For those with interests in metals, and more specifically in copper, I want to refer here to just released data from Standard Bank wherein that state that something in the neighborhood of 600,000 metric tons (kt) of “refined” copper is currently sitting in bonded warehouses in Shanghai, with another 100,000 metric tons (kt) in the southern Chinese ports, which is equivalent to around 11 percent of China’s total refined consumption and around 40 percent of China’s net refined copper demand.
With copper stocks at the Shanghai Futures Exchange (SHFE) of 172 kt and the London Metal Exchange (LME) stocks of 440 kt, I don’t think it’s an overstatement to say there is a lot of copper in the system that needs to be worked through.
The Chinese situation confirms rumors that the primary use of copper in bonded warehouse in China is used as a financing mechanism that’s aimed to provide cheap working capital for various types of business often unrelated to the metallic industry itself.
The scheme works initially via a letter of credit (LC) and then by using “deferred payment LC,” that creates a borrowing vehicle. Estimates for the amount of metal tied up for such proposals range from 40 percent to 80 percent of total bonded stocks, with Standard Bank’s own estimates more towards the upper end of this range.
Chinese property developers that include the property developing arms of what they call “conglomerates,” appear to be behind the lion’s share of this type of financing activities. It’s no secret that unwillingness by domestic banks to extend finance or the bank’s “imposition” (yes, we are in China!) of interest rates of anything from 10 percent-20 percent stimulate without any doubt these kind of unsound financing schemes.
Keep in mind that interest rates on metal of LIBOR plus cost of funding look very attractive indeed to Chinese property developers.
Of course, a scenario of falling Chinese property prices, combined with a government clampdown on “alternative sources” of funding, would therefore have a devastating outcome for the copper market, whereby we would see simultaneously (1) robbing the metal of an end-user and (2) leading to a mini credit crunch.
Investors should keep in mind that under such circumstances the obvious home for the concerned bonded copper would then become the London Metal Exchange (LME) warehouses in the Asian region, which are Busan, Dubai, Gwangyang, Incheon, Johor, Nagoya, Port Klang, Singapore, Yokohama and of which, please take notice, not a single one is located within China, and that would undoubtedly have very negative implications for sentiment towards copper prices.
In my opinion, investors should put this situation on their negative watch-list, at least for the time being. In my opinion, investors who understand and can afford to speculate, shorting copper for the time being, take only “limited and small” risk on board.
We also shouldn’t overlook the fact that if we don’t see a rebound in Chinese activity in Q2, then we can expect a significant (logical) reappraisal of copper’s medium term price picture.
Notwithstanding, it now has become crystal-clear that copper has emerged as a financial instrument over the past decade that has stretched its links to the underlying fundamental drivers, we must accept that cheap money supply alone will not be enough to see copper set new record prices without the physical market supporting such a move. At least that’s how I see it.
Cheap money supply, for as long as that lasts, could be enough to maintain the status quo however under the absolute condition that investor confidence in copper’s longer-term bull story remains intact.
As always, only time will make us a lot wiser…
As always, details really do matter.
Today, the Chinese newspaper People's Daily, which is an organ of the Central Committee of the Communist Party of China (CPC), writes: “… As of now, the price of No. 98 gasoline has increased to 8.44 yuan per liter (8.44 yuan per liter equals US$4.845 per gallon) which is higher than the current price of gasoline in the United States …”
On this detail I have a simple remark. If actual gas prices start hurting today in the U.S., how can the Chinese middle class digest their current gas prices?
Finally, yesterday we saw Chile’s peso lower and that’s directly related to lower copper prices, but also on concern that Japanese car makers will have to suspend production at plants in China. The Chilean peso, so far this year, is the worst-performing major currency Latin America.
Yes, China has still interesting surprises up its sleeve.
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