June 23, 2014 / 4:16 AM / 3 years ago

COLUMN-China metals probe likely a short-term problem: Clyde Russell

--Clyde Russell is a Reuters columnist. The views expressed are his own.--

By Clyde Russell

LAUNCESTON, Australia, June 23 (Reuters) - The brouhaha over suspected metal financing fraud at China's Qingdao port is likely to cause short-term angst, but longer-term gains.

Banks and authorities are now probing allegations of whether a private Chinese metals trading firm was duplicating warehouse certificates in order to use a cargo several times to raise financing.

The immediate impact is likely to be a sharp tightening of lending practices to China-based metals traders, thereby limiting their ability to participate in the market.

Longer-term, it's likely that China's massive warehousing sector will come under further scrutiny and may eventually be forced to adopt tighter rules, such as those at facilities regulated by the London Metal Exchange (LME).

While the issue has so far been limited to Qingdao port and to deals involving copper and aluminium, there are concerns the issue may be more widespread and linked to more commodities, such as iron ore and soybeans.

While the potential ramifications from the Qingdao warehousing issues are significant, the impact on market pricing hasn't been so clear as yet.

Benchmark spot iron ore .IO62-CNI=SI dropped in the days after the Qingdao news first surfaced, hitting a 21-month low of $89 a tonne on June 16. It has since recovered slightly to close at $92.10 on June 20.

Iron ore has been on a weakening trend since December amid rising supply from global miners and concern over the pace of economic growth in China, which buys about two-thirds of seaborne cargoes.

Chinese traders are already being starved of credit as banks increase the scrutiny of financing deals linked to iron ore imports.

This may result in short-term selling of distressed inventory as smaller trading companies scramble for cash to pay off loans.

With Chinese port inventories at a record 113.4 million tonnes on June 20, up 0.8 percent from a week earlier, the likelihood of downward pressure on iron ore prices increases.

But it's not necessarily a one-way street for iron ore prices, as inventories of the raw material at steel mills are believed to be low, meaning they will be tempted to snap up supplies, especially given recent price weakness.

This may explain why spot prices have actually risen for the past four trading sessions.

Demand for iron ore from the steel sector is also positive, with global output rising at an annual 2.2 percent in May as output in China reached record levels and mills in North America and Europe boosted production.

While rising steel output is putting downward pressure on prices of the finished metal, it will serve to boost appetite for iron ore, suggesting that China may be able to chew its way through its excess inventories without causing prices to decline much further.

Certainly, iron ore futures on the Dalian Commodity Exchange are suggesting prices are more than likely going to stabilise around current levels.

The futures curve <0#DCIO:> is currently flat between the second and six month contracts, with the second month at 684 yuan ($109.96) a tonne and the six-month at 685 yuan.

A month ago, the curve was fairly steeply backwardated, with the second-month contract at an 8.8 percent premium to the six-month, a structure that implies prices are still likely to fall.


With copper, the impact of the Qingdao probe may actually be serving to boost prices, with London-traded futures rising for a sixth straight day on June 20, the longest winning streak this year.

The Qingdao issue is raising concern over the status of supplies, with physical copper in Shanghai now commanding a premium over front-month futures, having been trading at a discount earlier this month.

Another potential impact from Qingdao is that Chinese imports of metals will decline in coming months, as traders find themselves shut off from letters of credit.

This will likely only be a short-term issue as financially stronger players will be able to step in to fill any gaps in supply.

Longer-term, if the use of commodities as collateral for financing is curtailed, this should make the markets more responsive to actual supply and demand fundamentals, and ease volatility caused by uncertainty over so-called dark inventories, i.e. those being held for financing.

In the meantime, until the extent of the problems at Qingdao is quantified, there is likely to be uncertainty that may impact on liquidity in China's metal markets.

However, if the wash-up from Qingdao results in a more transparent warehousing system, stricter access to credit and a clear-out of less scrupulous operators, then it can be viewed as an overall positive. (Editing by Muralikumar Anantharaman)

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