(Andy Home is a Reuters columnist. The opinions expressed are his own)
By Andy Home
LONDON, March 11 The recent history of copper and iron ore has been all about China.
The country's property and infrastructure boom has sucked in huge amounts of each commodity, lifted prices to historically unprecedented levels and incentivised miners to invest massive amounts of money in new supply.
So you don't have to look very far to find the reason for the ferocious sell-off in both markets over the last couple of days.
On the London Metal Exchange (LME) three-month copper has fallen out of a long-established trading range to a Monday low of $6,608 per tonne, a level last seen in June 2013.
Spot iron ore as assessed by The Steel Index .IO62-CNI=SI has slumped even harder to $104.70 per tonne, the lowest it's been since an equally vicious sell-off in the third quarter of 2012.
These price swoons have been triggered by the same fears about the China growth story.
But the differing natures of the two markets may yet still lead to very different outcomes.
Both copper and iron ore markets are reacting to a bearish one-two combination of news out of China.
The most obvious is the headline-grabbing 18.1-percent slump in China's exports last month. The scale of the decline is quite obviously down to the timing effects of the Lunar New Year holidays. Exports over January and February combined were down by only 1.6 percent, which doesn't sound so bad.
But both iron ore and copper have been fretting for weeks, if not months, about the intensity of Chinese demand as the country's leaders crank up the rhetoric about re-engineering growth away from fixed asset investment towards a more durable consumer model.
Signs of slowdown in both property and manufacturing sectors have been steadily adding to the collective unease.
The weaker-than-expected export figures for the first two months of this year have simply crystallised the growing fear that Chinese demand for copper and iron ore is losing the white-hot intensity of previous years.
Timing, however, is everything in markets and the weekend release of the trade figures simply acted as accelerator to a sell-off that had already started on Friday.
That one had a less obvious trigger.
...AND SNEEZES AGAIN
Loss-making Chinese solar equipment producer Chaori Solar's default on its bonds, announced Friday , wouldn't on face value appear to have much to do with either iron ore or copper markets.
The problem, however, is that both have become inextricably bound up in China's shadow lending market, leaving them both susceptible to heightened credit risk.
The use of copper as collateral for loans, rooted in dollar-remnimbi interest rate arbitrage, is now a well-established part of what should be a purely industrial market.
Indeed, it acts as a powerful counter-cyclical magnet on the amount of copper imported into China. When Beijing squeezes the domestic lending market, it should mean lower imports as manufacturers adjust their credit lines. What actually happens is a surge in demand for the metal for shadow credit generation. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Graphic on China's refined copper trade:
This is partly why copper imports have mushroomed over the last few months, even as most real-economy indicators have suggested that China should be importing less not more of the metal.
The result is a huge build-up in copper stocks in China, some on the mainland, more in Shanghai's bonded warehouse zone.
The practice has spread to the iron ore market, not least because of the existing credit stress lines running down the entire Chinese steel production chain. As with copper, imports have been surging and stocks rising.
There are two problems here.
The first is the outright level of stocks overhang of both commodities. These are weighing heavily on domestic prices.
The second, bigger problem is the opacity of this collateral market. Even the size of the stocks being financed is uncertain.
How much copper is currently in bonded warehouses? There are no hard and fast figures, just estimates. The best guess seems to be around 700,000 tonnes. The only thing not in doubt is that the total has grown immensely over the last few months.
How much of the record 105 million tonnes of iron ore sitting in Chinese ports SH-TOT-IRONINV is credit sensitive? Again, no-one really knows.
The reaction of both markets to Friday's default tells us that there is credit stress but not, alas, how significant it is.
While copper and iron ore have each been hit by China's double-sneeze and for the same reasons, there are important differences between the two.
All that copper sitting in Shanghai has an escape outlet. If it is not needed by either Chinese manufacturers or collateral financiers, it can be exported, or maybe that should read "re-exported", back to the international market.
Indeed, there is a strong argument that this would be a good thing.
The phenomenal flow of copper to China over recent months has drained the rest of the world. LME stocks currently total 257,600 tonnes, the lowest they've been since December 2012.
Even that understates the degree of tightness in the market. Open tonnage, excluding metal that has already been earmarked for drawdown from the LME system, is just 134,150 tonnes, a level not seen since the boom times of 2008.
The result is persistent front-month backwardation on the LME contract. The benchmark cash-to-three-months period CMCU0-3 has eased in tandem with the outright price fall but as of Monday's close was still in $12.50-per tonne backwardation.
Some sort of global rebalancing of inventory looks overdue.
Where, however, are 105 million tonnes of iron ore going to go if not to mainland China?
There is no international escape valve such as exists for copper. The only way that stock overhang is going to be reduced is either via a surge in buying by steel mills, currently highly unlikely, or via deferred purchases of new iron ore imports.
Which is why executives at big miners such as Rio Tinto and BHP Billiton are having to fend off questions about defaults on booked shipments.
We've been here before in the iron ore market. The Q3 2012 price implosion was also triggered by credit concerns, that time further down the steel chain, and accelerated by physical dumping of unwanted material back into the spot market.
It's the only way the iron ore market, still in its infancy, can adjust.
Copper has a physical safety valve. Iron ore doesn't. (Editing by Anthony Barker)