Friday, May 20, 2011

Unintended Consequences: Copper and China

As it turns out, China's demand for copper (and possibly other commodities?) is driven by a quirk of lending constraints in China by which importers have been using the purchase of copper in order to secure financing for entirely unrelated operations:

With credit conditions tight, importing copper has become a way for businesses to circumvent the government’s lending controls.

A letter of credit—easier to obtain and cheaper than a bank loan—finances the purchase of copper on the London Metal Exchange. If copper prices are higher in Shanghai than they are in London, the importer can cover transport and storage costs, sell their copper at a profit on the mainland and enjoy the use of the yuan proceeds until the letter of credit expires—typically three months to a year later.

A premium of $210/ton for the three month contract in London over the price in Shanghai throws a wrench in the works for importers. But businesses still can use their copper as collateral for yuan loans and keep the copper in storage hoping that the price differential will move their way. Even if that doesn’t happen, demand for credit has been so strong that importers are willing to take a loss on the copper transaction just to get their hands on the cash they need to fund their other operations.

No comments: