Take that, copper!
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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:
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