It’s a key moment for copper, which is being used as financing collateral in China.
[This article originally appeared on HardAssetsInvestor.com and is republished here with permission.]
It has been a positive year for most commodity markets so far in 2014, but one metal has severely underperformed. Last week, copper prices sagged to their lowest point in 3 ½ years, sharply lagging other base metals such as zinc and nickel, which have surged in recent sessions.
The red metal has been reeling ever since news broke of China’s first-ever onshore corporate bond default earlier this month by Shanghai Chaori Solar Energy Science & Technology Co. More defaults may be on the horizon, with China’s premier Li Keqiang calling them “unavoidable.”
The prospect of a string of defaults in China does not bode well for economic growth—or copper demand—in the world’s second-largest economy. Still, any slowdown in China would presumably hit commodities across the board, but it’s been copper in particular that’s been feeling the downside pressure.
That’s because copper serves a dual purpose in China. On the one hand, copper maintains its traditional uses in electrical wiring, electronics and construction. On the other hand, copper often serves as collateral in financing deals.
Analysts estimate that perhaps one-third of China’s copper imports and one half of its copper stockpiles are used for financing. That leaves the red metal in a vulnerable position. If more companies follow on the heels of Shanghai Chaori Solar and start to default, lenders may be forced to liquidate collateralized copper to recoup their losses. Moreover, it’s the smaller, riskier firms that are likely to have used these types of financing deals in the first place.
A great unwinding of the copper trade in China would obviously be bad news for prices; thus, a decisive move below $3/lb can’t be ruled out.
“Our view is that Chinese commodity financing deals will gradually unwind over the medium term…,” said analysts at Goldman Sachs. “… an unwind creates excess supply and thus is bearish to prices,” they said, noting that 1 million metric tons of copper could be liquidated over the next year or two.
However, some analysts suggest that the sell-off in copper may be overdone.