China's imports of copper and iron ore may drop due to an alleged financing scandal, as banks withhold credit and customs officials tighten checks on incoming shipments, metals traders say.
Western banks are looking into allegations that a Chinese trading company illegally pledged metals as collateral to more than one lender.
The operator of Qingdao Port, the eastern Chinese port where the metals are stored, has confirmed that Chinese authorities are investigating allegations of fraud relating to stockpiles of metals.
China's government hasn't commented publicly.
Traders have used metals as collateral to bring in some $110 billion into China since 2010, Goldman Sachs estimates. That trade is a legal way to circumvent China's capital controls and has helped keep metal import volumes high even as China's economic growth has slowed.
Now, traders say there are a number of disruptions to this trade related to the ongoing probe and China's efforts to tamp down big capital inflows that have fueled rapid credit growth.
Customs officials are taking longer to clear metal imports since the allegations of fraud emerged, traders say.
"Customs are taking anywhere from 15 to 20 days to up to a month to clear shipments of copper cathodes. Earlier, it used to take seven to 10 days," said a Qingdao-based metals trader, who didn't want to be named.
Authorities were worried about the pace of growth of metals-backed financing even before the current allegations. In April, regulators raised concerns with local governments about the practice, which speculators have used to bet on higher Chinese interest rates.
That sent shivers through the market, traders said. In May, iron-ore imports fell 7 per cent from the previous month, while copper imports tumbled 16 per cent.
Imports in the months ahead could be even weaker, traders say. Many banks are starting to withhold letters of credit that are used in commodities financing, they add.
"Things are getting worse and worse. Imports have shrunk in May. It could fall even further in June and July," said an executive with a Hong Kong-based commodities trading company.
"Already, people are finding it very difficult to open letters of credit for import of copper and other metals in banks in China."
An estimated third or more of Chinese metal imports are believed to be used as collateral for loans from China's "shadow banks," a vast network of loosely regulated lenders. These stocks are rolled in and out of bonded zones instead of being used to feed actual demand.
China is the world's largest importer of many commodities, and these imports represent one of the most closely watched indicators of economic activity in the world's second-largest economy.
Copper stocks in bonded zones nationwide stand at around 800,000 metric tons, said Li Chunlan, a Beijing-based analyst with the metals consultancy CRU Group. At current prices, that's worth about $5.4 billion.
Premiums on spot copper prices for immediate delivery from Shanghai warehouses have shrunk to $70 a ton, down by more than half from around $185 in December, a signal that more people want to sell rather than hold the stocks, said the Hong Kong-based executive.
Three-month copper prices on the London Metals Exchange are down nearly 10 per cent since the start of 2014. After news of the probe broke two weeks ago, prices fell sharply but have remained mostly flat in recent days.
Some traders say imports could fall more sharply from August. That's because purchases are made in advance and problems with financing now would take a couple of months to show up in lower physical shipments.
Helen Lau, senior analyst with UOB Kay Hian, said prices could fall further if traders are forced to sell collateral to repay loans, dumping metals onto the market.
"The market concern about copper prices is real. I am not saying copper prices will keep falling, but there is a downside risk. Prices will fluctuate. There will be no upside in copper prices in the near term," she said.
Others say real demand for metals like copper and iron ore for industrial purposes will limit further declines in imports.
The official probe so far appears confined to Qingdao, and another nearby port, neither of which is a major player in commodities financing compared to larger hubs like Shanghai. The probe is unlikely to discourage many traders who still want to import metal for use as collateral in legitimate financing plans, CRU Group's Ms Li said.
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