Bronze Swan Lands: Goldman Explains How The China Commodity Unwind Will Happen

Tyler Durden's picture

Over a year ago we were the first to bring the topic of China's shadow banking system's problematic rehypothecation issues to the general trading public. In "The Bronze Swan Arrives: Is The End Of Copper Financing China's "Lehman Event"?" we explained how the Chinese commodity financing deals (CCFDs) worked and how they would inevitably be a systemic event for the nation so dependent on the shadow banking system for its credit (and its "growth"). The day has arrived when the Bronze Swan is landing (and it's unlikely to be soft). As we have discussed recently, the probe into 'missing' collateral (or multiple-used collateral) at China's Qingdao warehouse is a major problem... and now Goldman confirms, the Qingdao situation likely to continue ongoing CCFD unwind and has the potential to leave foreign banks with undercollateralized loans and/or losses.

Via Goldman Sachs,

Qingdao situation and the copper market outlook

According to reports, an onshore trading company is being investigated for allegedly pledging commodities (aluminium and copper) multiple times with different banks in order to gain access to cheap FX funding (specifically via repurchase agreements, or “repo” business). This has the potential to leave foreign banks with undercollateralized loans and/or losses.

Given this, a number of foreign banks may suspend their repo business in China, as well as shrink their commodity financing positions in China in general.

The Qingdao issue could be a catalyst for further CCFD unwinding

In our view the developments in Qingdao are likely to continue the significant scaling back of FX inflows from foreign banks into China via commodity financing business. This would disincentivize the physical holding of commodities in bonded warehouses, increasing ‘visible’ inventories and placing more downward pressure on physical (cash prices) than upward pressure on futures prices. As foreign banks reduce their exposure to Chinese commodity financing deals (CCFDs), the profitability of these could be reduced meaningfully (via an increase of US rates and/or a lower FX loan quota to CCFD participants), more physical metal previously tied up in financing deals would be freed up for the physical market, helping ease the current temporary regional tightness.

With respect to copper in particular, we expect more copper will either flow back to China or LME, depending on which market is relatively stronger. Indeed, there are signs of unwinding in near-dated tightness in the market recently, as indicated by the significant easing of both Shanghai premia and LME time spreads (Exhibits 2).

To explain in more detail, we expect this could result in:

Copper refiners having less incentive to export cathodes to bonded warehouses (since funding from repo business could be ceased).


Copper inventory holders finding it more reasonable to move copper out of bonded warehouses and place it in LME warehouses, both for funding availability and profitability considerations.


Importers may redirect their cargoes to other locations where premia trade at higher levels.

We remain bearish on copper for 2014

These factors, together with copper’s particularly high exposure to CCFDs, as well copper’s significant leverage to China’s weak property market, have seen cash copper prices fall 5% over the past week (now down more than 10% ytd). These developments are in line with our views expressed in Days are Numbered for Chinese Commodity Financing Deals (published March 18, 2014) and Concerned about Chinese property, still bearish on copper (published May 7, 2014).

We reiterate our year-end copper forecast of $6,200/t (we had already assumed a gradual unwinding of Chinese copper financing deals). Given the potential we see for the Qingdao situation to lead to a rapid unwind in financing deals, there is a risk our target is reached earlier than the end of the year. Further, we expect more refining capacity will be delivered in 2H14 to convert a concentrate surplus into a cathode surplus.

What is the “repo” business in China’s commodity industry?

The “repo” business in commodities in China is similar to any other “repo” business in the financial markets. Generally speaking, the repo is a short-term FX funding vehicle, whereby a commodity owner first sells the commodity warrants issued by bonded warehouses (paired with an equal amount of short positions) to banks, then buys the package back from the banks in 3 to 6 months. It is a way for commodity traders/refiners to gain access to foreign banks’ balance sheets and improve liquidity efficiently.

The Qingdao situation alleges the issuance and pledging of more warrants than the underlying physical commodity. Were this to have occurred, foreign banks may be exposed to asset write-offs due to potential collateral shortages and/or losses. As a result, some foreign banks may have reduced or suspended their commodities repo business in China, and could be undertaking further investigation as to whether to make any suspension permanent.

Likely reaction of foreign banks to the Qingdao issue

The initial reaction is likely to be to significantly reduce the exposure to different repo businesses and investigate whether there are any other multi-pledge issues in other deals. This is already happening in the market.

A further potential reaction, in our view, is for the banks to investigate the broader spectrum of their Chinese commodity financing deals (i.e. not just the repos or CCFDs, but the whole book) in order to clarify:

  • whether these deals are exposed to substantial underpriced risks;
  • whether the banks as a whole still want to continue the business;
  • if they choose to continue, what rules could be established and enforced.

Our base case is that, even if banks do not find any further cases during the investigation periods, they are likely to raise the bar for Chinese commodity financing deals in general, in order to broadly lower the exposure to this sector. This would occur via higher funding costs for the arbitrageurs, thereby slowly disincentivising repurchase deals and CCFDs, and resulting FX inflows. However, if there are further similar cases to be found, the whole exposure could be reduced sharply, which would lead to a disorderly unwind of repo and CCFD business in general.

However, the problem goes a lot deeper and has the potential to impact shadow banking systems around the world...

What do “repos” have to do with CCFDs? (see here for details)

If foreign banks try to reduce their broad exposure to Chinese commodity financing business via cutting commodity clients’ loan quotas and/or raising funding costs, this could reduce CCFDs’ ability to access cheap foreign funding and could potentially raise FX financing costs in future, thus affecting the profitability of CCFDs.

As illustrated in step 3 of the Exhibit 4, USD cash raised from repo business is an important link in CCFD funding. If we assume most of the copper in bonded warehouses is tied to both repo and CCFD business and the circulation of CCFDs are around 5 times, the FX funding from repo could be c.20% of total FX borrowings from Chinese copper financing deals. Thus, the suspension of repo business since last week by many foreign banks does directly impact the funding for CCFDs and reduces the incentive to hold physical inventories.

Another channel to access cheap FX funding is onshore banks’ funding of LC which is eventually funded by the interbank market (Exhibit 4). Thus, this channel would also be affected if the foreign banks try to lower exposure to China’s commodity business, because it would either raise the cost of LC funding or limit the LC funding quota for CCFDs, which would disincentivise CCFDs in both cases.



Even before the reporting of the Qingdao issues, the profitability of CCFDs in copper had been declining sharply since March 2014, due to:

  • lower CNY/USD rate differentials;
  • higher CNY volatilities against USD
  • higher LME rolling costs.




*  *  *

This leaves us with two significant questions:

1) how much physical copper/aluminum tied in to these deals will suddenly hit the market (for sale) - thus sending the price sliding (and contagiously spreading to numerous banks and trading shops around the world - as we discussed here); and

2) if we are right that somehow China managed to push gold lower via gold CFDs, then the unwind pushes gold higher:

Here's how that might work:

In the gold markets, the paper or synthetic 'demand/supply' dominates pricing as opposed to the non-precious metals which have at least a grain of fundamental sense to them still


Throughout 2012/2013 - as the gold CFDs were booming, Chinese demand for physical gold was soaring as the price plunged (due to the forward hedging required in the CFD transactions which pressured gold swaps/futures lower and thus dominated pricing)


As CFD unwinds hit en masse, these flows must unwind (cover hedges and ensure the underlying physical is there... and if not buy it)


This will pressure gold futures prices higher and because unlike in non-precious commodities where spot markets wag the tail of the futures markets - spot gold will likely be dragged higher also (as we know the demand for the physical has been high).

As the renowned Dennis Gartman might say, being short of commodities in precious metals terms may be the cleanest way to trade the coming CFD unwinds. Especially since Gartman himself is long of said commodities.

*  *  *
Finally, we noted previously, in brief (pun intended):

a complete, unpredictable clusterfuck accompanied by wholesale liquidations of "liquid assets", deleveraging and potentially a waterfall effect that finally bursts China's bubble, all due to a simple black swan. Although, in reality, nobody knows. Just like nobody knew what would happen when the government decided to let Lehman fail.

So is this China's Lehman? Sure looks like someone just hit the "oh, shit" button at the PBOC.

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BobPaulson's picture

Just fractional reserve banking really.

Hughing's picture

I have some cntrl-P cut into lines for that

Honey Badger's picture

50 people think they own the same kilo of copper and this is bearish for the metal? Got it, thanks for the tip gs!

ZerOhead's picture

The same thing is going to happen when gold crashes as the people find out they actually don't own the gold they thought they owned...

The world unfortunately works this way now.

mt paul's picture

death by



paper cuts..

OldPhart's picture

Culturally, there's a chinese curse...Death by a a thousand 'rehypothecated' cuts...

I think I'd prefer this to the guillotine for bankers and politicians.


OldPhart's picture

Umm, Goldman says they're bearish, which means I should be bullish, but buying while there's only 50 owners per ounce...while our gold certificates are so much more valuable with 100+ owners per ounce, and now-adays they have printers that can print damned near anything...


I'm confused...I continue to sit on my itty-bitty stash of hard currency.  I think I'll buy more of that.

foxenburg's picture

@honeybadger. So it seems. I am already fretting how bearish it will be for gold when 100 people are fighting for the same ounce. Obviously it'll drive the price through the floor.

Panafrican Funktron Robot's picture

"50 people think they own the same kilo of copper and this is bearish for the metal?"

It's bearish for the paper contracts.  Think it through:  you have a paper contract for, say, 100 tonnes of copper.  You just discovered that the copper is not there.  What price would you sell your paper contract for?

Quinvarius's picture

So now we are back to selling all the copper from these deals, eh?  Just yesterday Goldman said the copper didn't exist.  All I see is Goldman screaming sell copper for a month while it has been rising.  And Goldman's warehouses seem unable to deliver anything at the same time no one else can.  How about this for a plan?  Goldman needs to just start delivering product from their warehouse if they want supply on the market.  I mean surely Goldman actually has some physical copper in those warehouses and is merely too incompetent to get it out of a dock door.  Couldn't be anything else going on.  And BTW, they execute people for fraud in China.  So that missing supply in China WILL be purchased.

AccreditedEYE's picture

Are you trying to say that the only big bank that retained their commodities trading unit, and has a history of telling people one thing but actually doing another, may be up to some foul scheme to enrich themselves? No way.

jonjon831983's picture

Conveniently they are trying to sell off their warehousing biz.

The Duke of New York A No.1's picture

Bundesbank says: "Who cares about a Bronze Swan ... we've got a freaking Golden Swan over here in Germany!!!!!!!!!!!"

NotApplicable's picture

Just tell everybody they'll get their copper in 7 years, problem solved.

NoIdea's picture

Until they find out it's a tungsten swan sprayed gold

MsCreant's picture

Now this could be a stress test. 

youngman's picture

So Goldman thinks the foreign banks might stop doing this...ya think....scam me once..mi culpa...scam me twice...its big bonus time.....I read this and the first thing that came to why do this in the first place..who thinks this crap up really...another synthetic derivitive.....ghost money investing in these toys

RaceToTheBottom's picture

radioactive tracing of batches of commodities....

mt paul's picture

new Gold


radioactive tax stamp

Joebloinvestor's picture

I said it before, only in the GS bizzaro world does a shortage depress the price.

Hughing's picture

GS wants their Muppets to sell into the shortage.

Carpenter1's picture

Christine Lagardes favorite mantra right now: "We must cooperate."
Translated as, "When it hits the fan, everyone pitches in to stop it, by any means."
These pricks understand that if even a housefly strays from the party line, they'll be hanging from lamposts. Expect this to disappear like every other black swan that should've taken the system down.

BUT, these extreme measures come at a cost, an ever increasing cost. It won't be one that breaks their back, it'll be the cumulative. They'll see it coming and pull the plug first by announcing their reset and whatever new worthless currency they want us to believe in.

Groundhog Day's picture

when will they peddle their basket of currencies bullshit.  will the sheep go along and use the new fiat after they've been fleeced or will they grow some balls and fight the system.  My money is on fiat.  I pray for change, but I dont think it will ever come

KnuckleDragger-X's picture

I just wonder whose going to demand that all the warehouses have their holdings audited. There a lot more commodities than the ones we're talking about stored away in China.

are we there yet's picture

A bigger question is who is the insurers of the various claims on comodities.  Such asset references have underwriters. Who is really holding the bag.

mt paul's picture


copper traders ....

Schmuck Raker's picture


For the love of God, WWHHHEEEEEENNNNNNNNNNN???????

*The suspense is killin' me!

Rock On Roger's picture

The thieves continue to steal grounding cable at our rural industrial facilities,

We haven't caught the buggers yet,

Next time we'll be able to track them down.


Somebody is stacking real copper.


Stack On

Atlas Crapped's picture

The entire world has been in a depressionary collapse for quite some while. The 1% only need so much copper. But all this is academic. The world is run on paper and that will collapse. Soon we will actually look at the supply opf real copper, and the real world demand for it, and that will be the onlt thing that matters. Paper will stand on the sidelines to burn.

falak pema's picture

swan song of yellow, brown or black swan; as long as its not for white swan Putin doesn't care! 

That's the beauty of swan lake! 

Ivan Nokabolokov's picture

So a company which under any normal accounting procedure should have been wound up in 2008 deems to lecture others on financial matters. Ha. Ha. Ha.

Downtoolong's picture

more physical metal previously tied up in financing deals would be freed up for the physical market

Why isn’t it more likely that more physical metal will be needed to comply with the CCFD deals already in place? Effectively, Goldman is admitting that the CCFD market (one which they played a big part in promoting and profiting from over the years) is one huge fraudulent scam that will now be defaulted on. And, just like every other debacle in the financial markets, We The People will somehow pay the price for it, one way or another. Worse yet, Goldman is casually assuming we must all just accept that and move on. They somehow think that by finally telling us the truth it excuses them from corrupt and ethically devoid business practices in the past.  

This case proves that financial commodity markets on the margin distort fair pricing and damage physical commodity industries. They do more harm than good, especially in the OTC derivatives sector. It’s much less about supply and demand for the commodity and much more about supply and demand for the highly leveraged cash they can generate. The tail clearly wags the dog because the tail is ten times the size of the dog.


Wild Theories's picture

Because nobody wants the physical copper. They want money.

The copper is just a collateral for credit, everyone who wants the copper only want to sell it.


A layman comparison:

Replace the copper with a house, and consider a bad loan where the bank repos your house. And your house didn't exist, you gave a false address.

Do you go buy another house of the same value and give the deed to the bank to clear your debt? No, you just give the money straight to the bank, you don't buy another house and give that house to the bank.

SweetDoug's picture




the repo is a short-term FX funding vehicle, whereby a commodity owner first sells the commodity warrants issued by bonded warehouses (paired with an equal amount of short positions) to banks, then buys the package back from the banks in 3 to 6 months. It is a way for commodity traders/refiners to gain access to foreign banks’ balance sheets and improve liquidity efficiently.


How abouts if we just ended all this bullshit and you grew your company on profits and keeping your own cash instead of these goddamn ponzi schemes?


Juz sayin'…