For seasoned investors in copper, stories of shadowy traders from China roiling the market won’t sound too unfamiliar.
In November 2005 global copper prices surged to what was then a record high (of around $4,200 a metric tonne) thanks to a trader from China’s State Reserve Bureau known as Liu Qibing.
Liu suddenly went missing, leaving behind massive short positions at the London Mercantile Exchange (LME). The Chinese authorities at first denied Liu’s existence, then branded him a rogue trader, but finally took responsibility for his positions, with the State Reserve Bureau making sizeable copper sales to cover Liu’s contracts. This was thought to have cost up to $200 million in losses (as well as 200,000 tonnes of its copper reserve). Liu was arrested and sentenced to seven years in jail.
By our calculation, Liu must have served his time. But huge positions amassed by a new breed of Chinese copper traders have commodity investors holding their breath once again.
This time the volatility has been triggered by a regulatory crackdown on a popular shadow credit scheme known as copper financing.
The copper in question has not been imported for commercial use. Instead it has been hoarded as a way of accessing cheaper credit. The process works like this. Buy up a stock of refined copper on a 180-day letter of credit (LC). Park it in a warehouse, borrow against it from a bank, and put the proceeds in higher-yielding investments. Six months later, sell the copper (the price of which has gone up too hopefully), pay off the bank loan, and settle up on the original LC.
WiC first reported on the opaque practice two years ago (see issue 103). But these commodity-based collateralised loan schemes have grown in quantity and complexity since.
Initially, the trade drew the attention of speculators seeking an arbitrage opportunity. But increasingly, small enterprises and property developers (deprived of bank credit) have been importing and reselling copper just to get access to loans – sometimes even at a loss on the underlying copper trade.
“It’s like robbing Peter to pay Paul,” insiders told the National Business Daily. “The more an enterprise loses the more it imports.”
According to figures from MyYouSe.com, an internet portal specialising in non-ferrous metals, copper stockpiles in Shanghai’s bonded warehouses have surged to 1 million tonnes, up from 400,000 tonnes last year. At least 80% may have been bought for copper financing purposes.
The authorities now look more intent on outlawing the copper financing schemes. Earlier this month the State Administration on Foreign Exchange issued new rules on forex inflows to control commodity-backed trade finance more closely. Banking regulators have also pressured lenders to stop issuing LCs to copper traders.
Beijing policymakers, it seems, have grown more concerned that the copper shenanigans have started to pose lending risks. Copper-backed loans, the state-run Shanghai Securities News suggests, now amount to at least Rmb100 billion ($16 billion). The newspaper forecasts that up to Rmb30 billion could turn sour for lenders.
The related question is what this all means for copper prices. Intuitively, the crackdown on copper financing will sap a source of demand. And what happens to all that copper in the warehouses? As it gets released onto the market, it might drive down prices.
This is a worry for traders who have already seen copper fall nearly 10% on the LME this year (it currently trades at around $7,200 per metric tonne). Unsurprisingly, these traders are watching events in China very closely, given that it consumes 40% of the world’s copper output. Adding to their gloom: HSBC’s recent Chinese PMI data showed the industrial sector contracting, which may hit copper imports too.
“Basically copper has entered a bear market,” surmises National Business Daily.
Then again, if the copper price continues to drop, Global Entrepreneur expects there will be at least one willing and able buyer: China’s State Reserve Bureau. A large copper reserve, the magazine says, remains as one of China’s key “strategic objectives”.
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