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Weaker Yuan Hurting Chinese Investors And Copper Prices – Analysts
By Neils Christensen of Kitco NewsThursday March 13, 2014 12:08 PM
(Kitco News) - Continued weakness and rising volatility in the Chinese yuan is being felt in the copper markets, a trend that some analysts are expecting to continue as investors adjust to higher risks and more open Chinese markets.
On March 3, USD/CNY opened at 6.1648, its highest open since July, 2013. Prices have since come down but still remain well above the mid-January lows around 6.040. As of 11:58 a.m. EDT USD/CNY was trading at 6.1371.
Marc Chandler, head of global currency strategy at Brown Brothers Harriman said the yuan’s current price represents a drop of about 1.5%, which is not a very volatile move compared to other currencies; however, he added the drop has been sudden enough to squeeze investors.
Chandler added that a popular investment vehicle was to borrow low-yielding U.S. dollars and purchase Chinese yuans and higher yielding bond investments, sometimes referred to as the “Chinese carry trade.” As long as the Chinese currency continued to make gains, investors made money, he said.
“What is important is that the (People’s Bank of China) has changed its tactics and is re-introducing some volatility in the (yuan),” he said. “There are a lot of structured products that were leveraged bets that the currency would stay strong. Even though 1% is a very small move - if you are leveraged 20 to 1, it kills you.”
Chandler said the reason the yuan is having an impact on copper prices is because the two are linked together. He pointed out investors used copper, iron ore or gold as collateral against these carry trade investment products.
“The unwind of the (Chinese) carry trade is not just about U.S. dollar/(yuan), it is also about (yuan)/commodities too,” he said.
Robbert van Batenburg, director of market strategy at Newedge agreed with Chandler and said “The unwinding of this copper-financed borrowing activity can both explain the excessive weakness in copper prices and the recent weakness in the yuan.”
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Batenburg added that as much as 10% of China’s short-term foreign exchange lending can be associated with copper being used as collateral.
The BMO analysts agreed that copper prices have suffered recently because Chinese investors have recently been forced to re-evaluate a variety of investment; however they said this only a small part of the market and “is likely to be absorbed by real demand.”
Analysts from BMO Capital Markets pointed out copper prices are down about 8% in the last four days but adds that they think the price drop is an aberration.
Denis Gartman, investor and publisher of the Gartman Letter also highlighted the problems copper has faced are a result of problems in China’s banking system.
He describes the weakness in copper as “forced margin liquidation” as smaller banks call in these loans.
The Chinese government advised markets of its intention to create a more open marketplace; however some analysts are not convinced that the recent moves are the result of this or the fact that the government needs a weaker currency to support a softening economy.
Overnight, Chinese retail sales were much weaker than expected showing an increase of 11.8%; analysts were expecting to see an increase of 13.5%.
“So long as the fixings remain stable, or even move slightly lower, the more benign assumption that policy-makers are merely allowing more two-way risk should hold,” said currency analysts from BNP Paribas. “Any sign of backtracking or change in strategy would hurt risk as it suggests growth is much weaker than they feared as recently as November.”
By Neils Christensen of Kitco News; nchristensen@kitco.com
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