LME Asia week in Hong Kong is a strange marriage between financial and physical players, though the balance seems to be on the financial side. That is more and more true in the market as well.

All of which leads me to speculate, when will the pendulum swing the other way, and what might cause it to shift? Or more precisely, who? Will we ever see the physical market resume its former importance?

In the aluminium market, it is hard to see any producer could possibly take a lead, and bring the market back to a more physical basis. Rio Tinto has split its aluminium assets into two and written of billions of dollars from their value. Chalco is losing boat loads of money, to the point they are moving assets off their books. Alcoa has declared exceptional losses the last several quarters, and Rusal is deep in debt.

Yet the metal itself is a valuable commodity, and is essential to both the developing economies (in the infrastructure, electrical and transport sectors) and to the developed economies (especially in packaging and transport sectors.) Not only that, metal premiums remain very high, despite the metal price itself being depressed.

Right now there are some millions of tonnes of aluminium sitting in warehouses, under the control of those who can take a physical position. With low interest rates and a healthy contango, it makes sense to hold the metal off the market. The combined costs of interest and warehousing still leave enough profit in the contango to make it worthwhile to hold the metal.

Those who actually consume the metal still need to get their supplies, so they end up paying a premium. The bottom line is that the net amount of money paid must now be shared between the producer and the new class of middleman - the financial player.

The surprise in all of this is that middle men have not sought to increase their split of the price, and why producers haven’t sought to improve their share of the same pie.

As I mentioned earlier, producers don’t have the cash to mount a fight to improve their revenue split. But I wonder when the middlemen will start to move further into the game, and increase their take from that pie?

If rhetoric was a commodity (and in a perverse way it is), the HKEX/LME Asia Week in Hong Kong this week would have the market cornered.

Although some reporters have managed to squeeze some words out (more likely to meet deadlines than to report major stories), mostly the sessions today have been long on platitudes and aspirations, with little in the way of substance. Charles Li declared at the start of his speech that he would be candid and honest, but when it came to how HKEX would compete with Shanghai, there was not a lot of firm planning. Even his admission that HK can’t quickly develop a domestic warehousing structure (where could you possibly put a new warehouse on this crowded, hilly island?) was deflected by a promise that they would solve the problem eventually.

To be fair to Mr Li, for that part of his speech about competing with Shanghai, he gave it in Mandarin, and the translators did a pretty poor job of keeping up with him.

The lunchtime panel consisted of 4 speakers and had the heading of”How can Asian exchanges strengthen cooperation to better serve Asia’s real economy?” That was the topic, but nobody told the moderator or the speakers. Most speakers sought to praise HKEX for their brilliance in buying LME, and spoke on how they could cooperate to develop greater innovation and success in China. But the 4 speakers were all Chinese, with no other “Asian Exchange” represented, and nobody on the panel who could rightfully claim to be able to speak about better serving Asia’s real economy. Almost none of the answers were even about serving China’s real economy, with perhaps the only bright spot being one speaker’s admission that China’s regulators have some pretty important hurdles and challenges to meet. But that wasn’t stopping China’s exchanges (Dalian, Zhengzhou and presumably HKEX) pressing Beijing to free up the market for them.

Perhaps the brightest point of the day’s proceedings to date was the morning panel with Dr Ma jun from Deutsche Bank and Daniel Smith from SCB admitting that in the short term, China is in for a rough ride. Both men were bullish about China in the medium to long term, in spite of the short term pain.

The second panel was disappointing, as it consisted of 8 people who had almost no time each to speak their mind in the 50 minutes allotted (the moderator ate up a bit of the time with introductory comments, plus of course each question had to be put before it could be answered). As it was, the best speaker on the panel was Tong Li from BOCI, but she didn’t get to speak until towards the end of the session.

The moderator in this case was Bonnie Liu, previously an analyst with Macquarie Bank. Bonnie joined HKEX only 3 weeks ago, and has a tough job in front of her, as Vice President, Asia Commodities for HKEX, but goes into the job with an excellent reputation amongst her peers in the base metals world inside and outside China.

The world’s financial press has been increasingly worried about the health of China’s banks, as credit becomes increasingly tight. The Washington Post carried the headline “Thursday was a very bad day for China’s economy”, while the Wall St Journal declared that the signs of distress are running deeper.

Both articles, especially the Washington Post, are excellent summaries of what has been happening.

Patrick Chovanec, a leading economist and a previous speaker at two of our conferences, makes the point that the build-up in the crisis has uncanny similarities to the Lehmann Brothers collapse in 2008. He also points out that the credit squeeze in China right now comes just a few weeks after the Government clamped down on shadow financing via bogus export invoices. Speculators were moving money into the country through the back-door method of creating an invoice for the export of goods, even though the sale never took place.

But is it completely the same sort of crisis build-up as the US experience of 2008? While all the signs are the same, it seems to me that there are a couple of Chinese characteristics that make this crisis a little different - not completely different, but different enough to make note.

First, all the big banks in China are owned by the government. The Communist Party of China is the biggest shareholder (though not by name). Second, the agenda for the decision makers in the two situations is completely different. For the leaders in the USA in 2008, the agenda was to protect the financial system from melt-down. For China’s decision makers, it’s about defending and protecting the Party’s power. This makes unrest in the real economy a much higher priority. While US Government and FED decision makers were also trying to protect jobs as they made their decisions in 2008, there was always a realisation that some jobs would be lost. But America had some sort of safety net for those who found themselves unemployed.

In China, unemployment is a huge potential risk to the Party. There is no safety net to speak of, and there is no ballot box in which to express one’s dislike for the party in power. There are only the streets and the barricades around the government offices. China’s decision makers will place a much higher prominence on preventing shocks to the real economy, for their own sakes.

There is another risk to the world that comes only with China’s version of a financial crisis. Should China enter into a full-blown crisis, with wholesale closures of factories, it will be bad for economies such as Australia, Indonesia and Brazil, who sell iron ore, coal and other commodities to China. But it will also be bad for the rest of the world. Chinese goods are likely to get cheaper. In the event of mass unemployment in China, the already-low wage levels will go lower. Since the Chinese economy will still be in shock, those factories that survive will increasingly look for export markets, using their new lower cost base. Just when the US and other mature economies were looking to bring manufacturing back to life, Chinese goods will arrive on store shelves at even lower prices.