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Tuesday, 24 April 2012

Commodities watch

There's been a number of reports about projected oversupply and weak demand for various commodities in the last week due to China slowdown concerns, including zinc, steel, sugar, stainless steel and copper.  Interestingly for copper, Chinese traders are now reported to be re-exporting excess stocks of copper which had been acquired for speculation and financing.

Copper financing to slow?
There are two aspects here; firstly the giant inventories of copper which have been sitting in Chinese warehouses for the last year or so and second, future expectations of price declines (hence the desire to ship now).  On inventories there was much comment about the excess supply of copper in China last year.  Holdings data were unreliable and diverged with market estimates.   The divergence (and the distortion it caused on pricing) was noticed back in 2010 and was initially seen as being due to trading strategies, which sought to profit from the difference in prices between the London and Chinese metals exchanges or to construct hedges against inflation or currency risk.  One story by Bloomberg back in 2009 identified that pig farmers in China were acquiring stocks of copper and other metals to offset Chinese monetary stimulus measures.

But the inventory story was more complex.  During 2011 it emerged that stocks of copper had also been used as cheap collateral for loans to companies and property lenders which were struggling to get loans from regular domestic Chinese banks as Chinese banking authorities sought to restrain credit in the overheated economy.  Such financing contained increased risks and during the year Chinese regulators sought to slow down such financing schemes, closing down some activities directly.

Fast forward to 2012 and speculation has continued, as this detailed investigation by Reuters explains:

At Shanghai's Waigaoqiao port, a sprawling 10 square kilometer free-trade zone, thousands of tonnes of copper cathode plates sit in stacks turning green after years of exposure to the elements.
"They don't get shipped to end-users because they were bought for speculative reasons," said a warehouse manager at the port, who would only give his surname Zhu, standing in the port's control room overlooking yards piled high with metal....

And regulators have only been partly successful in restricting this market.  As the Reuters article points out, use of copper financing schemes is popular while credit is so contrained in the Chinese economy and there are limited other regulated sources of finance.

So why the sell offs?  On the demand side it seems that copper traders also anticipate falling prices and demand this year.  In particular, investment bank China International Capital Corporation indicated in an interview today  its expectation of slower demand growth of copper as the Chinese government maintains restrictions to slow the property market (while copper futures fell on inflation expectations earlier in April).  It seems possible copper may follow aluminium which has had a "profitability downturn" as the industry is struggling in China amidst overcapacity with CICC predicting a quantity surplus this year.  As has been seen in other markets for aluminium, conflicting interests between users and speculators may coalesce around warehoused stockpiles so there could be more comment and conflict arising in the copper warehouses of Shanghai.

Holding onto copper...for now
Rise of the Redback
This week saw the launch of the widened trading band of the Chinese currency, the Yuan (Renminbi) which is part of a number of financial liberalisation measures aiming to increase the convertibility of the Yuan and to help open up the Chinese economy and bolster economic growth.  A fuller review will be conducted in the future but it is worth pointing out that copper financing may continue to be encouraged by flows of speculative capital or "hot money" which can fund commodity-based trades and that until full convertibility exists between domestic and offshore yuan deposits, traders seek to profit from any mispricing.
Initial feedback suggests there has been no increased volatility in the currency during the first days of the new regime, but a statement from an official at the State Administration of Foreign Exchange, indicates they are remaining wary of further inflows.

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