China’s Hand in Copper’s Collapse

China's Hand in Copper's CollapseDr. Copper is sick and China’s economy isn’t doing anything to better the situation. 

Copper prices haven’t fared well since the end of last week. The red metal took its first hit on Friday, and by Wednesday, three-month copper on the London Metal Exchange had declined to its lowest level since July 2010, changing hands at $5,376.25 per tonne. According to The Wall Street Journal, the metal has given up 13 percent of its price year to date, shedding the bulk of that amount over the course of the last week.

Copper has long been considered the bellwether of the economy, a characteristic that earned it the nickname Dr. Copper. However, of late it seems that the red metal has found itself entangled in China’s financial system and is now feeling the pressure as the Asian country’s fragile economy continues to be tested.

In China, copper acts as collateral for loans, and that has sparked a mass sell off of the red metal as the Chinese government cracks down on the country’s shady financial sector.

“Financial deals being unwound due to sliding copper prices are in turn driving copper prices the value of collateral even lower,” The Sydney Morning Herald states.

Concerns over copper prices have left investors a bit worried. The metal was hit particularly hard after a small solar panel company, Chaori Solar, became the first company to default on a bond payment. Despite the company’s small size, investors took that as a signal that the Chinese government will be altering its ways, no longer bailing out companies.

That change is expected to trigger a “domino effect” whereby lenders pull back and corporate borrowers can’t roll over their debts. Quartz believes that will lead to a lot less lending from banks and therefore reduced need for collateral. If that comes to pass, the publication explains, chances are that “all the copper that has been locked up in warehouses could come back onto the market, driving supplies higher and prices lower.”

John Hardy, head of foreign-exchange strategy at Saxo Bank, states in an email comment that “the general risk from here is that this move in metals prices further destabilizes the Chinese financial system and will raise concerns of a hard landing in China if the authorities can’t get ahead of the pressures and potential contagion effects this move is generating.”

On a slightly more positive note, Barclays (LSE:BARC,NYSE:BCS) analysts seem to think that copper prices have hit bottom. They noted this week that there is “an indication of interest at lower prices,” also commenting that the worst is likely over, or at least on the horizon. Demand should pick up in the second quarter of the year.

 

Securities Disclosure: I, Vivien Diniz, hold no direct investment interest in any company mentioned in this article.