Tag Archives: Glencore

This is one of those obscure stories that may become a very big mainstream story, just like collateralized loan obligations, collateralized debt obligations, and credit default swaps became big stories during the last financial crisis. From Tyler Durden at zerohedge.com, with a story that should be read in full, including the highlighted link. This is a time bomb.

Since we first exposed the topic of China’s Commodity-Financing Deals (CCFDs) in May 2013, deals which some have since called China’s commodity “carry trades”, and warning of the looming “bronze swan” once said deals are unwound, copper (among most collateralized commodities) has been slumping.

The double-whammy of central-bank-inspired overcapacity, with a crackdown on the CCFD shadow credit markets has now flowed into the miners/producers – no more so than Glencore and Trafigura (as we have detailed).

A subsequent analysis by Goldman attempted to quantify just how big CFD “carry trade” is as follows:

Fast forward to the recent shocking developments involving Glencore, which recently crashed to a record low price as the market finally realized what we had been saying all along: Glencore is a levered bet on not only China’s economy, but the fate of copper pricing.

And while talking heads proclaim the worst is over, Bloomberg looks back at the carry trade first discussed here, and finds that as much as 70% of finished copper backs the “carry trade” whose upcoming unwind will lead to even more price pain.

As we introduced in 2013, the critical issue of how China uses commodities as financial assets was, and remains, largely ignored and vastly misunderstood: i.e., the fact that copper’s ubiquitous arbitrage and rehypothecation role in China’s economy through the use of Chinese Copper Financing Deals (CCFD) is coming to an end.

Copper, as China pundits may know, is the key shadow interest rate arbitrage tool, through the use of financing deals that use commodities with high value-to-density ratios such as gold, copper, nickel, which in turn are used as collateral against which USD-denominated China-domestic Letters of Credit are pleged, in what can often result in a seemingly infinite rehypothecation loop (see explanation below) between related onshore and offshore entities, allowing loop participants to pick up virtually risk-free arbitrage (i.e., profits), which however boosts China’s FX lending and leads to upward pressure on the CNY.

Since the end result of this arbitrage hits China’s current account directly, and is the reason for the recent aberrations in Chinese export data that have made a mockery of China’s economic data reporting, China’s State Administration on Foreign Exchange (SAFE) on May 5 finally passed new regulations which will effectively end such financing deals.

The impact of this development can not be overstated: according to independent observers, as well as firms like Goldman, this will not only impact the copper market (very adversely) as copper will suddenly go from a positive return/carry asset to a negative carry asset leading to wholesale dumping from bonded warehouses, but will likely take out a substantial chunk of synthetic shadow leverage out of the Chinese market and economy.

Naturally, for an economy in which credit creation is of utmost importance, the loss of one such key financing channel will have very unintended consequences at best, and could potentially lead to a significant “credit event” in the world’s fastest growing large economy at worst.

To continue reading: The Unwind Of China’s Copper “Carry Trade”