-- Posted 21 July, 2011 | | Discuss This Article - Comments:

China steals the show when it comes to commodities.  Large public works projects, particularly in developing key infrastructure and housing projects, buoy commodity prices.  Increases in demand are naturally bullish for inelastic necessities like copper, which has only strengthened as spending from Beijing keeps China’s GDP on the up and up.

Silver investors should be interested in the market price of copper.  Most silver is merely a value-add to copper producers, who stumble upon the metal in search for the easier found copper.  Higher copper prices lead to more copper production, and silver comes with it.

Copper Demand Artificial

When a product has an inelastic demand curve, a change in demand brings a larger change in price.  If copper demanded increased by 10% as supply flat lined, high bidders would have to buy out the interest at the bottom of the price curve. 

Government programs often come with very few restraints on pricing.  This is true in the United States, where research and development costs for major military developments frequently cost multiple times more than their projections.  It’s also true in China, where cost is hardly a constraint for a government keen on keeping employment strong, even if it means investing in new projects that provide zero economic return on capital.

Behind copper’s rise is a direct investment by the Chinese government to develop new affordable housing units.  Alongside the new housing projects, infrastructure investments in the electricity grid keep copper demand strong.  But one has to wonder how long copper used in Chinese projects will remain in Chinese projects.  Remember, the Chinese government has long been a fan of building real estate developments for tens of thousands of people – only to tear the buildings down a few years later. 

A savvy investor would note that if China isn’t interested in returns, only employment (which is natural for a country with a Communist history), then it would be naturally interested in continuing this trend to every last detail.  Scrapping copper for recycling allows the Chinese to show employment in building homes, and employment from destroying and reusing their components.  

The financing effect

It’s impossible to look at China and ignore the widespread price controls.  Price controls are obvious in financing – so obvious that the copper market has become proxy for those who want to borrow inexpensively.

Hedging prices between London and Shanghai is big business.  If prices between the two markets become thick enough, the costs cover the shipping from the LME to Shanghai.  From there, buyers can offset the easily funded purchases from the LME with hard to raise cash from Shanghai.  The net effect is several months of free borrowed money.  Not only is the money free, but it’s also highly-valuable in a country that tightened lending controls to slow rampant inflation.  For those with access to the financial markets, forward copper contracts are net out a win-win scenario.

How long this proves to be true, however, is another story.  As Chinese financiers hedge the difference between their cost and the cost on the London exchange, more and more copper is purchased months in advance, some of which will be purchased during periods which might not benefit from China’s fiscal stimulus.

Silver supply, which is necessarily affected by rising copper prices, might not be around for much longer.  Such extreme leverage to one economy with strong price controls should leave investors to consider the long-term implications of a short-run government program: rising silver supplies might be temporary.

Dr. Jeffrey Lewis

www.silver-coin-investor.com