LORD COPPER: Qingdao – a step back in time?

The Goodwood Revival motor racing meeting in September every year advertises itself as “a magical step back in time”, with its theme of cars and costumes from the heyday of the circuit.

The Goodwood Revival motor racing meeting in September every year advertises itself as “a magical step back in time”, with its theme of cars and costumes from the heyday of the circuit.

When I read the news of the alleged irregularities in the issuance of metal receipts by warehouses in the Chinese port of Qingdao, I felt somewhat the same.

You see, we’ve been bombarded by scams based on exotic derivative products, or by the threats posed by the electrification of markets and the (alleged) dark deeds of high-frequency traders, but here we are, back to basics. An (alleged) fraud based on nothing more sophisticated or modern than the age-old practice of issuing two – or more – warehouse receipts for the same parcel of metal, thereby enabling twice (or more) the amount of finance to be raised against the collateralisation of that metal.

It doesn’t require huge computing power or armies of salesmen to miss-sell; just somebody ready – presumably – to issue false documentation. Add to that the way the real spur to the recent nickel market surge was a down-to-earth supply/demand story based on the Indonesian ore ban, and we seem to have taken that step back in time.

If indeed the Qingdao story is true, one has to have a degree of sympathy with the victims. I would tend to discount the stories of lenders accepting photocopies of warehouse receipts as documents triggering payment – that would be plainly irresponsible; the lender – bank, trading company or whatever – will be presented with a package of documents, including the warehouse receipt, against which they will make payment.

If more than one warehouse receipt for the same material is issued, it would be very difficult for them to know that. Their fallback security is on the integrity of the warehouse’s internal control systems. Even if they go and inspect the cargo in warehouse, all that tells them is that it exists; it doesn’t help them know if another bank made the same inspection for the same purpose yesterday.

In the last substantial example of this type of fraud that I can recall – which was the RBG Resources/Fujitrans/Credit Lyonnais et al case – the fault was traced to an employee who was colluding with the borrower of the money to release metal to more than one counterparty.

The reason that the major warehouse companies have such a strong position in the market is not least down to the fact that their systems for preventing this kind of fraud are generally robust.

So what’s going to happen?
Well, proving title will be a very long and confused business; at the risk of sounding occidento-centric, it will be rendered more difficult for being in a Chinese port, presumably under a variety of legal codes. The RBG case was complicated enough, and that was all under Singapore/UK law.

In the meantime, there is a gap in the market; there are those who thought they held metal which it turns out they don’t. I would assume that in pretty much all cases that metal would have been hedged, either in Shanghai or on the LME. So logic would suggest that they would need to buy back those hedges.

In this case, though, the picture may be slightly more complicated.

The banks who have advanced money and are holding metal (they think) as collateral are no doubt holding off from market action until the situation becomes clearer.

But the metal importers, who have pledged their metal and taken loans against it, have been fairly actively liquidating the long positions they have been holding as their own hedge against the metal they have monetised.

The result of that confusing picture has been substantial long liquidation and, I would suggest, speculative selling of the market.

Why would speculators be selling? Well, take away the speculative metal imports to back loans which are used elsewhere, and suddenly maybe Chinese demand looks considerably weaker.

That would not be bullish for prices.

On the other hand, though, some traders have suggested to me that the whole metal-for-loans deal is so important that the problem will be contained and collateral will be properly reallocated.

I’m not totally convinced by that; I think this has the potential to stifle business going forward.

Commodities are not exactly flavour of the month with the banking fraternity at the moment, and to see that such an (alleged) fraud can be perpetrated despite all the collateral managers, cargo inspectors, documents specialists and so on will, I suggest, lead to a serious reassessment. Trading companies are perhaps in a slightly different position, for obvious reasons.

But anyway, even a reallocation of collateral will not cover the gap though; as I’ve said before, I wouldn’t want to be long of speculative Chinese property. In its potential to reach into all parts of the economy, this is a thoroughly modern scam, after all.

Click here for all Metal Bulletin’s coverage on the Qingdao story.

Lord Copper

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