(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, July 9 (Reuters) - Copper prices on the London Metal Exchange (LME) have this week touched a new six-year low of $5,240 per tonne.
In many ways the latest copper collapse resembles that of January, when the LME three-month delivery price slumped to $5,339.50.
Then the London market was rocked by Chinese funds and this week has been a repeat performance, albeit an amplified one, with the Shanghai Futures Exchange (SHFE) playing the lead and the LME reduced to a supporting role.
History never quite repeats itself even if it does rhyme and there are important differences between now and then.
However, this year will go down in the metal market history books as the one in which China changed from fundamental driver to true market driver of prices.
******************************************************* Graphic on LME and SHFE copper prices this week: link.reuters.com/tyh25w Graphic on LME copper put option positioning: link.reuters.com/vyh25w *******************************************************
Once again the LME market has been roiled by waves of selling from China with London dealers learning to set their alarm clocks according to SHFE trading hours.
Macquarie Bank’s summation of the price action on Tuesday was explicit in the linkage between the two markets.
“The day began with LME copper moving below $5,500 per tonne during Shanghai day-trading for the first time since February (...) After the Shanghai afternoon session closed, the LME complex steadied but drifted lower in London trading, before the opening of the SHFE night market (2pm London time) unleashed waves of selling taking (...) copper down to its -6 percent limit after around an hour and a half.”
As in January, volumes were massive on both Shanghai and London copper contracts, marking the second Chinese storm to rock LME copper in the space of six months.
As in January, the sell-off in London was exacerbated by option market accelerators as those short of downside puts rushed to cover. This is one key differentiator with the SHFE, where there is no options contract.
The LME slump from more than $5,800 on Friday morning to yesterday’s low of $5,240 brought into the money almost 700,000 tonnes of downside options exposure.
And that’s just what shows up in the LME’s market open interest figures. The over-the-counter options market positioning is likely larger.
It’s the nature of such accelerators that they work both downwards and upwards. So when the SHFE surged back on Wednesday afternoon (London time), options cover would have been unwound, adding to the volatility.
The big difference between January and this week, of course, is the origin of the sell-off.
In January it was all about copper, with Chinese funds leading a bear attack based on what now seems a smart call on the likely weakness of copper demand in China over the first part of 2015.
This time around, though, both Shanghai and London copper markets have taken collateral damage from the bursting of a Chinese stock market bubble that had assumed frightening proportions over the last couple of months.
Logically, as analysts at Capital Economics argue, a falling stock market “need not necessarily depress physical demand”. (“Metals prices to recover, despite head winds”, July 8, 2015).
Panic, however, does not obey the laws of logic and there may well be hidden mechanisms by which the stock market rout feeds the commodity market rout.
The combination of margin trading and multi-asset positioning, actively stimulated by Beijing’s attempts to limit short-selling on the stock market, creates the fault lines through which panic radiates.
Specifically, this might mean a fund closing a position on copper to meet a margin call on stocks.
This injects a more chaotic element into trading than January’s directional play on lower copper by Chinese funds, since both long and short positions may have been sacrificed to stay in the stocks game.
Shanghai Chaos, for example, was touted as one of the most aggressive bears in January, based on the perhaps questionable assumption that its positioning is matched by that of its SHFE brokerage arm.
The broker has disappeared this week from the list of short-position holders on the SHFE copper contract, suggesting that the Chaos fund itself has liquidated at least part of its short exposure.
If the case, this would be price supportive for copper, albeit just one of many elemental forces in play within the Chinese fund space.
China’s direct influence on London metals trading reflects the growing arbitrage trade between the LME and the SHFE.
The latter has expanded its product offering to include all the core base metals traded on the former.
It’s no coincidence that LME nickel has also been savaged this week. Nickel has long been a favourite among Chinese investors and both volume and open interest on the new SHFE contract have mushroomed since its launch in March.
The arbitrage is still imperfect, which is part of the rationale behind the purchase of the LME by Hong Kong Exchanges and Clearing (HKEx).
HKEx is explicit in its ambition to connect China’s giant metals industry with the rest of the world, promising that it is the best placed player to change China’s role from being a price taker to price maker in the industrial metals sector.
While it formulates its strategy, the market itself is evolving faster.
January was just a taster of the potential influence of Chinese players in setting copper prices. This week has brought the confirmation.
But this week has also shown how unpredictable a price maker China can be.
Its markets are no more immune to bouts of irrational exuberance and panic than their Western counterparts. The complicating element is the role of the state, which arguably fanned the fires of the raging bull market in stocks and which is now imposing ever more numerous restraints on trading to try and put a floor underneath the market.
What does this mean for copper?
While there is no direct linkage between stock market sell-off and manufacturing demand for copper in China, there are a host of unknowns surrounding the stability of the financial system in the country and the potential knock-on effects on the broader credit market.
But right now, it’s all about the Shanghai Composite Stocks Index. It holds the clue to what happens next to copper prices.
China has truly emerged as a copper price setter. Just not in the way that anyone, either in China or outside China, expected. (Editing by David Clarke)