Commodity markets are ‘captives of a Chinese saga’

Copper is widely seen as a barometer of global economic activity. So the red metal’s near-10% slump last week to a four-year low looks alarming. But this reputation is exaggerated, says Economist.com’s Buttonwood blog.

Copper fell for much of the 1990s, for instance, when the world economy was growing strongly. These days it really tells us more about China, which accounts for 40% of global demand, thanks to the infrastructure boom of recent years.

The price slide partly reflects recent weak economic data, which points to a slowdown in China now that the authorities are cracking down on the lending that has fuelled growth since the financial crisis.

But analysts reckon around half of the copper in Chinese warehouses isn’t used in the economy, but is instead stored as collateral against loans. To get around strict credit and currency controls, copper is used to raise loans in dollars, which are then changed into yuan or invested in yuan-based assets.

It’s basically a carry trade, says Randall W Forsyth in Barron’s. Until recently, the yuan was almost a one-way bet; the government was allowing it to appreciate gradually. But earlier this month, there was a slide in the currency, flushing out speculators. The yuan decline meant losses for carry traders, who were forced to sell the copper backing their loans to raise money.

The government last week also widened the yuan’s trading range (either side of a rate that the Chinese central bank sets every day) to 2% from 1%. This will make the currency more volatile.

With many of the dollar loans raised against copper vanishing into the shadow banking system, the prospect of defaults spreading through the system and prompting further copper sales to cover losses is unnerving investors.

So far, the decline is a result of “speculators trying to anticipate the unwinding of financing deals, rather than actual widespread unwinding itself”, reckons Deutsche Bank. But last week marked the first corporate bond default in China’s history, and this week brought news that a property company with debts worth $570bn is facing bankruptcy.

It’s a nasty reminder that weaning the economy off a $16trn credit spree could be messy, as Ambrose Evans-Pritchard points out in The Daily Telegraph. The commodity markets, like the rest of us, “are all captives of the Chinese credit loan saga”.

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

MoneyWeek magazine

Latest issue:

Magazine cover
In the balance

How May 2015 could hit your pocket

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

Russell Napier: deflation is coming – hold on to your cash

Financial historian Russell Napier talks to Merryn Somerset Webb about the next deflationary bust – why it's coming, what it means for you, and how you can survive it.


Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.


27 November 1924: Macy's first Thanksgiving Day parade

On this day in 1924, New York department store Macy's held its first Thanksgiving Day parade. It would soon become a city institution, kicking off the run-up to Christmas.