China is being buried alive in copper | FT Alphaville

China is being buried alive in copper

According to Wikipedia, compulsive hoarding is a disorder characterized by the excessive acquisition and inability or unwillingness to discard large quantities of objects that would seemingly qualify as useless or without value.

We’d like to make the case that China is suffering from this disorder and that we’re at the stage where a psychopharmacological intervention needs to be organised by China’s friends and family. If not China’s hoarding tendencies could destroy the world as we know it.

Case in point, the following picture from a Standard Chartered’s trip to examine copper inventories in bonded areas in eastern Shanghai last week.

(Hold out for more pictures at the end of the post…)

What you are looking at here is a staff car park that’s currently serving as a spillover area for copper inventory storage at a major warehouse.

Standard Chartered’s Judy Zhu and Han Pin Hsi say they were simply floored by the amounts of inventory they encountered:

On a routine trip to examine copper inventories in the bonded area in eastern Shanghai last week, we were astounded by how much copper is being stored in warehouses. We visited one of the biggest warehouse operators (which holds nearly one-third of the inventory in Shanghai‟s bonded area) and saw some interesting sights (Charts 1-6). Copper plates were piled to the maximum allowable height (based on weight so as not to damage the land it is sitting on).

The covered warehouses were full. The staff car park was used to store copper. The driveway between warehouses was blocked by copper. The warehouse operator told us that it cannot accept additional inventory until existing inventory is shipped out.

That last paragraph indeed sounds more like something you might encounter on this TV show, than in a research report.

Furthermore, it’s not a unique phenomenon. Bonded warehouses all over China are just as full:

The same operator told us that warehouses in Yangshan, another bonded area in Shanghai – but more remote and hence not a preferred place to store copper – is also full of copper. We estimate that total copper inventory in China, which includes inventory outside of the bonded areas, has reached about 1mn tonnes (mt).

While we believe that excess inventory in China, which consumes about 40% of global copper, is a clear near-term headwind for price increases, we caution investors not to be too bearish – especially in regard to price expectations for H2. Risk appetite could suddenly turn positive, especially if our expectation of stronger global economic growth in H2 proves to be accurate.

But the copper story does get weirder.

First off, LME cancelled warrants surged 89 per cent last week to a record high.

As many commenters have noted, this can be interpreted as bullish for the fundamental picture because it shows that institutions are taking delivery of copper stored in the LME inventory system for real-world use. Unsurprisingly the copper futures curve moved aggressively into a bullish backwardation structure as a result of the inventory news.

But checking out the chart, you’ll notice that the increase was not only large and sudden, but also very much against the historical trendline.

What’s more, according to the Standard Chartered guys, overflowing inventories in China suggest fundamentals are not yet strong enough to support a sustainable rally in prices.

The picture is thus oxymoronic.

Which is why we would be inclined to agree with those who say that cancelled warrants just don’t mean anything anymore.

Indeed, rather than implying imminent delivery, the the cancellation could just be leading to inventory being shifted into the private non-LME section of the warehouse. The logic as to why this happens is pretty simple.

In the past, holding inventory “on warrant” at the LME was considered as good as holding cash. From a balance sheet point of view it ensured liquidity, irrespective of whether the copper backing the warrant had been sold or not.

This was great for freeing up working capital. But it was hardly a long-standing solution for longer term funding needs. More to the point, you still needed funding to buy the copper in the first place.

But nowadays banks don’t like to lend unsecured. And commodity houses and traders don’t conventionally have access to large amounts of acceptable “safe collateral” such as AAA government bonds.

They do, however, have access to commodity inventory. This is especially the case if they represent producers and/or have contracts marketing producer inventory.

So, shift part of that inventory off warrant into the dark inventory universe — unaccounted for by LME stock statistics — and you’ve get yourself a workable long-term funding solution in the form of a commodity securitisation. In some cases deals may even be structured as repos, being brought on and off warrant as and when it suits the banks (usually related to when it suits them to have exposure to the underlying inventory or how easy it is for them to pass on the long position to investors).

A nice neat sum going off warrant in one large convenient move thus hints strongly of a securitisation deal, rather than any pick-up in underlying demand.

And if that is the case. that means a trend that first started off in China has now fully migrated and been absorbed in the West.

One thing’s for sure. If this report from the Shanghai Daily is anything to go by, you have no chance of building a bulk commodity trading center in China if you don’t have the permission to facilitate collateralised financing:

COMPANIES can use bonded cargo in the Yangshan Free Trade Port Area as a pledge to get bank loans under a trial, a senior official said yesterday. Copper and aluminium are the first batch of goods allowed to be used as a pledge for financing, said Jian Danian, vice director of the Shanghai Free Trade Zones Administration, adding that more products will be included in the future. The Bank of China signed agreements with three firms yesterday to provide financing totaling US$1.45 million for the pledged bonded goods. Four other banks, including the Industrial and Commercial Bank of China and China Construction Bank, have also been allowed to launch the service. Yangshan is the first port in the Chinese mainland to get the preferential policy. Formerly, duty-free goods could not be pledged for loans.

Pledging bonded goods to get loans will help bulk commodity firms as Yangshan port aims to build a bulk commodity trading center.

We’ll leave you with some more excellent copper stockpile pictures from Standard Chartered:

Related links:
Oxymoronic LME stocks
– FT Alphaville
Let’s count the copper with dust on it
– FT Alphaville
The curious case of un-cancelled warrants – FT Alphaville