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Copper and Yuan Carry Trade

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By EconMatters

 

Copper fell more than 3% on Wednesday, April 4, its most in nearly two months after the latest meeting minutes from the U.S. Federal Reserve meeting showed policymakers seem not quite ready to launch further economic stimulus.  The red metal did manage to rebound a bit to $3.79 per pound on Friday after the BLS reports showing an improving labor market, and on hopes that China may loosen its monetary policy to avoid a hard landing.

 

Prices of copper have slid about 5% since hitting their highest levels in nearly five months at $3.9950 per lb in February.  China, the biggest copper consumer in the world., reported strong copper and copper product imports in February to 484,569 tons, up 17% over January and imports in the first two months this year were 50% higher than the same time last year (see chart below).

 

However, rather than a sign of strong end user demand, a lot of the stockpile copper will never get shipped out to end-users because they were bought for speculative reasons.  Traders are using copper as collateral for other investments - offshore yuan forwards and interest rate differentials seems to be the most popular trade right now.


 

From Reuters,

"Before a selloff in the offshore markets in September, trading firms were using copper to fund a carry trade, where they secured LCs in low-yielding dollars to fund plays in the spread between onshore and offshore yuan, layering an element of FX gains on top of commodity price gains.

They could also speculate on the currency by using yuan non-deliverable forwards, which are contracts betting on the yuan's direction but settled in U.S. dollars. 

The premium for the offshore market has climbed as high as 3% over the onshore rate last year due to limited supply and high demand for exposure to the Chinese currency, whose trade is limited outside the mainland."

According to Reuters, the offshore market, or CNH (Chinese yuan traded in Hong Kong), is largely the result of China's experiment to promote its currency's use in international trade and has traditionally traded at a higher value in dollar terms than the mainland yuan.

 

The premium for the offshore market has climbed as high as 3% over the onshore rate last year. Local traders estimate some 80-90% of the bonded copper stocks in Shanghai belong to trading houses using imports as a way to get cheaper financing.

 

 

This type of financing deals draws world's copper stocks into China depressing local prices, tightening supply outside of China, while distorting other supply, demand and price indicators such as imports data and reported stock levels.

 

Various projections point to a world copper production deficit of about 250,000 metric tons in 2012 as supply growth continues to lag behind demand growth, and supply and demand is expected to reach balance by 2013.  However, analysts estimate that more than 1 million tonnes of mostly unreported commercial stocks of refined copper cathode are currently sitting in warehouses, the highest level since 2009.  That's about 4 times of the expected deficit this year, which suggests the current copper market seems more than balanced than most people believe given the slowdown in China's economy.

 

For now, traders are still bullish on copper as Managed money funds increased their net long position on copper futures and options by 25% in the week ended April 3, according to the data from the CFTC (see chart below).

 

 

In the long run, copper price outlook is positive just on rising mining costs, diminishing resource base, and the demand growth expectation.  But don't expect copper to break out unless there's a real pickup in consumption, and Chinese players start offloading the surplus stockpile.

 

 

Source: Stockcharts.com

 

From a technical standpoint (see chart above), copper's been trading in the $3.70 to $3.95 per pound range since the start of the year, and should find short-term support at $3.70, with major support at $3.30, major resistance at $4.00.  So if you are shorting copper, put the stop at $3.70, but start the long position (with a stop at $4.00) if copper breaks the $4 resistance.

 

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Mon, 04/09/2012 - 15:17 | 2329007 CTG_Sweden
CTG_Sweden's picture

 

Perhaps China imports lots of copper in order to improve its electric grid in order to make electric cars a realistic alternative for the consumers? An electric vehicle is a convenient alternative for a consumer that has access to a 1000V/100A outlet on his driveway or in his garage and at filling stations along the road.

 

On the other hand it seems as if aluminium is more popular for high voltage/heavy current applications. So more Chinese imports of copper is perhaps not a strong indicator of an intention to radical improvements of the Chinese electric grid.

 

But even if the Chinese do not intend to improve their electric grid I think that this should be the smartest thing they could do. Why not dig trenches for high voltage/strong current cables at the same time as they build new residential areas and new roads? It should be less expensive and more practical to invest in the electric grid at the same time as the residential area or road is built rather than afterwards. It should be easier for a country which probably has to invest more in housing and roads than Europe and North America over the next decades to improve its electric grid. And why not let the ghost towns get an improved electric grid before people begin to move into these areas? If it is possible to recharge your electric vehicle at home in a few minutes and have a car that run on a very inexpensive fuel I reckon that should make housing in such an area more attractive.

 

Since it is also a lot easier to produce electricity domestically than liquid fuels in a densely populated country, more electric vehicles is also an easy way to improve the balance of trade. Today, China pays for oil imports by exporting sneakers. In order to be a competitive exporter of sneakers you got to pay people low wages. If China could reduce its import of oil it would not have to export products that take low wages to the same extent. That would in turn mean that China instead of spending money on wages to people working with producing sneakers rather would spend money electricity production and a smaller number of people on electricity producers payrolls. Since the jobs at the electricity producers would be so much more productive it would be possible to pay these people a lot more than the people at the sneaker factory.

 

I don´t know how China should spend the money gained by reducing oil imports. One alternative is to spend some of the money on increased wages at the sneaker factory by raising minimum wages. Another alternative is that people quit working at the sneaker factory since the factory is no longer competitive in the export markets due to raised minimum wages and instead begin to work in more productive, capital-intensive sectors of the economy such as the automobile industry and the white goods industry. If China doesn´t have to spend as much on imported oil it is possible to spend more on cars, refrigerators and air conditioners.

 

Furthermore, it should be possible to spend more on wages in China if more vehicles run on electricity since electric motors are more power efficient than internal combustion engines and since even wind mills produce less expensive fuel than imported oil (at current prices). Why not spend more on wages in China in some way and less on imported oil? As long as the oil price stays higher than $100 per barrel I think that it is obvious that more electric cars benefit oil importing nations even if balance of trade aspects are not considered.

 

I also think that Europe and the US should consider the idea to improve the balance of trade by improving the electric grid and increase the number of EV:s. Especially the countries in southern Europe which don´t have very productive economies and where the climate is more suited to EV:s I think that an improved electric grid and more EV:s is a great idea. You don´t have to add expensive heating devices for the batteries in countries with a hotter climate than in Northern Europe. Spain, especially coastal areas, Portugal, central and southern Italy and Greece are perfect for EV:s. Southern France is also perfect for EV:s.

 

Perhaps the ECB should lend money to Spain, Portugal, Italy and Greece so that they can improve their electric grid faster? That would create jobs in the short term and improve the balance of trade in the longer term.

 

Furthermore, people should keep in mind that with a sufficient electric grid, EV:s do not need an internal combustion engine like the Chevrolet Volt/Opel Ampera, for instance. That reduces the cost and makes it possible to have a larger battery that increases the range for the vehicle.

 

I know that internal combustion engines powered by ethanol and methanol probably is a less expensive solution at cost price compared to electric motors. But I doubt that there is enough room to produce the raw material needed for, let´s say, half of all the cars on the road in the US, Europe, India and China in 20 or 30 years. Therefore, I doubt that the consumers will pay near cost price for ethanol and methanol in the future. Perhaps liquid fuel produced by algae could make internal combustion engines more competitive in the future. But if that seems unlikely to happen I reckon that an improved electric grid should be considered by many countries.

 

Mon, 04/09/2012 - 07:39 | 2327447 Schmuck Raker
Schmuck Raker's picture

It's good to get a perspective of recent vintage on an issue that's already been visited occasionally here at ZH.

Though I almost stopped reading at...

"...BLS reports showing an improving labor market..."

Mon, 04/09/2012 - 05:59 | 2327407 silverdragon
silverdragon's picture

Clicked on the the slowdown in China's economy

Written by some retard that has never been to China, done business in China nor knows anything about China. Best they quit journalism and go back to flipping burgers at Mcdonalds.

Some comments about their nonesense:

1. GDP is way larger that stats as Sole proprieter businesses all pay nominal tax rates and their turnover is creative. Black economy is not small.

2. True GDP stats are higher not lower, when the west is broke why let them know you are flush. 

3. Ref Japan who gives a shit.  Why buy their radioactive products when other suppliers can be found.

4. Anyone that gives weight to nonesense like "the HSBC/Markit Flash Purchasing Manager’s Index (PMI)" needs two in the back of their head.

5. All employers in China are screaming for employees.

6. Don't worry your pretty little head about China managing debt. If govt gets in red it can increase power, water, electricity and phone costs etc by a couple of percent and back to black.

7. Govt flatlining property as any competent govt would do, its a good thing. Forcing investors and business people to better allocate cash resources. Casino is shut for a while.

Bottom line, China is the energizer bunny and batteries are fine.

 

 

Mon, 04/09/2012 - 11:01 | 2327962 irie1029
irie1029's picture

Well said.  My OPINON China GDP is at least DOUBLE what is reproted.

Mon, 04/09/2012 - 03:09 | 2327352 ReligiousAtheist1
ReligiousAtheist1's picture

Excellent piece

Mon, 04/09/2012 - 01:30 | 2327306 chump666
chump666's picture

iron ore and steel stockpiles + China inflation blowout and stagflation =  short ASX200 and AUD

Sun, 04/08/2012 - 23:54 | 2327213 Yen Cross
Yen Cross's picture

Your Copper chart has a 50/200 day and the RSi and Stochastic are WEAK!

 

Sun, 04/08/2012 - 23:24 | 2327179 Errol
Errol's picture

I have read that China has overinvested in infrastructure (ghost cities, ghost malls, underused high speed rail lines, etc).  Add to that the Eurozone slowdown, and I think it's possible that copper consumption and prices may trend strongly down.

Mon, 04/09/2012 - 05:13 | 2327395 silverdragon
silverdragon's picture

Errol,

Chinese govt, investors and business people will continue to buy copper as sooner or later they will need more and its a much better place to have cash than dollars or Euro's.

Most infra structure in China is maximized. Don't worry too much about undermaximized property or infrastaructure as economy still booming compared to Western growth rates.

All this nonesense ref empty apartment buildings is attempting to state something negative about China property. Reality is govt flatlining property to allow those that missed the train to get aboard, its cultural that you can't relax until you own a property, its also given as a gift when kids get married.  When any family member gets rich he or she must help buy every relative they have never met a property. Add to that most property in China was purchased when prices were cheap so debt to equity ratios low.  Also very difficult to borrow against property.  Deposit for second property is 100% cash down unless first property paid off. First property is 20% down.

Credit card debt tiny and stuff all vehicle debt.

Infra structure spending will continue to boom.

Ref China investment environment property is a crap short term investment and so are stocks so commodities and PM's will be snorted by the China market.

So buy lots of silver.

 

 

 

Sun, 04/08/2012 - 23:08 | 2327156 Yen Cross
Yen Cross's picture

 Ohh please? I understand your context, "buy", not the underlying issues.

  " Sounds familiar"?

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