Breaking 7 but not 5 – don’t get too excited just yet

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Breaking 7, but not breaking 5 – don’t get too excited yet. Author/Source: China Fertilizer Network. Date: August 7, 2019. Click-through rate: 46. Recently, the fertilizer market has been rather sluggish; this coincides with the hot weather, giving one the feeling of being caught between hot and cold conditions, almost like catching a cold. The potash fertilizer industry is the same; it seems to be in such a “sick” state that there isn’t even any energy left for speculation. This morning, the exchange rate broke through 7. Finally, some industry insiders perked up; they started sharing posts and leaving comments. I’d like to join in the fun too, by briefly discussing what this “breakthrough of 7” means for the potash industry. 　　What is a “break below 7”? The People’s Bank of China has authorized the China Foreign Exchange Trade System to announce that as of August 5, 2019, the central parity rate of the RMB in the inter-bank foreign exchange market was 1 US dollar equal to 6.9225 RMB. This mid-rate dropped by 229 points compared with the previous trading day, marking the first time since December 2018 that the USD/RMB mid-rate has fallen below the 6.90 mark. Around 9:16 a.m., the offshore USD/CNY exchange rate fell below the 7 mark. At around 9:32 a.m., the onshore exchange rate also dropped below 7. Subsequently, the offshore exchange rate declined even further, at one point falling below 7.1. 　　What is “Po Wu”? In traditional Chinese New Year customs, the fifth day of the lunar calendar is commonly known as \"Po Wu\"; another name for it is \"getting rid of the five kinds of poverty\" (poverty in wisdom, knowledge, literature, fate, and social connections). Upon dawn, people set off firecrackers and clean their homes, expressing the working people’s sincere wish to ward off evil and disasters and to welcome good fortune and blessings. ““Po Wu” implies “seeing off the old year”. After this day, everything gradually returns to how it was before New Year’s Eve, signifying that the good days of the new year are now officially beginning. 　　So, what is the relationship between the “breaking 7” and the “breaking 5” mentioned in the title of this article? Naturally, under normal circumstances a depreciation of the RMB is beneficial for exports. Now that the exchange rate has dropped below 7, exports of urea, ammonium sulfate, ammonium phosphate, and so on should benefit to some extent; the same is true for potassium sulfate exports ； Some industry insiders also point out that the currency devaluation effectively means higher import costs for potassium chloride. Previously, the price of potassium chloride remained at a certain level; now, however, it needs to be raised in order to offset the increased costs resulting from the devaluation. This can also be regarded as a positive factor supporting market conditions... In short, good news has arrived—it’s cause for celebration! It seems we just need to set off some firecrackers, like when the “5” threshold is crossed, to mark the occasion! 　　But is that really the case? Don’t get too happy just yet! 　　Let’s first take a look at the responses given by officials from the People’s Bank of China to journalists’ questions regarding these issues following the breakdown below 7. The author has excerpted some of the key points as follows: Affected by unilateralism and trade protectionist measures, as well as expectations of additional tariffs on China, the RMB depreciated against the US dollar today, falling below 7 yuan per dollar ； Overall, the RMB has been appreciating; it continues to remain stable and strong against a basket of currencies ； The People’s Bank of China must take necessary and targeted measures to resolutely crack down on short-term speculative trading and ensure the stable operation of the foreign exchange market. It has the experience, confidence, and capability to maintain the RMB exchange rate at a reasonably balanced level ； We recommend focusing on the core business and avoiding excessive effort in trying to predict or speculate on exchange rate trends. A \"risk-neutral\" financial mindset should be adopted; the use of foreign exchange derivatives should aim at locking in exchange rates, reducing uncertainties in operations, and boosting profits from the main business, rather than aiming for profits from trading those derivatives themselves. 　　Now, let’s return to the potash fertilizer market. Rising costs of potassium chloride? This needs to be considered separately: the large contract at $290 per ton concluded last year is nearing completion. Therefore, it doesn’t make sense to say that the import costs for the current stockpile of over 3 million tons in ports have risen ； The negotiations regarding the new major contract remain uncertain for now. However, assuming that the final price still ends up being $290 per ton, the new cost will be approximately 65 yuan per ton higher than previously (calculations based on exchange rates of 6.85/7.05; same applies hereafter). However, it is not enough to separate just these two points; further division is necessary. First of all, there is the assumption mentioned above that the price of the large contract remains unchanged, which will not be reiterated here ； Secondly, let’s not forget that we have discussed this many times before: even large contracts this year may take a long time to be finalized. Given the current situation in both domestic and international markets, it is likely that the prices of new large contracts will decline. At least a decrease of 10–20 dollars per ton can be expected for now. Once the price drops below 7 dollars per ton, the cost will decrease by around 60 yuan. If the decline in the prices of new large contracts does not exceed 10 dollars per ton, then the import costs will hardly change at all; in fact, there is even a possibility that costs could rise despite the decline in contract prices ； Finally, what if the large contract ends up causing prices to rise instead? Well, let the new exchange rate come into play along with the new prices; there seems to be no upper limit to costs – they can only keep rising. As long as there’s no concern that domestic demand won’t keep up and lead to a sharp decrease in volume, another price drop is inevitable sooner or later. So, it’s actually pointless to go into too much detail at this point, because the extent of the price drop for the potassium chloride contracts is still uncertain, and the exchange rate itself has not yet stabilized. Simple changes in the exchange rate do not have a definitive impact on the current price of potassium chloride or its future trend. Instead, we should recognize that such significant fluctuations in the exchange rate will expose importers to greater risks. This will also be another factor contributing to the postponement of large contracts, and it serves as yet another bargaining chip for us to drive down prices. Similarly, the impact of exchange rates on the potassium sulfate market is similar. In reality, in any market, it’s not accurate to simply say that “a depreciation is beneficial for exports, while an appreciation is beneficial for imports.” This is because too many assumptions must be made beforehand, and there are also numerous variables at play. So, since it’s been said that “it’s actually useless to go into too much detail now,” let’s stop here for this time. If the situation of the exchange rate breaking through 7 continues to develop in the future, we’ll discuss it then. Calm down first. Can you please calm down a bit? 　　(Adu)