China has had an almost insatiable demand for copper, but a lot of it was not going into construction but held as inventories for "shadow" loan collateral. When the metal is used as loan collateral, copper is no longer copper. It becomes a financial asset which reflects credit conditions in China.
China consumes about 40% of all global copper production, but the demand is also associated with its use as a collateral for loans, or as the process is described by some, "buy, store, hedge, and pledge". The copper price will change with the demand for loans. If credit is restricted through normal channels, the copper avenue will be the mechanism for new funds. Some have argued that one third to one half of all copper inventories has been tied to loan arrangements. If bank funds are tight, the copper serves as the physical collateral for loans especially in the construction market. Copper has been used especially as collateral for 180-day letters of credit.
If the price of the copper collateral falls, more will have to be posted for loans. Similarly, if there is a tightening of shadow bank regulation, copper will be sold because it cannot be used for these arrangements. There will be a negative feedback loop in the market. The government passed regulation to stop this process last year, so this new environment all places down ward pressure on copper. Other base metals are higher on the year because the financial aspect of copper is weighing down the price.
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