While some metals merchants could be subject to mark to market margin calls due to RMB depreciation, they might opt to do more transit trades to meet cash requirements rather than selling copper outright, although this may only last for a short period of time.
We believe that the recent sell-off is a combination of speculators trying to anticipate the unwinding of financing deals and a lack of buying in China due to sluggish real demand…
With the SHFE/LME arb moving deeper into negative territory (Figure 7) and higher costs associated with RMB, such trades could become less attractive. However, as long as the returns on the unsecured loan in CNY are sufficiently high, such trades could remain profitable.
Copper is hedged in financing deals and is 100% cash backed. (It is rare to get financing deals with copper prices un-hedged these days.) As a result, falling copper prices do not trigger financing deal unwind…
…Although a less attractive financing vehicle, the use of iron ore in import financing has gathered pace since the end of last year. This has been a function of elevated liquidity pressure at steel mills. In contrast to copper, we believe that iron ore financing is more vulnerable to unwind risks as iron ore positions are typically un-hedged thus subject to high volatility. Furthermore, as a low value product with greater difficulty for storage, iron ore financing is not sustainable, in our view.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
