As much as it may sound barmy to stockpile commodities to obtain better terms on financing, Michael Pettis claims that’s one of the factors behind what looks to be unduly aggressive purchases of copper by the Chinese. An excerpt from his latest newsletter, courtesy Michael Shedlock:
China had been importing for many months far more copper than was needed for real use…. Imports continued even when London prices exceeded Shanghai prices by more than the equivalent of China’s value-added tax.
Instead of being shipped to end users, it seems that copper was being stockpiled in warehouses. Why? One possibility of course was pure speculation…
It turns out, that the copper purchases were not entirely, or even mainly, speculative. They were part of a financing scheme for companies that….were having trouble accessing bank credit.
Credit-starved companies were importing copper because they could obtain trade finance or some other sort of foreign financing, and then used the physical copper (or warehouse receipts, I guess) as collateral for domestic borrowing. The financing was continually rolled over. Buying copper was just a way to borrow for companies that needed loans and were otherwise unable to get them.
As I mentioned two weeks ago, when I discussed this in February with a senior executive in a major commodities company, he responded by saying that he thought the same thing might also be happening in soya…
Here’s how it works. Even when London prices are above Shanghai prices, companies eager for loans are importing copper in order to get back-door financing, whereas local traders, noticing that domestic demand isn’t strong enough to justify those import quantities, and perhaps eager to arbitrage the prices, are selling copper abroad. The weird distortions in the banking system, where credit isn’t rationed by price but by quantity and hierarchy, has turned China, at least temporarily, into a revolving door for copper imports and exports.
There is more on Mish’s blog, and as he indicates, even more in the underlying Pettis newsletter. Note that there have been reports for some time of stockpiling of base metals as a popular investment among private business owners. So any recent hoarding, whether for investment or to obtain funding, presumably is in addition to these uncertain but presumably not insignificant hidden reserves.
Update 6:00 AM: jck doubts that the numbers add up to much and as indicated in comments, the mechanism has me a bit perplexed. However, Pettis does have good contact, and I’m curious to see whether readers have corroborating information.
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A few points:
1) Buying copper for loan collateral costs you the money in the first place – so what exactly is going on there? IS the same copper collateral for several loans, like the REPO fraud?
2) Chinese ports have some import-export privileges – so there may be some tax dodge involved or a way to play Yuan/Dollar.
3) Old fashioned corner (f.e. by Goldman, JP MOrgan, Glencore, DB). They are buying up the physical and put it in Chinese port warehouses?
Guess we will not find out what kind of games are played in copper.
Exactly, I don’t see how buying copper to borrow against it makes an iota of sense, unless the initial purchase is levered (ie, the collateral is pledged twice) OR you have serious valuation issues (as in you buy it for $100, you can get it valued in another market for $125 and you can borrow $115 against that). Still sounds awfully convoluted (and you are right, taxes may make this make more attractive than it appears to at first blush).
Hopefully someone can shed some light. The longer version of the Pettis piece makes clear the officialdom has been digging into this for a while, so it does appear to be real.
I could be wrong or misinterpreting the question, but I think the idea is to borrow $X worth of copper (using non-domestic trade or foreign loans) with $Y worth of base equity, and use that borrowed copper as ‘collateral’ for harder to obtain DOMESTIC loans worth $Z, where Y>Z>>X. It’s a crazy abuse of the system where you can get a loan even if you shouldn’t be able to get one as long as you’re willing to pay interests twice.
Please note that I am not endorsing or confirming Pettis’ claim, just restating it plainly; but that is easy enough to do.
A Chinese company would like Renminbi financing, but Chinese banks will not lend to it. Or perhaps it just that rates on unsecured lending are unpalatably high. Implicit in this story is that Chinese banks will not accept USD cash or receivables as collateral. But they will finance copper imports; perhaps because it is a “manufacturing input.”
Foreign banks cannot lend Renminbi – capital controls. But they can lend USD to buy copper. This gives the Chinese borrower indirect access to Renmbinbi. Or perhaps it is just that USD interest + secured Renminbi interest is cheaper than unsecured Renminbi if you close your eyes and ignore the risks. Perhaps the USD borrowing is secured by USD receivables.
If you believe the Renminbi is going to appreciate vs the USD, why not take out a USD loan to buy commodities to use as collateral / payment for a Renminbi loan ?
You get the loan, and when the Renminbi rises, you pay off the (relatively) cheap USD loan. It seem a roundabout way to play the Renminbi currency market, but China’s currency controls prevent a more direct approach.
http://ftalphaville.ft.com/blog/2011/04/13/545456/goldman-says-theres-been-a-copper-collateral-crackdown/
http://ftalphaville.ft.com/blog/2011/04/28/555991/chinese-bonded-warehouses%e2%80%99-copper-inventories-still-on-rise/
add some tinfoil-
http://ftalphaville.ft.com/blog/2011/05/05/560096/glencores-achilles-heel/
Somebody must provide credit for the initial copper purchase and it was interesting to note that Standard Chartered thought
restricting the use of letters of credit as collateral and enforcing USD deposit inspections would curtail this. This tells me that if copper drops in price then there are chinese companies which will default on there loans to western banks. The question should be where is the hedging for this activity and what are the consequences. My guess would be that there are implications for the value of the dollar.
This is really the tip of the iceberg though in terms of a shadow banking system in China. There are reports of firms lending to each other, local government leveraging on land values. Quite possibly the only people not doing banking are the chinese banks. This does not bode well for a soft landing if things deteriorate rapidly in my view.
Those betting against copper should be aware that the Chines are planning to spend US$314bn on power grids till 2015, and even more later. http://www.ifandp.com/article/0010975.html
http://deblockconsulting.com/blog/china-news/chinas-ultra-high-voltage-plan-slimmed-down/
While the onshore part of the cables will mostly use aluminium (AC), a good chunk of the long distance HVDC cables onshore might be copper, and the offshore part (linking to offshore wind energy) will require lots of copper, too …
It seems that an entire factory system built in China almost exclusively for export and mainly to American consumers needs copper far off into the future for all of the electricity using appliances, power charging cords for ipads, laptops, flat screen TV’s and the next big thing, recharging electric cars and solar electric panels. So, regardless of the warehoused assets of rolled and spooled copper being hoarded for gaming the business lenders, copper is the indispensable commodity required for the most high margin finished products, the one with electrical cords.
I can see why a business man figures that he just can’t lose loading up on this metal. It would seem to be a safe bet to return better than US Treasuries. And if it can’t be used in China, then India or Japan or Korea could put it to use for the same manufacturing purposes.
Maybe? Yyou’re a Chinese company and can’t get a loan from the local Communist Party Bank Branch, but you can somehow buy copper with vendor financing and then you’ve got copper. Maybe it’s that having copper raises your stature in China. So now you’re a player, and you go to the bank and say “Yo Commie Dudes, give me a loan” and they say “Aren’t you the same guy who came in here for a loan last week?” And you say “Yes”. And they say, “Didn’t we say no?” and YOu say “Yes” And they say “So why are you back?” and you say “I have 87 tons of copper in my driveway”. And they say “How much do you want to borrow?” I wonder if this is a form of madness or just business as usual when things are loopy. I wonder if they can securitize these copper vendor financing loans and sell them to the Germans at a few basis points over LIBOR. Better than Greek bonds, maybe.
«mainly to American consumers needs copper far off into the future for all of the electricity using appliances, power charging cords for ipads, laptops, flat screen TV’s»
And how are the USA consumers going to pay for all that? What is the USA going to export to pay for all the copper that China is buying?
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