Copper drops like a stone

The macro influences remain: China worries; Russian-Ukrainian tensions; sluggish Japanese data; indifferent US data; steel demand in China and the slide into bear markets of industrial commodities.

The latter is now a real concern; overnight CME copper futures for May dropped 2.7% to $2.950 a pound, after having seen an intraday low of $2.942 - the lowest read for an active contract since June 2010. Copper is already down 13% year-to-date, but the demand for the industrial metal is being questioned further as China sees exports and inflation contracting at faster rates than expected.

There are a lot of questions around China’s situation right now; is industrial and consumer demand fading?  Are we about to see further defaults across the financial spectrum? Is the credit crunch about to resurface?

All of these macro issues are feeding into China hysteria. What is compounding the situation is the emergence of how much copper and ore is being used as collateral.

In recent days a lot is being made of how the Chinese have used collateral to finance projects. There are some that estimate that between 60% and 80% of China’s copper imports over the past three years has been used as collateral.

This is an amazing estimate; it would change the perception of ‘Dr. Copper’ as a gauge of the Chinese economy, as it’s not being used for industrial production, but rather as a financing tool for whatever reason. It has also emerged that iron ore is being used in a similar vein with estimates suggesting one third of the 108 million tonnes of ore at Chinese ports is under financing.    

The concern now is with so much cargo under financing, and with prices falling, collateral value will raise the prospect of margin calls and therefore defaults. Now in most cases you would expect hedging; however in the case of iron ore this hasn’t happen and having seen demand in the fourth quarter of 2013 spike, the average price of iron ore at this time was US$130 to US$135 a tonne which would suggest losses are at 20% or more.

Defaults are a worrying development as dumping is a real possibility, which will see a spike in supply at fire sale prices. What is likely is that we will see a combination of liquidation and defaults. The latter (as strange as it is) would be more beneficial to supply as the banks would take ownership of the collateral, but they are unlikely to sell off the commodities until prices stabilise.

Ahead of the Australian open

We are currently calling the ASX 200 down 16 points on the 10am bell (AEDT) to 5397. The copper plays are going to be the ones to watch due to the rout seen overnight; the likes of Oz Minerals, PanAust and even Sandfire Resources are likely to see pressure selling. What may see some stabilisation after two days of sell-offs are iron ore plays, after having seen the iron ore price stabilising overnight. 

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication.