Wednesday, October 12, 2011

The Complicated Lives of Copper and Chinese Real Estate

Obviously there is a link between copper and construction, but in China there is another shadier relationship. Copper is being used as an intermediary device in a kind of single-currency carry trade. A loan at low rates is obtained to buy copper. The copper is warehoused and a letter of credit is issued confirming the copper's existence. That letter is taken back to the bank and borrowed against at 80-85% of value. The money is then used for projects that have had their financing banned, such as real estate. Or the money might be used in the underground banking system to net returns of 10% per month in interest.

If Ken Lay were still alive he'd have died of jealousy just reading that.

Why would anyone go to all this trouble? Well, banks won't loan you money for anything other than buying copper, of course. Now you have money that you can use unrestricted.

No one knows how big this copper loan slight of hand is, but between 2005 and 2009 copper imports grew 100% while GDP grew 30%, implying that much of the difference was warehoused.

Why does it matter? Well, as the price of copper falls (in a reverse Crash JP Morgan sort of way) the collateral backing these loans will no longer cover the loans, leaving the copper carry-trade borrowers insolvent and the banks that issued the debts insolvent as well. Presumably a tipping point will be reached where the banks start liquidating these collateral copper holdings before the price falls any farther.

China's red metal alert
Any move by Beijing to institute new regulations to limit this activity may prove to arrive too late. Speculative tools like copper and real estate have been used in informal and formal lending, making them harder to regulate, thus increasing China’s vulnerability to price declines and financial risk. Beijing understands it needs to clamp down on copper speculation, but it is wary as this may lead to a big rise in non-performing loans at banks.

This article stands in stark contrast to this Reuters one which mentions that copper imports have exceeded GDP (by 10% per year), but fails to mention why, or even theorize where that copper may be going, and it opens with statements from an exceedingly biased gentleman (Fan Shunke, the president of China Non-ferrous Techno-Economic Research Institute) who was trying to sooth the concerns of Swedish miners.

If they can talk the metal up, they can stave off the sour loans, true enough.

No comments: