Three-month LME copper fell by 3.7% to $6,785 a metric ton in heavy trading after a bond default in China sparked fears of a Bear Stearns moment, an FT article reported over the weekend, as some analysts suggested this could be the start of a flight from China’s bond market and a resulting credit crunch.
The failure of Shanghai Chaori Solar could be the event that prompts investors to reassess the risk of investing in Chinese corporate debt and possibly leads to a Lehman Brothers-style banking meltdown the markets feared.
Other base metals were also under pressure. Nickel, which hit a nine-month high earlier in the week, dropped 1.5% to $15,242 a ton, while zinc lost 2.5% to $2,056 a ton and aluminum fell 1.7% to $1,765. Shares of big mining companies such as Anglo American, Glencore Xstrata and Antofagasta were also lower.
Michael Widmer, metals strategist at Bank of America Merrill Lynch is quoted by the FT as saying, “China’s authorities could decide to let some of these trusts default, which may destabilize the shadow banking sector. In the worst case, this could lead to a credit crunch, further damping China’s commercial copper demand and that may not be offset by a potential rise of copper shipments for financing purposes.”
Apparently, fears were not just confined to base metals on Friday.
Bulk raw materials were also under pressure. Benchmark iron ore for delivery into China dropped 2.3% to an eight-month low of $114.20 a metric ton, according to TSI. This followed rumors of the first debt defaulting in the steel sector as a mill producing 3.6 million tons per year from Shanxi province shut five to six furnaces.
But yesterday the markets calmed, particularly the Chinese domestic debt markets, as the news was digested and the balance of opinion evolved that Beijing is using the failure of Shanghai Chaori Solar as a message to investors that they cannot assume the debt markets (bonds and trusts) will be underwritten by government going forward.
The markets appear to have been coming to this conclusion on their own, as the average yields on investment-grade debt have fallen this year, while the spread between highly-rated and low-rated credit has been widening steadily for the past six months – an indication that investors had already begun re-pricing risk.
In another article, Shuang Ding, an economist at Citi, said the Shanghai government has sufficient resources to rescue Chaori, but also “understands it is not the right way to impose market discipline,” especially as it seeks to become a global financial center. He added that any further defaults would largely depend on the “mentality of local governments” involved, and that each would be dealt with on a case-by-case basis.
In other words, expect more, but not a domino effect; failures in the private sector will be permitted, the intention being to send a message to investors that market discipline will be allowed to operate and debt should be priced accordingly – although to call it market discipline and then say the state is deciding which firms fail or not runs counter to our understanding of what “letting the market decide” means.
But there you have it, because this is China.
What This Means for Metal Buyers
The takeaway for us is despite the sharp drops in the base metal, equity and bulk markets, the Chinese debt markets do not look like they are on the brink of imminent collapse; indeed, we may see a bounce-back once the news has been absorbed.
More will depend on the strength of the US dollar, which is having a depressing effect on base metal prices at present, and on estimations of Chinese growth rates, which will be the topic of a follow-up article.