A crackdown in China aimed at curbing distorted credit growth has triggered growing demand for the use of commodities as collateral to raise cash, causing distortion of another kind in the international trade of copper.
China's copper imports rose to a nine-month high in June and are likely to stay strong through the third quarter on growing demand for using copper-backed financing as a cheaper and more accessible alternative to bank borrowing.
Financing demand led copper imports into China in June to buck the wider trend of falling shipments in industrial raw materials as economic growth slowed. In contrast to copper, the volume of iron ore and crude imported into the world's second-largest economy fell from the previous month.
New rules to control credit growth have encouraged demand for copper for collateral for financing, partly by making banks and firms hold the physical metal. Companies have also turned to the practice after being blocked from other credit sources.
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China is the world's top consumer of copper and more imports flowing into financing are offsetting soft industrial demand for the metal and lending some support to weak global prices, which have dropped 14 percent so far this year.
"Demand for copper financing will continue to stay robust in the third quarter since credit in China will remain tight. Banks may be told to lend more to the small and medium-enterprises, but that won't happen because banks want to manage risks," said Lian Zheng, a copper analyst at Xinhu Futures.
"If the arbitrage for imports remains attractive, we may see strong imports for the rest of the year."
Since the imports are not actually consumed, they inflate China's copper demand and yet remain in storage, an overhang that would pressure prices if copper financing is unwound.
The use of copper for financing could undermine what is widely regarded as Beijing's most drastic credit clamp down in two decades to rein in shadow banking networks fuelling lending.
(Read More: Shadow banking bolsters China as credit tightens)
"Because of the latest liquidity crunch, we've actually seen more companies come to us and say they are interested in copper financing," said Jing Chuan, chief researcher at Citic Futures.
For the broader economy, the persistence of China's 'cash for copper' financing scheme underscores the difficulties Beijing face in controlling the grey credit market.
The International Monetary Fund has said that shadow banking, which the People's Bank of China estimates to account for over 20 percent of total outstanding loans, as one of the key risks in China's increasingly complex regulatory system.