Industrial metals will be hit by China’s Debt Crisis
China’s debt crisis to hit industrial metals
All the warning signals point to a continuing slide in prices as the full extent of China’s economic problems emerge and bearish sentiment grips commodity trading houses
By Andrew Critchlow8:00PM GMT 16 Mar 2014CommentsComments
Investors in vital industrial metals such as copper and iron ore will have their nerves tested again this week after China’s unfolding debt crisis caused volatility on commodity markets.
All the warning signals are now pointing to a continuing slide in prices as the full extent of China’s economic problems emerges and bearish sentiment grips the large commodity trading houses.
Fears over a possible credit crunch in China have blown away previous assumptions that 2014 would be a year of steadily rising prices for industrial commodities as the global economy continued to recover. Copper prices have fallen 14pc so far this year to about $3 a pound on futures markets. Iron ore has tumbled to an 18-month low and closed the week at around $104 per tonne.
After years of turning a blind eye, China’s government is finally getting serious about reining in the country’s poorly regulated shadow banking system, which has grown so big that it could derail the world’s second-largest economy. Beijing has also moved to restrict credit to steel smelters at a time when real demand is slowing fast. Official data showed an 18pc drop in China’s exports last month.
Factory-gate consumption is equally weak. China imported a total of 380,000 tonnes of raw copper and copper products in February, down sharply from the 536,480 tonnes shipped into the country the previous month.
In addition to providing the raw material for China’s dramatic urbanisation over the past 20 years, metals such as copper and iron ore have been used as a form of collateral to enable companies and investors to borrow in China. This may have artificially driven up the price of industrial resources, creating vast stockpiles in warehouses and ports across China.
Analysts estimate that around 60pc of the copper in Chinese warehouses is held in storage as a form of collateral against debt. This system is now unravelling with dramatic consequences as the number of Chinese creditors defaulting increases and lenders rush to sell commodities they hold as collateral to recoup their losses while prices still hold up.
However, brokers are divided on the ultimate direction that prices are headed next. In a command economy such as China, much will depend on the response that policymakers in Beijing take to prevent domestic markets from completely seizing up.
Ziao Fu, a commodities markets strategist at Deutsche Bank, said: “In our view, the recent sell-off in copper prices has been primarily driven by speculators trying to anticipate the unwinding of financing deals, rather than actual widespread unwinding itself.”
According to Macquarie, one of the “sanity checks” the bank uses to gauge volatility in the iron ore market is iron’s price ratio to scrap metal. Currently, the price of an iron unit in scrap is 2.22 times that in iron ore, the highest level since September 2012 when prices last collapsed and the ratio hit 2.8 times. That ratio is well above the 1.86 times average to scrap that Macquarie has tracked over the past year.
“What this suggests is a degree of panic in iron ore, as scrap tends to be the more liquid transaction-backed spot price and better reflective of what a marginal iron unit buyer would be willing to pay,” wrote analysts at Macquarie late last week.
Deutsche Bank is also pessimistic about the prospects for iron ore in the near future and is forecasting that a tonne of the steel-making commodity will soon fall below the key threshold of $100 per tonne. “As a low value product with greater difficulty for storage, iron ore financing is not sustainable, in our view,” the bank wrote in a note to investors.
Regardless of whether industrial metals prices recover this week or sink further, the recent turmoil suggests that presumptions over China’s future consumption and reliance on Beijing to support prices may have to be reassessed.