Exchange Gives Peek Into China's Secret Copper Stocks

The Shanghai Futures Exchange is conducting a little-known test program that would allow copper futures to be backed by stockpiles from two bonded warehouses, giving traders and analysts their first glimpse into how much metal actually lies behind the warehouses' doors.

Copper inventories held at SHFE warehouses jumped 12% in the program's first week thanks to an added 30,104 metric tons of copper at the two locations. While overall SHFE inventory levels have fluctuated since then, the amount of bonded copper remained the same.

China is the world's biggest consumer of copper, and metal traders and analysts have long thought that the country harbors vast private stores that aren't reflected in exchange or government reports.

Much of it is in Shanghai, sitting in bonded warehouses. These warehouses act as a duty-free way station for imported goods, which are taxed once they are released to domestic buyers.

"We've got no idea how big those stocks are," said Robin Bhar, senior metals analyst at Crédit Agricole Corporate & Investment Bank. "People can make guesses about how big they are and where they were at the beginning of the year, but they're really guessing."

This glimpse into the shadowy part of China's market is already sparking a debate about the state of global supplies of copper, which is used in goods ranging from electronics to appliances to houses. Most market watchers forecast a copper-supply shortfall for 2011, with the average deficit at 299,000 metric tons. World demand for the year is estimated at 20.5 million metric tons by metals consultancy GFMS, which pegs production at 20.1 million metric tons.

"Now there will be better discovery, there will be more transparency, and transparency is better for liquidity," said Bart Melek, head of commodity strategy at TD Securities.

Copper prices are already down 3.6% from records hit in February and on Monday settled at $4.4535 a pound on the Comex.

"Some of the risk premium gets bid out, because we'll have a better idea of what's really out there," Mr. Melek said. "You remove uncertainty about inventories and you remove some of the price premium as these inventories materialize."

Previously, the network of warehouses licensed by the SHFE for physical metal deliveries didn't include any bonded warehouses because the tax implications were unclear. The pilot program also included aluminum and is to run for an indefinite period of time, according to Chinese officials.

The inclusion of these previously unreported stockpiles into the SHFE network shed light on why China has pulled back from copper markets. China's refined-copper imports fell 28% in February from a year earlier, to just 158,185 metric tons. March copper imports were down 33% on the year to 304,299 metric tons, but off February lows.

Some of the copper imported into China in recent years was bought by speculative investors there for resale. Now, that copper's records are behind it, those investors are selling aggressively, traders and analysts say.

"The severity of the decline in February imports is more due to a shift in purchasing patterns, than a sudden shift in real demand," said the Royal Bank of Scotland, which pegs the bonded-warehouse stockpile around one million metric tons. "We have warned that a sustained release of this material into the manufacturing supply chain could lead to a period of lower Chinese copper imports," the bank said.

To be sure, some market watchers say visible stocks won't translate to more supply or lower prices.

Stockpiles of aluminum reported through the London Metal Exchange are high, but it was the best performing metal in the first quarter, "so visible inventories don't necessarily suggest lower prices," said Justin Lennon, base-metals analyst at Mitsui Bussan Commodities in New York.

Much of the aluminum stored at the LME is used as collateral for short-term loans. These "financing deals" lock up metal for the duration of the loan, preventing it from being sold on the open market.

This trend, which worries manufacturers reliant on available metal supplies, has spread to China's unreported copper stocks. Standard Bank, which estimates those stocks at 600,000 metric tons, said as much as 80% of the metal is being used "as a financing mechanism to provide cheap working capital for various types of business often unrelated to the metallic industry."

This suggests that even if China's hidden copper stocks become visible, their impact on prices will be limited until that metal is available for sale, Mitsui Bussan's Mr. Lennon said.