Chinese Trade Data Brings New Hope Even As Old Discrepancies Remain
Overnight equity markets are getting a lift from headline-making beats for Chinese exports and (more importantly) imports. A 10.9% YoY rise in imports (compared to a +1.0% expectation) and a surge in copper 'demand' has the media calling the turn on the global economy (even as China's trade balance at $17.82bn missed expectations of $26.9bn by the most in 4 months and for the second month in a row). But... one glance below the surface of this 5.5 Sigma beat for imports and the other absurdities discrepancies are glaring...
In order of importance (from least to most...)
First, the 10.9% exports print is 5.5 Standard deviations from economist estimates and is the biggest beat of expectations in almost 3 years (sound reasonable given the global economic back drop?)
Second, the Chinese trade balance missed expectations...
Fourth, the data for Copper imports (which is being extrapolated into some indicator global growth renaissance) - which have risen at a remarkable 52% in the last 2 months...
is perfectly reflective of the growth in cash-for-copper that occur when Chinese liquidity conditions get tight...
Via Goldman Sachs,
The recent tightening in Chinese financial conditions is, somewhat counter intuitively, likely to be raising Chinese demand for non-domestic (LME priced) copper, via ‘Cash For Copper’ (CFC) financing. In essence, some Chinese market participants – particularly those that are highly leveraged – are buying non-domestic copper material in order to raise CNY cash, in a development we have not seen since mid-2011. Specifically, CFC financing – which is allowed by SAFE, and has been a factor in the copper market for years – involves the purchase and importation of non-domestic copper into China, the immediate sale of this copper into the Chinese domestic market post-importation (for immediate CNY cash), and a 3-6 month loan at foreign interest rates issued by an onshore bank. In this way CFC’s are a combination of the China/ex-China price and interest rate differentials.
The recent increase in short-term Chinese rates has resulted in CFC’s being highly profitable. Put differently, higher short term Chinese rates have resulted in an opening of the interest rate adjusted copper import arbitrage (Exhibit 1) – raising China’s demand for non-domestic material, and likely contributing to the recent pick-up in Chinese bonded physical premia (to record highs of $180-$200/t), higher LME Asia cancellations, and tighter LME copper spreads. In this way, interest rates differential changes, via CFC financing, can change where global copper inventories are located (today there is a pull on non-domestic copper inventories into the domestic market).
A typical CFC financing deal
Exhibit 4 (below) is a simplified flow chart, illustrating a typical ‘Cash for Copper’ financing deal (CFC). As can be seen, CFC financing involves 3 main steps:
Step 1: Onshore banks issue letters of credit (LC), typically 3-6 month duration;
Step 2: Offshore copper owner sells to onshore copper importer. Physical copper imported into China (from either bonded warehouses or other offshore markets) by onshore copper importer. Imported copper is sold into the Chinese domestic market, CNY cash is received by onshore copper importer.
Step 3: Onshore copper importer repays the LC at end of LC period.
CCFDs vs. CFC financing: 2H13 outlook for less CCFDs, more CFCs CFC’s differ from CCFDs in that CFC financing involves moving physical copper from offshore to onshore; and there is no circulation of warrants, as compared to multiple circulations of warrants in CCFD financing (thus CFC’s are allowed by SAFE, and are much simpler/easier).
Having said this, CFCs and CCFDs do share one incentive in common: access to CNY cash through cheap FX funding. The interest rate banks charge for LCs is LIBOR plus a certain premium, while the gain importers realize by holding the CNY cash is the onshore shortterm interest rate.
In 2H13 we expect a reduction in CCFDs (resulting in more availability of bonded copper inventories, which currently sit at c.430-450kt), and higher CFC’s, which should support high bonded and ex-China physical premiums, and incentivise stocks to shift from bonded and ex-China markets to the Chinese domestic market.
As we explained before for CCFDs, CFCs have the odd feature of raising Chinese demand for non-domestic (LME priced) copper - which, as Goldman notes, market participants should be wary of interpreting these recent ‘signals’ – including ongoing resulting copper import strength and potential near term LME draws – as bullish, since they are in part driven by Chinese liquidity tightness, and not primarily driven by real Chinese demand/re-stocking.
Fifth and finally, we urge readers to ignore all of the above. As a reminder, there is a consistently massive, to the tune of $10 billion per month, discrepancy between what China "reports" are its net exports to the US and what the US indicates it imports from China.
(Blue is China's version of the truth which is bigger than the US's orange version of the truth)
Since the two have to align, one or both nations are lying, which means that essentially all trade data arising out of China is simply fabricated. So aside for kneejerk algo reactions, and providing a few hours of pundit talk time, the so called trade data is anything but positive.
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