Chinese Commodity Financing Trade On Borrowed Time
BMI View: Used as a means for circumventing capital controls and importing low-cost foreign funding into the country, the commodity financing trade in China is unlikely to be sustained over the medium term as several issues come to the fore. The heightened volatility of the Chinese yuan, a looming surge in bankruptcies of unprofitable corporations and greater regulatory scrutiny by Chinese authorities suggest that an end to this trade practice is imminent. Crucially, an unwinding of the financing trade would be bearish for commodity prices as stockpiles of metals would be liquidated from China's bonded warehouses.
We expect a gradual unwind of the commodity financing trade in China to be a drag on industrial metal prices over the coming quarters. Commodity funding deals have proliferated following the credit crunch in China in mid-2013, when Beijing's first real attempt at tapering triggered a serious spike in the country's interbank lending rates ( see' Beijing's Credit Crunch Conundrum', June 20, 2013). Anecdotal evidence suggests that an increasing range of commodities are being used as collateral by credit-starved companies to circumvent capital controls and bring in low-cost foreign funding into the country. These include commodities such as copper, gold, nickel, iron ore, soybean, palm oil and rubber.
Broadly speaking, copper is the most widely-used industrial metal in the commodity financing trade. This is because it has a high value-to-density ratio (hence lower storage and transportation fee), long shelf life (collateral value will not depreciate significantly with time) and a highly liquid paper market (which allows effective commodity price risk hedging). These characteristics make gold an equally attractive metal for financing deals and could be the key reason behind the surge in gold imports over recent years. However, given the lack of clear data on the method and degree of gold's use as a financing tool, the full extent of gold's involvement in the practice remains unclear at this stage.
|Boosted By Financing Demand|
|China - Bonded Warehouse Copper Stocks (LHS) & Iron Ore Total Ports Inventory (RHS)|