Cash for copper in China (or whack-a-mole financing)

Cash for copper in China (or whack-a-mole financing)

FT Alphaville | Jul 10 15:06 | 13 comments | Share

Kate’s post on the June China trade data mentions that commodities imports were the only bright spot (although it’s a somewhat dubious bright spot if it indicates a resurgence in investment). It turns out that copper imports were particularly strong, recording a 9.7 per cent year-on-year increase in June, a rather large change compared to a 14.6 per cent decline in May. Goldman point us to one compelling reason why that might be the case. It’s basically another case of whack-a-mole financing in China. Hit over-invoicing over the head and up pops ‘Cash For Copper’ (CFC) financing. This differs from more traditional Chinese Copper Financing Deals in that CFC financing involves moving physical copper from offshore to onshore; and there is no circulation of warrants. But the point of the two mechanisms is the same — getting access to CNY through cheap FX funding. A CFC financing deal looks a little something like this (click to enlarge):

Goldman-July-9-2 Goldman-July-9-1And here’s Goldman’s Roger Yuan, Max Layton and Jeffrey Currie to flesh it out a little:

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, the interest rate differential adjusted copper import arbitrage is now substantially open – 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).

While these developments are typically a sign of a tightening copper market, we believe that market participants should be wary of interpreting these recent ‘signals’ – including future resulting copper import strength – as bullish, since they are in large part driven by Chinese liquidity tightness, and not primarily driven by real Chinese demand/re-stocking.

So Goldman expect strong demand for non-domestic copper (LME, Chinese bonded), supporting high bonded and ex-China premia and Chinese imports which will mean extra supply that is unlikely to be met by real Chinese demand.

This also ties into our argument that China’s powers-that-be, seeking to keep dollar shorts from unwinding — in the face of rising US bond yields, FX volatility and Fed taper speculation — are encouraging borrowing at foreign rates, mainly by inflating their own rates in relative terms.

High domestic rates make accumulation of commodities sensible so the copper keeps rolling in — especially as the PBOC remains committed to appreciating and internationalising the renminbi. The shut down in over-invoicing and the carry-trade unwind threat both fit the narrative and make China a bit of a commodity aberration. Goldman point back to mid-2011 to reinforce the point:

China’s short-term interest rates spiked, driving up the profitability of importing via CFC financing. Put differently, the rise in short-term rates led to the opening of the interest rate differential adjusted import arbitrage, resulting in a substantial rise in Chinese copper imports (Exhibit 1).

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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