Monday, April 18, 2011

Copper(Top) Heavy - Apr 18th

Copper(Top) Heavy
April 18th, 2011

Copper prices have been sliding thus far in 2011, and the outlook for higher prices is murky at best.  While there are some bullish factors at play; a weaker U.S. dollar, projected supply deficit, and a lack of new mine production coming on-stream (not to mention declining ore quality), the bear camp may be gaining control of the market.

China:  The Elephant in the Room

As with many commodity markets, Chinese demand is a huge driver of copper prices, and will be the focus of today’s post.  Last year, usage of refined copper grew by around 7 percent worldwide to about 19.4 million tonnes, though the apparent growth in Chinese use was more modest at 4.3 percent.  This compares to 2009, when copper use grew by around 37 percent, helping push prices to what were then all-time highs.  Back in 2009, the market had a 175,000 tonne surplus, which turned into a 305,000 tonne deficit last year.  Chinese buying has slowed so far in 2011, falling 15.6 percent in the first quarter, according to customs data.  They are also moving aggressively to curtail growth on several fronts.

-Reserve Ratios

China has embarked on path of higher and higher reserve ratios, the percentage of deposits a bank must hold rather than lend out.  They announced last night that once again reserve ratios will increase, this time to a record 20.5 percent.  The Chinese central government is obviously intent of slowing down growth and inflation, which continue to beat expectations. 

-Metal Specific Growth Limits

As part of its 12th five-year plan, China announced that it will limit the expansion of nonferrous metals production to 8 percent per annum, as well as increase recycling efforts.  China produced 6.33 million tonnes of recycled copper, aluminum, and lead in 2009, and the plan would see that number grow to 12 million tonnes by 2015. 

-Crackdown on “Inventory Financing”

It has been a closely watched, though often not heavily covered, carry trade taking place in China, and apparently not confined to the copper market.  Chinese traders have been buying copper using 180 letters of credit from Chinese banks; these loans do not get repaid for 180 days after the copper is delivered.  In the meantime, traders will use the copper, stored in bonded warehouses, as collateral to obtain a loan, less a small haircut akin to a margin requirement.  The proceeds from the loan are then used to buy higher yielding assets.  This carry trade has led to a buildup of supplies in China, some estimate as much as 600,000 tonnes. 

While this type of transaction is technically ‘legal’, Chinese law dictates that the loan proceeds are not used for investment purposes, though this seems to be largely ignored by the trading community.  In order to crackdown on the practice, the Chinese government has introduced new rules surrounding the trade.  Without getting into the specifics, the new rules require traders to complete the contracts (i.e. make or take delivery) prior to using the proceeds.  It also reduces the amount of copper traders can buy/sell with deferred payment schedules, and imposes restrictions on converting foreign currency from these transaction to renminbi.  The goal is to reduce the number of traders who buy copper solely as a source of financing.  Without these transactions, apparent Chinese demand could be substantially reduced.  It is worth noting however, that it is as yet unclear how effective the new regulations will be. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

1 comment:

  1. When does the new rule suppose to be effective?