Did China's Bronze Swan Just Arrive? Copper Inventories Crash Most In History

Tyler Durden's picture

Buyers withdrew more copper from the London Metal Exchange’s global warehouse network on Wednesday than at any time since daily records began in 1996, extending a 19-day drop.

As Bloomberg notes, while the net decline in percentage terms was also the biggest since the height of China’s raw-materials boom in 2006, some have warned against reading such moves as an end to a years-long supply glut. A tug of war between financial traders with opposing views of the market has led to sharp swings in metal moving in and out of storage in the past year.

However, stockpiles also slumped 8.2% on the Shanghai Futures Exchange, which is notable because last year we saw the London and Shanghai inventories see-sawing (up in London, down in Shanghai, and vice versa)...

A question that emerged is what China is spending all this newly created money on. One answer emerged overnight when Bloomberg reported that after tumbling in the first half of 2015, copper inventories at the Shanghai Futures Exchange had been steadily rising, and in the most recent week soared by 11% to an all time high of 305,106 tons.


At the same time reserves at the London Metals Exchange declined for 11 days to the lowest level in more than a year, in other words China is shifting idle inventory from Point A to Point B.

But, this most recent withdrawal surge (the largest in history) suggests a sudden failure of the long-running commodity "collateralization" transaction - or CCFD - regime implemented in China years ago, as described in this post and summarized in the chart below...

Copper, as China pundits may know, is the key shadow interest rate arbitrage tool, through the use of financing deals that use commodities with high value-to-density ratios such as gold, copper, nickel, which in turn are used as collateral against which USD-denominated China-domestic Letters of Credit are pleged, in what can often result in a seemingly infinite rehypothecation loop (see explanation below) between related onshore and offshore entities, allowing loop participants to pick up virtually risk-free arbitrage (i.e., profits), which however boosts China's FX lending and leads to upward pressure on the CNY.


And sure enough, we have seen USDCNY surging in recent months... (even if the RMB basket against global currencies has stabilized)



An example of a typical, simplified, CCFD


In this section we present an example of how a typical Chinese Copper Financing Deal (CCFD) works, and then discuss how the various parties involved are affected if the deals are forced to unwind. Exhibit 3 is a ‘simplified’ example of a CCFD, including specific reference to how the process places upward pressure on the RMB/USD. We believe this is the predominant structure of CCFDs, with other forms of Chinese copper financing deals much less profitable and likely only a small proportion of total deal volumes.


To summarize, Goldman notes that these shadow banking vehicles - CCFDs - involve a long copper physical positions and a short futures position on the LME.

And so, the current crackdown on leverage in the system by Chinese authorities may be forcing unwinds of the CCFDs - thus putting upward pressure on Copper futures (unwinding short positions) and selling physical copper (which would mean procuring the physical metal before passing it on). These are exactly what we are seeing in the market currently.

So is this the bronze swan?

*  *  *

Barclays has also called the copper rally overhyped, while Bank of America Merrill Lynch said it’s the metal most at risk of a reversal, with the optimism of investors in financial futures disconnected from slow conditions in the physical market.

“When you look at the state of the refined copper market, you certainly question why prices have risen so significantly,” Snowdon said by phone from London.

And finally, bear in mind that the lagged response to China's credit impulse is about to hit base metals...The rise and fall in China's credit impulse that has been so highly correlated (on a lagged basis) with copper for the last eight years...

However, as one analyst noted,

“Getting short in any base metal is risky right now when you have this broad positive macro theme and increasing investor participation, particularly in China’s onshore market."


“This is probably one to stand back from and wait for Chinese macro sentiment to turn.”

And finally, bringing the narrative back to American shores, DoubleLine's Jeff Gundlach tweeted recently about the "Copper/Gold ratio soaring to the high of the year!"...


"Not good news for the "1.50% 10 year" crowd. Neither is 10 year Bund holding above 50 bp."

If China's legged credit impulse is about to have its peak effect on Copper (as we showed above) then perhaps, just perhaps, the real pain trade (given the surging shorts in T-Bonds), is a 1.50% 10Y yield after all... driven by a plunge in copper prices.

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Storm-Clouds's picture

Ya never want to go 1st.....

Got a lot of dead point me in the march....

Couldn't resist the chart porn with a bloomy Chinese twist...

The dead will start off with a pu pu platter....

strannick's picture

Inflation indicator Copper overvalued says GS to the Muppet auditorium.

Same as Zinc? Same for Nickel? and Aluminum?

GS upset commods getting the jump on equities?

pitz's picture

Bullish for copper? 

RedDwarf's picture

Copper wil go up thanks to the hurricane and threats of war.  Broken windows means more copper demand.

Disgruntled Goat's picture

Copper "inventories" crash? Very simple actually. They probably cracked down on manufacturers using the same copper multiple times for collateral.

Nobodys Home's picture

Ain't no thang. Been doing that with gold forever.

roddy6667's picture

You beat me to it. It's probably just on paper. Home, office, and industrial construction is still going gangbusters, that's the biggest use of copper. And don't believe that Internet meme about empty cities. When you actually go to one of these "cities" and check them out, you find that they are not even cities. They were almost all sold by the builder for cash. He paid off the construction loans and moved on to another project. The job was a success. The writers of these articles con't understand the reasons why Chinese buy a second or third home for cash and sit on it. So many people do it that some cities have a 200% home ownership rate. 

SoDamnMad's picture

But you can't buy a Chinese building and just close it up for 5 years and expect it to hold up and not decay.

roddy6667's picture

Of course you can. I own a home on the eighteenth floor of a high rise. The homes above and below me were empty shells until recently. That's 5 years. Nothing decayed. This is done in millions and millions of homes all over China. Where do you get this crap? Buildings here are made from steel-reinforced concrete. They don't need any more attention than a highway overpass or a bridge abutment. 

Sonny Brakes's picture

The funny thing about copper is that it is less complicated than an iPhone or almost any other piece of electronic equipment, but without that connection to the electrical outlet, you're pretty much screwed.

tmosley's picture

Should be a good use for that asteroid silver when it starts raining down. That's IF they don't switch over to ultra-conductive CNTs. 

Herodotus's picture

Slowing industry means lower demand for copper.

Nobodys Home's picture

Where da baltic dry index at?

order66's picture

Trying to make something out of nothing. China has virtually unlimited capacity to arrest any (and I mean ANY) problem that threatens its growth.

DelusionsCrowded's picture

And the pent-up demand is unstoppable . The whole countries rowing in now the same direction as they realize they are under attack . A well educated workforce with scientific acumen and plenty of proofs of possibility built and building all around them .
China knows where its going .The West sadly has had intellectuals undermine its social fabric and destroy its education system in an obsession with MC-PC .

JerseyJoe's picture

China is the wild west with the party boys cashing in on whatever they can.

Nobodys Home's picture

A long time ago, I said to myself, "Those that control us, meaning our money, in the US are abandoning us and moving it all to China. Rich pickins there."

DelusionsCrowded's picture

Who will be the financial supremacist of the 21 century ?

Scuba Steve's picture

The Fed, whom all sit around and eat with rice with chop-stix, eating caviar and sipping on vodka.

you just know it.

sinbad2's picture

“Gold for royalty, silver for gentlemen and copper for the working man”

Nobodys Home's picture

That's why the working man keeps stripping wires and plumbing in vacation homes!

Nobodys Home's picture

Prime rib, sirloin and hamburger (with pink slime)

Sky flyer's picture

Another bullish sign for equities

Nobodys Home's picture

I just got a system wide ban on disqus..Again! All I said on Breitbart was that Arabs and Israelis sound the same to me.

I've been buying phyzz from JM bullion...Best prices and service I can find but,,,their copper rounds and bars are always way overpriced. I want to buy a couple large copper bars...2lb...5lb....to use as bookends, but it's always crazy expensive. Even their 1 oz is crazy. 0.99 for an ounce and they have this one bar...1oz that always costs 1.19. Fvckin crazy stuff! I know it sounds like I'm cheap, but I don't like to get ripped off!

bluskyes's picture

Order some industrial bus bars from an electrical supply store.

Schmuck Raker's picture

CCFDs, wow I remember those... good times, good times!:D

How come they never panic over aluminum? Is it a bank thing?

FarCanal's picture

Yes Copper BS. story, why not comment about the other commodities rising aswell. Aluminum,Zinc,Lead,Nickel,Tin,Rice,Corn,Soybeans.etc. etc.
But place your bets and your trust in the banks why not, that always turns out well doesn't it?, Goldman, Bank of America Merrill Lynch, Barclays.

ds's picture

China's entry into the global markets with their regulators' vanities that they can force equilibria for their economy alone. Keep going in providing the volatility and liquidity (for other instruments) for trading algos to exploit. All economies are priced by the agnostic global markets, not the other way around. Disequilibria are not linear.

The trading desks of global banks are still managed by wannabees. They can't beat the algos out there with their buggies. Innovations not entertained to protect the tribes. DoubleLine, etc are exceptions. They have skins in the games and live or die by their trades not dependent on massive marketing campaigns to sell trust (actually snake oils) to muppets.

The more the regulators play deluded by equlibria for their economies, the better. The more People are employed vs algos, the better. Yes, you still need traders but only the kind like Jeff, etc who understand that trading is now a team thing with an equal partner (the algo techie). Many of the trading desks of global banks (vanities) are easy meals for algos. (keep going !).