Why’s China buying so much copper?

Late on Tuesday morning, as I had just finished chasing the pigeons out of my house, there was a knock on the door. “Hi, it’s me,” she said as I opened the door.

“Not going to office today?” I asked.

“Don’t feel like. It’s nice to take a weekday off once in a while.”

“Yeah, even I don’t feel like going to office today,” I said

“Well, then let’s discuss the economy. I feel China has started to revive again,” she said, making herself comfortable on the couch.

“And why do you say that?”

“Because copper prices have risen almost 50% to $4,700 per tonne on the London Metal Exchange in the last three months. China’s copper imports in the first two months
of the year are up 71% vis-à-vis last year to 451,400 tonnes.”

“But what has copper got to do with Chinese economic recovery?” I asked.

“Guess you did not study your science properly in school. Copper is a metal that is used from making everything from water pipes to electrical wires and electronic products. China’s State Reserves Bureau has been buying copper in good amounts over the last three months and this has led to an increase in the price of copper. Why would they buy copper unless they plan to use it in some form of industrial activity? Some experts are of the view that an increased demand of copper means Chinese industrial output is picking up again. Industrial output for the month of March picked up 8.3% annualised, after 3.8% in the first two months,” she said.

“Interesting. But I have another theory for this. China has foreign exchange reserves worth $1.95 trillion. Of this, nearly 85% is invested in the United States in one form or another. China is buying copper to lower its dependence on the US, given the perceived weakness of the US dollar and financial securities issued by the US government. In fact, if experts are to be believed, it has bought much more copper than it is likely to use this year. And copper is not the only metal it is buying. It is also buying metals like aluminium, nickel, titanium and zinc, the entire idea being to build a storehouse of real physical assets instead of having a major portion of the foreign exchange reserves invested in financial securities issued by the US government. I’d say they are trying to follow the ageold investment adage, “Don’t put all your eggs in one basket.”

“Fair enough. But how do you explain the rally in the Chinese stock market? The Shanghai Composite Index has gone up by more than 25% in the last three months. The market is rallying primarily because it expects the Chinese economy to start picking up in the next few months and that in turn will lead to global economic recovery. How about that?” she asked.

“Madam, hold your horses. If economics was that precise a science, all these problems wouldn’t have happened in the first place. The Chinese stock market has rallied despite company profits being 37% lower in the January-March period this year, compared with the same period last year. So there is a little more to the rally than the expectation that the economy will do well in the days to come. And the answer in most cases lies in the money supply numbers. Chinese money supply is now around 25% higher than it was a year ago, which clearly means the People’s Bank of China, which is the Chinese central bank, is printing more yuan. This has been the fastest growth in money supply in the last 12 years. And where is most of this money going? It is going into buying stocks and is being fuelled into the property market, to firm up prices.”

“So are you saying the Chinese are trying to rebuild the bubble they burst last year?”

“Yeah, that is way I look at it. The story gets even more interesting if we look at the amount of lending the banks have been indulging in. For the first three months of this year, Chinese banks have lent 4.6 trillion yuan ($585 billion). This is larger than the fiscal stimulus of 4 trillion yuan that the Chinese government has planned. If we combine these numbers, what we get is a number that is equal to 30% of the Chinese gross domestic product (GDP). With all this lending and spending, the Chinese government hopes the economy will be back on its feet again.”

“And how is that?”

“Well there is something known as the “wealth effect” in economics. If stock markets and property markets continue to go up, people will start to feel more wealthy. They would then go out and spend more money on buying goods and services. This, in turn, will benefit local Chinese companies and entrepreneurs. By doing this, China is trying to break its dependence on exports, which currently constitute nearly 40% of its GDP. Exports in March fell 17% and in February by nearly 25%, which indicates an attempt to kick start the domestic consumption exercise. But this won’ be a miracle cure because the Chinese dependence on exports as a way of earning money is not going to go overnight.”

The example is hypothetical

References: A ‘Copper Standard’ for the world’s currency system?, Ambrose Evans-Pritchard, April 16, 2009, www.telegraph.co.uk; New Bubbles Brewing in Shanghai and Wall Street, Gary Dorsch, April 14,2009, www.safehaven.com; Jury still out on China’s exports dependence, Geoff Dyer, www.ft.com, April 16,2009.