19 Mar 2010 10:32

Guest column: A potential revaluation of the renminbi may depress copper imports

By Wang Lixin In this week's Interfax guest column, Wang Lixin, an analyst with Umetal, discusses how an appreciation of the renminbi could effect China's copper imports. Translated from the original Chinese by Xu Hong.Shanghai. March 19. INTERFAX-CHINA - Since the start of the year, relations between China and the United States have been strained by several incidents, including the Obama Administration's pressure on China to appreciate its currency. Meanwhile, the currency market is also very much looking forward to a renminbi appreciation, which may attract a large amount of speculative funds into the domestic commodities market and push up prices. Chinese metal commodities, including copper, saw price increases on March 17, as some traders entered the market in anticipation of further developments in re-evaluating the renminbi, which would directly affect the commodity market.

The renminbi non-deliverable forward (NDF), which can illustrate the changes in the exchange rate of the renminbi against the U.S. dollar, is now in a downward trend, which also implies that the currently stable renminbi is facing increased appreciation pressure against the U.S. dollar.

If we want to find out how the commodity market is linked with the exchange rate, we need to look at two aspects. Firstly, if the renminbi falls against the U.S. dollar, it will force domestic commodity prices to drop close to the price level of dollar-denominated international commodities. If the renminbi rises against the U.S. dollar the opposite will happen. Secondly, a large amount of "hot money" from the international market is expected to flood the domestic commodity market if investors have a positive outlook over the Chinese renminbi and the overall price of domestic commodities would be pushed up.

By and large, the outcomes of these two scenarios are completely different, with the former harming the prices of domestic commodities, and the latter achieving the opposite result. In this article, I will elaborate on the first point and show how domestic copper prices and imports will be influenced by the exchange rate.

Every year, China imports a considerable amount of copper concentrate and scrap copper from overseas, and the settlement price is denominated in U.S. dollars, consequently, if the renminbi-U.S. dollar exchange rate fluctuates widely, it would have a huge impact on domestic copper imports. During the period of Nov. 27, 2008, to Dec. 5, 2008, the renminbi declined by 0.78 percent against the dollar, which allowed arbitrage of domestic spot copper and imported copper in the spot market to increase by 8 percent and the arbitrage between domestic copper futures and copper futures on the London Metal Exchange (LME) to increase by 5.5 percent. However, from Dec. 5, 2008, to May 5, 2009, the aforementioned arbitrage still increased, while the renminbi rose by 1 percent against the U.S. dollar. Therefore, it is not prudent enough to simply measure the change of LME and Shanghai Futures Exchange copper arbitrage by changes in the exchange rate.

However, arbitrage between domestic copper and imported copper started to slide between late April 2009 and late June 2009, and remained low. So, we can conclude that, arbitrage between domestic raw materials and imported raw materials will be influenced by renminbi appreciation, but not immediately, and this effect is more likely to be slow and lasting. Let me take the copper market as an example, the arbitrage of domestic copper and imported copper did not change until 5 months after the last appreciation of the renminbi. In my view, this is not only because traders always decrease trading when the exchange rate is unstable, but also due to inflation caused by speculative inflows from overseas markets, which push up domestic copper prices and reduce the amount of domestic copper and imported copper arbitrage.

During Aug. 19, 2008, to July 3, 2009, domestic importers were profitable as the price of domestic copper was higher than the price of imported copper at that time, while the Chinese renminbi quickly rose against the U.S. dollar and then u-turned to keep falling against the U.S. dollar for half a year. After a further six-month period, the volume of imports became sluggish as the price of imported commodities rose and importers' profits were limited.

In conclusion, the renminbi is expected to appreciate soon, and it will bring down the price of domestic commodities. However, this negative effect will be partially offset by massive speculative inflows, which will support the price of domestic commodities. Therefore, in the short term, the arbitrage of commodities on the domestic market and overseas markets should remain stable. However, as the market has such a strong expectation for the renminbi to appreciate at present, we can anticipate that copper arbitrage on both markets will decline soon, which means domestic copper prices may become lower than imported copper prices, making it barely profitable to import copper. If China has to continue importing copper, due to raw material shortages, then the price gap between domestic copper and imported copper will keep shrinking.

Translated from the original Chinese by Xu Hong.

The above is a personal opinion piece by the author. Its publication in no way implies that Interfax shares the views expressed in the article.