Take that, copper!

By Ben Walsh
March 13, 2014

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In the last week, the price of copper on the London Metal Exchange has dropped 9%, to its lowest level since 2009. The start of the decline coincided with China’s first corporate bond default. BofA analysts called the default China’s “Bear Stearns moment” — the first major event of a what could be a severe financial crisis. With China consuming 40% of the world’s copper, a Chinese crisis would be trouble for global copper prices (among other things).

The FT’s Jamil Aderlini called BofA’s characterization a “bold, attention-seeking call that is also patently ridiculous”. Aderlini points out that the default was by a small Chinese company in the always-on-the-verge-of-crisis industry of solar panel manufacturing. It’s rare for a single analyst note to cause an extended sell-off, and Joe Weisenthal points to two more plausible reasons for the decline: “Copper has a reputation for being a good global economic bellwether… Copper also plays a role in the Chinese financial system (as collateral)”.

The WSJ dives into the growth angle, pointing out that it’s not just copper getting hit. Pretty much anything that’s typically tied to increased global demand — and Chinese demand in particular — is down, including iron, oil, and soy.

The WSJ’s Ira Iosebashvili and Tatyana Shumsky have a good overview of the collateral issue. As China’s government has tried to reduce lending, companies have looked for new ways to borrow, importing copper to use “as collateral for loans from banks and other lenders. They then invest the money in higher-yielding assets”. Catherine Virga of CPM Group, a commodity research firm, says “it’s their financial innovation… Companies that aren’t able to borrow [from banks] turn to the shadow-banking system”. The FT reports that for the Chinese coal and steel sectors, “import financing is one of the few sources of cash flow left for companies that are already cut off from loans by state banks at official interest rates”.

How big is this market? By one estimate, 60-80% of copper imported into China is used to secure financing. Joseph Cotterill puts the value of copper-collateralized lending at “a tenth of all short-term FX loans”. In other words: big. As for why other commodities, like iron ore, aren’t used similarly, Cotterill has a fairly deadpan explanation. Iron ore, he writes, only has high value in physically large quantities. Easily transported amounts just aren’t worth enough.

Izabella Kaminska points out that this has been going on for quite some time. Companies assumed that, even if prices fell in the short term, one day “demand would recover enough to ensure the collateral would be sold off profitably one day. When that didn’t happen, everyone doubled/trebled up instead”. — Ben Walsh

On to today’s links:

Old Normal
America’s long and productive history of class warfare – Justin Fox

Nobody Knows Anything
Hollywood’s blockbuster disasters and the end of “film as a platform” – Ivey Business Review

Charts
The labor market slack debate in a nutshell: should we give up on the long-term unemployed? – Matthew O’Brien

Hackers
How Target missed both of its chances to stop the biggest retail hack in history – Bloomberg Businesweek

Price Points
Amazon just raised prices for Prime (but you know you’ll still pay for it) – Jason Del Rey

Regulations
Translating the EPA’s new global warming rules: “next year” could mean “never” – National Journal

Charts
The war on drugs fills up half of America’s prison cells – Know More
This may finally be the beginning of the end of the war on drugs – Pacific Standard

So Hot Right Now
Rental income from repossessed housing is the next big thing in securitization – Euromoney

Oxpeckers
How to write a San Francisco trend story: a cut and paste guide – SF Chronicle

Crisis Retro
Lehman’s terrible advice to clients from 2007 – Euromoney

EU Mess
“The tragedy of the Greek political class is not that they failed to enact Troika policies, but that acquiesced to them” – Mainly Macro

Primary Sources
Snowden’s talk at SXSW: full transcript and video – Inside

Facebook
You can spread your unhappiness over social media – WSJ

Let’s Hope So
Sbarro’s decline might make way for better mall food – Neil Irwin

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