an alternative view on chinese copper demand

For a clue as to why copper is lagging behind many other commodities, investors could look to Wenzhou, China.

A recent government crackdown on predatory lending in the coastal city has upended a flourishing market: borrowing on margin to buy and then resell copper.

The business of flipping copper in China has grown in recent years amid easy credit and soaring copper prices. The market helped create a virtuous circle for copper, as rising prices enticed more people to borrow and make bullish bets.

Many of these buyers are small-business proprietors who are parlaying their profits into the copper trade. While some used letters of credit issued by banks, others sought financing from underground lenders like those in Wenzhou.

The government move in Wenzhou has attracted interest from other copper traders, many of whom see the case as an example of what may be in store. It also comes as China more broadly is seeking to raise the cost of borrowing.

While it is difficult to pin down the prevalence of speculative trading, market participants say it has a big impact on prices.

Copper futures plunged by roughly a third from the end of July to Oct. 20, in part because of China's attempts to rein in lending, traders say. Since then, they have recovered but are down 21% this year. On Monday, copper for November delivery finished at $3.4855 a pound on the Comex division of the New York Mercantile Exchange. Crude-oil futures are up 7.4% this year.

'There is a liquidity crunch in China for speculative trades,' and that is pressuring prices, said Bart Melek, senior commodities strategist at TD Securities.

The copper decline is a reminder of how sensitive the commodities world is to the whims of Chinese buyers, and, more importantly, to the health of the Chinese economy. Investors and analysts are focused on demand within China for everything from copper to cotton to corn. And even a marginal move one way or the other can have a big impact on prices.

China is the world's biggest consumer of copper, using it for goods ranging from wiring in electronics to glaze used to coat ceramics.

Some have long argued that speculative bets in China have distorted the signals that copper consumption and imports typically send about the strength of manufacturing sectors.

'People were looking at copper imports and making assumptions that China was growing faster than it actually was,' says Simon Van Den Born, who heads London Metal Exchange-traded metals at commodities and futures broker Marex Spectron. 'Now, the risk is that falling copper imports will signal a weakness that's not really there and potentially set the market up for a big fall.'

So far this year, imports of refined copper have plunged 39%, according to China's customs service. They fell 8.3% in 2010, after more than doubling in 2009. The declines are largely being attributed to the reduction in lending to speculators.

A big focus remains on copper inventories in China. Although there is no hard data on exactly how much copper is stored in warehouses, analysts forecast that stockpiles will decline this year due to a fall in speculative activity.

But the copper industry also is feeling the pinch of reduced credit, said Simon Hunt, an industry consultant. The copper going into China isn't 'destined for furnaces, because the overall level of business is not good,' Mr. Hunt said.

A revival in copper prices isn't out of the question, especially if China moves to loosen lending again or embark on economic stimulus, said Leon Westgate, an analyst with Standard Bank.

But, so far, there is little sign China will change course, and Mr. Westgate thinks it is unlikely there will be any monetary easing this year. 'As a result, we continue to believe that rallies in copper should fade,' he said.

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