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‘Canaries In Coal Mines’: Copper and Iron Ore Markets Breaking Down

Posted by Larry Doyle on March 12, 2014 10:23 AM |

Having focused meaningful attention on developments in China in recent commentaries, I am compelled to draw even further focus to the ‘canaries in the coal mines,’ that is, the copper and iron ore markets.

Let’s navigate eastward once again as the FT writes,

Copper continued to take a pummelling, with Shanghai traded futures in the metal falling by their daily limit on Wednesday morning.

That came after a frenzied day of trading on Tuesday, when copper prices sank below $6,500 a tonne to a near four-year low as concerns mounted over the fragility of the Chinese market.

In frenetic afternoon trading, prices tumbled more than 2.5 per cent to a low of $6,470. Since Thursday, copper for three-month delivery on the London Metal Exchange has tumbled by nearly $600, or 8.9 per cent.

On Wednesday morning, Shanghai traded copper futures fell 5.4 per cent, a fifth straight daily loss, to Rmb43,690 ($7,115) a tonne – the lowest since July 2009.

The slump in copper was sparked by China’s first corporate bond default on Friday, which has caused a reassessment of credit risk in the country.

Copper has become an increasingly popular source of collateral for Chinese traders who can obtain US dollar loans and profit from interest rate arbitrage. As a result, copper imports have rocketed in recent months, with much of the stock headed into warehouses rather than factories.

If the financing deals were to suddenly unwind, vast quantities of metal would pour into an already well-supplied market. China accounts for 40 per cent of global copper consumption, but demand in the physical market has been weak this year.

Tuesday’s reported suspension of trading of Baoding Tianwei Baobian Electric Co bonds and shares on the Shanghai stock exchange, because of mounting losses, added to the copper jitters, according to Stephen Briggs, analyst at BNP Paribas.

“The market is worried about what could happen in China, since financing deals have now become much less attractive,” he said.

Iron ore prices in China have come under pressure as mills that opened three-month letters of credit in December to tide themselves over during end-of-the-year credit tightness sold stock to repay their loans.

“The main problem is financing,” said Chen Yan, iron ore analyst with SteelHome in Shanghai.

Financing is always the issue especially when entities are excessively leveraged as many in China are.

I would keep a close eye on these commodity markets specifically and the ripple effect that they have on emerging markets generally and then developed markets beyond that.

Navigate accordingly.

Larry Doyle

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  • In today’s Financial Times

    Copper flashes red

    By Michael Mackenzie

    Investors have reasons to worry and must examine their portfolios

    Copper prices have long been viewed as a proxy for the health of the global economy, hence its popular moniker Doctor Copper.

    In recent years, however, the red metal’s fortunes have waned even as expectations for a stronger global economy have propelled equity markets sharply higher.

    Such a divergence, however, may soon face a day of reckoning as the sharp slide we are seeing in the price of copper and to a lesser extent, that of iron ore, may well be a sign that a nasty financial crunch is developing in China.

    With copper having tumbled nearly 10 per cent in the past week and at its lowest level since July 2010, global equities and commodities are on the defensive, while government bonds are attracting buyers.

    Beyond its economic significance, copper has become a key asset used in China as collateral for US dollar loans that are coming under serious pressure because of recent official efforts to weaken the currency.

    Much of the slide in the copper price is being attributed to fears that the Chinese financial system is on the cusp of experiencing pronounced stress as the currency weakens. A default by a domestic company last week has also triggered a broad reappraisal of credit risk in China.

    The big danger is that a significant unwinding of financing deals that use copper and iron ore has the potential to squeeze the financial system with potentially major consequences for China’s broad economy and commodity markets. In turn that will recoil through the global financial system.

    With copper flashing red, investors have reasons to worry, particularly as it heightens the prospect that China will fail to meet its economic growth target of 7.5 per cent, its lowest such projection since 1990.

    For US equity investors sitting on large gains from a five-year bull market, the prospect of Chinese financial flu and weaker global growth should merit an appraisal of their portfolios.






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