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TMFAleph1 (94.93)

The Bull 'n Bear on the Chinese Copper Trick

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7

May 20, 2011 – Comments (4) | RELATED TICKERS: LNKD , SCCO , FCX

This week, I alluded to the unintended consequences of central planning in the Chinese electricity market. Today, the Wall Street Journal's Heard on the Street column (the best part of the newspaper) highlights a distortion in the copper market with its origins the Middle Kingdom. Apparently, Chinese companies take out letters of credit to buy copper in London and ship/ store it in China -- once they have sold it locally, the can use the proceeds until the letter of credit must be repaid (typically, in 3 months). Why do they do this? Because letters of credit are easier to obtain than bank loans due to the Chinese government's lending restrictions.

The article cites a precious metals analyst who estimates that half of the current copper inventories are tied to these operations. The problem is that this operation is becoming increasingly expensive/ risky, as copper in China now trades at a premium to that which can be bought in London. Companies must either accept to take a loss on the operation or hold the copper on the hope that the premium will reverse. If Chinese companies unwind this copper carrry trade on a massive scale, it would not do anything good for copper prices, which already look like they have topped out anyway.

On the LinkedIn IPO: If you are buying in at these prices, may God protect you because no earthly power can. At yeserday's closing price of $94.25, the shares were trading at 31 times trailing twelve months revenues; for reference, at the end of its first day of trading, Google was trading at less than 12 times revenues. The investors who paid $122 for LinkedIn share yesterday, or 40 times trailing revenues, are partying like it's 1999, but the hangover will be monumental.

Finally, check out an interesting article by Gillian Tett of the FT on the risks associated with the drop in the average maturity of outstanding Treasury debt.

Enjoy your day!

Alex Dumortier

4 Comments – Post Your Own

#1) On May 20, 2011 at 4:49 PM, JakilaTheHun (99.94) wrote:

Good blog, Alex. 

The copper trick is one reason I'm betting against copper producers right now.

Question: why the new name?  I thought "MarathonMan" worked pretty well.

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#2) On May 20, 2011 at 4:57 PM, rfaramir (29.42) wrote:

I think you've got this reversed: "The problem is that this operation is becoming increasingly expensive/ risky, as copper in China now trades at a premium to that which can be bought in London."

In my vocabulary a 'premium' means a higher price (unless it's different in the copper industry?). Buying low in London and selling high in China sounds like a great way to make money to me. Don't you mean that this *used* to be the case, but now, perhaps with all the copper accumulating in China, copper in China now sells too cheaply to continue doing this?

(Your link demands a subscription after the first 2.5 paragraphs, so I can't tell whether you've gotten it wrong or the article did. Of course, it could still be me, somehow!)

You're right on with respect to LinkedIn. At 600 times trailing profits, this 9 Billion market cap company has to up its profits by many, many multiples to make sense as an investment.

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#3) On May 20, 2011 at 5:37 PM, TMFAleph1 (94.93) wrote:

@rfaramir

The second paragraph in this excerpt from the article should clear things up (emphasis mine):

A letter of credit—easier to obtain and cheaper than a bank loan—finances the purchase of copper on the London Metal Exchange. If copper prices are higher in Shanghai than they are in London, the importer can cover transport and storage costs, sell their copper at a profit on the mainland and enjoy the use of the yuan proceeds until the letter of credit expires—typically three months to a year later.

A premium of $210/ton for the three month contract in London over the price in Shanghai throws a wrench in the works for importers. But businesses still can use their copper as collateral for yuan loans and keep the copper in storage hoping that the price differential will move their way. Even if that doesn’t happen, demand for credit has been so strong that importers are willing to take a loss on the copper transaction just to get their hands on the cash they need to fund their other operations.

Cheers,

Alex Dumortier

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#4) On May 20, 2011 at 5:42 PM, TMFAleph1 (94.93) wrote:

@JakilaTheHun

I explain my rationale for the change in this post:

TMFMarathonMan Is No Longer...

The original MarathonMan moniker was meant to symbolize the relationship between training for and running a marathon and long-term investing (and allude to the fact that I've run 3 marathons.) However, the metaphor is far from obvious.

Best,

Alex Dumortier

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