Collateral damage from Qingdao probe

Investigations into irregular financing using copper send global prices lower

Copper markets are being shaken by developments at Qingdao Port, where metal inventories have reportedly been used in fraudulent ways to raise funds.

Officials are looking at whether metals stockpiled at Qingdao Port fell short of obligations used to secure loans, and they're focusing on Decheng Mining, a Qingdao-based private metals trader, Reuters reported, citing two police sources with direct knowledge of the matter.

Public security authorities are probing alleged fraud involving materials held in its Dagang bonded storage area, Qingdao Port International Co said in a statement on June 6.

Claims that single batches of copper and aluminum at Qingdao Port were pledged as collateral for multiple loans could undermine a broader practice under which traders use everything from iron ore to rubber to get funding.

Benchmark copper futures in London have fallen amid concern that the probe at Qingdao will curb demand for the metal. Copper has lost 9.2 percent this year, making it the worst performer among the six main metals on the London Metal Exchange.

Analysts at Goldman Sachs Group Inc said the price may further fall to about $6,200 a metric ton before the end of this year from about $6,660 at present.

Copper has also been declining in New York as the investigation erodes demand prospects, with the benchmark futures price down 11 percent this year on the CME Group Inc's Comex in New York.

In addition to weighing down copper prices, observers said the investigation may curb foreign exchange inflows to China.

"Feedback from trading house contacts suggests that this investigation has cast a pall on the financing trade as a whole," Barclays Plc analyst Sijin Cheng wrote in a report.

"The developments in Qingdao are likely to continue the significant scaling back of forex inflows from foreign banks into China via commodity financing business," Goldman Sachs said, adding that foreign banks may lend less money against commodity inventories in China.

"This investigation may lead to a 'freeze' in activity," Deutsche Bank AG said in a report. "We also believe it is likely to raise market awareness of the risks involved in commodity financing."

While there is still considerable uncertainty regarding the extent of fraudulent transactions, this will be another step in cleaning up commodity financing in China, Deutsche Bank said, adding that the move could lead to much tighter audit rules for warehousing receipts over the medium term, which could raise the cost of repurchase deals.

Some Chinese banks have raised margins for letters of credit for iron ore financing to as much as 50 percent from a 30 percent maximum previously.

"Over the long term, however, tighter control will add a degree of confidence to the copper market, limiting the divergence between real and apparent demand," the bank said.

Chinese demand accounts for 40 percent of the global copper market and two-thirds of the global iron ore market.

Wu Yuneng, vice-president of Jiangxi Copper Corp, the second-largest copper producer in China, said the alleged scam in Qingdao won't affect China's overall copper demand over the long term.

"What's happening in Qingdao is an isolated case. It will not change the production and consumption of nonferrous metals or alter the supply-demand relationship in the market.

"The decline in copper prices is only related to macroeconomic risks and the fundamental supply-demand relationship, neither of which is an outcome from Qingdao," he said.

"It is also possible that this wave of price declines is the result of speculative behavior," said Xu Qiyong, a metals analyst with Guotai Junan Securities Co Ltd.

Shares of Qingdao Port, which was listed in Hong Kong only last week, fell another 1.9 percent to HK$3.53 (45 cents) on Thursday.

The Dagang area in Qingdao port has been sealed, and gates to the area have been chained and padlocked. The amount of metals involved in the probe is about 20,000 tons of copper, almost 100,000 tons of aluminum ingots and about 200,000 tons of alumina, Reuters said.

CITIC Resources Holdings Ltd, the commodity trading unit of China's biggest and oldest State-owned financial conglomerate CITIC Group Corp, said on Tuesday that metals it owns at the Qingdao port may be affected by the probe.

China's State Reserve Bureau is checking that its purchases of copper in recent months are free of collateral risks amid the probe into metals stored at Qingdao Port, Bloomberg News reported on Thursday.

The agency bought at least 200,000 tons of copper from bonded storage areas in March and April, Bloomberg cited unidentified sources as saying.

Some copper may be moved from China to LME warehouses in South Korea, and possibly Singapore and Malaysia, said Jeremy Goldwyn, head of business development in Asia for Sucden Financial Ltd.

Analysts fear that the crisis in Qingdao may spread to bonded warehouses in Shanghai, where there are some 600,000 tons of copper stockpiled. That's equivalent to 2.5 percent of global supply, so it could have an impact on the global market, they said.

But Xue Baoqing, head of the nonferrous division of China National Geological and Mining Corp, said there is "little chance" that the Shanghai bonded area is also involved in similar fraud, as the area that handles more than 80 percent of China's copper imports has a sound financial regulation system.

Considering that China's economic slowdown is still within acceptable parameters, the country's copper consumption will exceed 10 million tons this year, Xue said.

"China's copper consumption will maintain annual growth of 4 to 5 percent, supported by urbanization and the residential property market," he said.