rebar futures contract traded a notional value of about $47 billion in that day's market action, representing 111.8 million tonnes of underlying rebar. That's almost exactly half of China's 2014 output of rebar traded in one day.
We've seen this movie before. Chinese individual investors rush in to buy exchange-traded products, the volume and prices skyrocket, and then there's a crash. Last Thursday's $47 billion notional value of rebar traded in China's three commodity exchanges totaled 50% more than the yuan volume of trading on the Shanghai Stock Exchange that day.
That is also nuts. They are metal rods, for goodness' sake.
So, that's another thing for the bulls to worry about. When futures prices start to turn down, investors are going to start receiving margin calls on their commodity contract positions. When that happens, stocks are often the first assets to be liquidated as they are often (except for last Thursday, apparently) the most liquid financial assets owned by investors.
The Shanghai Stock Exchange Composite Index is down 16.7% year to date and 31.9% in the past 12 months. Last year's precipitous plunge in the Shanghai Composite started in mid-June, and I fear we are in for a repeat of that performance in 2016. Investors may be liquidating stocks to put their yuan into rebar contracts, but if that is the case, I am extremely worried about another Shanghai implosion like we saw last August. It may have simply been a follow-through from the June correction, but on that crazy Monday morning of Aug. 24, it certainly felt like the world was ending.
So let's be careful out there.