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The disconnect between oil prices and copper prices is gaining increasing attention.
Naturally, the curiosity boils down to the fact that while oil prices are rising, copper prices are doing anything but:
It’s particularly intriguing because strong demand for copper, especially from China, has often been cited by analysts as clear market proof of a global recovery in action.
Yet — despite that — there have always been anomalies to the story.
Consider, for instance, the need to rationalise growing imports versus ongoing stockpiling of refined copper inventory in Chinese bonded warehouses — even despite a discounted Shanghai market versus London.
Now consider the following from Standard Chartered’s analysts this week (our emphasis):
Warehouse sources report substantial volumes of copper inflows after the Chinese New Year holiday. A very small proportion of this copper has been sold to the domestic market so far. Chart 4 shows that Shanghai copper has been trading at a significant discount to LME copper since October 2010, reflecting pressure from increasing stock levels.
Makes no sense right?
Luckily for us, Standard Chartered comes up with another more logical explanation:
With more material available, trading firms have been diverting metal into finance deals and using copper as collateral. Copper tied to these deals will be released to consumers, but only when demand picks up more decisively. We estimate that roughly 550kt of copper was stockpiled in bonded warehouses in Shanghai in late February, the majority of which is tied to financing deals.
To reiterate: that’s Chinese companies using copper as collateral for financing deals — also known as a somewhat ingenious nationwide inflation hedge (in the event copper prices continue to rise).
Let’s just say it’s a bit like living off a loan taken out against your house. The loan won’t be a problem because you believe the price of your house will only go up.
And while that remains your view, there’s no reason not to double up. Buy even more houses for the sole purpose of transforming cold hard cash — not inflation proof — into an asset which can continue to be monetised via ever depreciating bank loans.
Magic.
That is, of course, until copper prices stop rising.
At which point we should remind you to what degree those original post-crisis copper spikes coincided with China’s mega stimulus splurges.
As Sean Corrigan of Diapason Commodities wrote back in January 2010:
Further to the suspicion that much in the way of Chinese metals imports are related to schemes to game the cheap money there by circumventing capital controls "“ -whether in order to bet on Yuan appreciation or commodity price rises, or both "“ note that the relative prices of copper, aluminium, and zinc in Shanghai vis-à-vis that on the LME bear more than a passing resemblance to the volume of new loans concurrently granted by Chinese banks (including a rough estimate of ~CNY1 bln for January, as widely bruited on the newswires).
Translation: Be very, very afraid of further Chinese monetary tightening moves if negative copper equity is what you fear.
Related links: What really drove Chinese commodity imports? – FT Alphaville China, the currency factor and copper "“ FT Alphaville Is "?cash for commodity' the biggest trade in town? "“ FT Alphaville
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