By Greg Peel

Between the big fiscal stimulus package of late 2006 and late 2011, Beijing incrementally tightened monetary policy in order to head off a bubble-bust scenario ? in the economy in general and in the local property market in particular. The government flooded Chinese banks with loans in 2008 but began reeling in access to such funding as soon as it was apparent that loans were mostly flowing out to heated property speculation.

The tighter policy made it difficult for smaller businesses to access the funding they wanted, but a loophole was soon exploited. As was explained in September's China: More Than Meets The Eye, companies were securing back door loans by buying and stockpiling copper and then taking out "inventory financing" from Chinese banks, using the copper as collateral. The extent of such activity was unknown and only anecdotal evidence existed, but those businesses were taking a risk on a fall in the value of their stockpiled copper. Were such stockpiles to suddenly be liquidated, the global copper price would have found itself under a good deal of pressure.

We seem to have survived through to 2012, nevertheless. The spot copper price is off 5% from its February high but Chinese imports grew 17% in February over January and total January-February imports were up 50% on the same period in 2011. That seems to be a big increase for an economy suffering from a forced property market downturn and otherwise weaker data in past months. Beijing began easing policy once more late last year but only incrementally.

Are we looking at rampant "inventory financing"? Perhaps, but ValueWalk suggests there's more to inventory financing than just SMEs back-dooring business loans. The latest popular activity in China is one in which commodity traders build up copper stockpiles and use them as collateral to secure US dollar lines of credit at low yields in order to play the onshore/offshore yuan spread.

While Beijing provides little access to foreigners to the Chinese currency, which is pegged in a range to the US dollar, it has allowed for the establishment of a separate market for yuan traded in Hong Kong in order to quietly promote the currency's use in international trade. There is plenty of demand from foreigners trying to ride on the back of the Chinese economy, ValueWalk notes, but not a great deal of yuan supply. Hence the onshore/offshore yuan spread blew out last year to as much as 3%.

Such spreads tempt speculators into "carry trades", in which one currency is borrowed at a low yield and invested via the exchange rate into another currency with a higher yield. In this case Chinese commodity traders are not simply speculating on the price of copper but they are using that copper to play the currency spread, thus enhancing their investment. On that basis, locals suggest that some 80-90% of copper inventories in China belong not to end-users but to trading houses, ValueWalk reports.

With limited new copper production underway across the world, consensus estimates have global copper demand-supply hitting a deficit of 250,000 tonnes in 2012. Such consensus has provided support for the copper price for some time. Yet analysts estimate around one million tonnes are currently sitting in Chinese warehouses, most of it officially unreported. Given the extent of those inventories tagged for the simple purpose of financial speculation, one might conclude the global copper market is a lot more balanced than forecasts suggest.

Beijing will report China's March quarter GDP on Friday. If the result is consistent with China's recent weakening trend, there is little impetus for any new surge in the copper price. But if there is a reason down the track, a surge will still be unlikely, ValueWalk suggests, given the inevitable sell-down of speculative copper stockpiles. Global supply constraints remain supportive of the copper price but the upside appears limited.