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The copper price dropped 3.5% last week after a weaker than expected gauge on manufacturing activity in China together with a probe into the use of metals in trade finance deals rattled the market.

July copper futures in New York ended the week at $3.0585 a pound ($6,700 a tonne), down from $3.37 at the outset of 2014.

Chinese authorities have begun an investigation into allegations that several companies pledged the same copper and other industrial metals held at the port of Qingdao as collateral for loans to different banks.

Beijing is stepping up efforts to curb the country's vast shadow banking system and the revelations could see a further clampdown on this lending practice which have been a key part of the commodities trade – particularly in iron ore and copper – for years.

As these deals are being unwound it could lead the dumping of copper onto the market that would otherwise have been tied up in financing deals leading to sharply lower prices. China consumes 42% of the world's copper.

The process is already playing itself out in iron ore which has slumped 20% over the past month. Iron ore was hit first because apart from the credit clampdown China is also targeting the steel industry's chronic overcapacity and environmental impact as part of its "war on pollution".

While iron ore at the China's ports continues to be stockpiled at record levels, official copper inventories have been sharply reduced over the past couple of months.

However, while deliverable stocks held by the Shanghai Futures exchange has dropped to 92,000 tonnes it is estimated that China's unofficial copper stocks used in financing could be as high as 700,000 tonnes according to a new report by Capital Economics meaning the tightness in the market has been artificial.

While iron ore imports slowed to 77.4 million tonnes in May, down 7.2% and copper imports fell 15.6% from a month ago to 380,000 tonnes, year on year imports are still expanding at a rapid rate.

Should  stockpiles of iron ore of more than 110 million tonnes and the "off-market" copper warehouse inventories be released, both commodities have further to fall.

Iron ore has recovered somewhat after falling to a 21-month low of $92 a tonne end of May and copper is still trading well above near four-year lows of $2.92 hit in March.

Copper plummeted 8% over just three trading days during the March slump which was prompted by China's first ever corporate bond default and markets could now be entering a particularly rough patch as banks start to call in dubious loans.

Capital Economics sees the correction this way:

"If the historic relationship between copper and iron ore prices is to be restored, it is likely to take the form of a renewed fall in copper prices."

The research house predicts "another leg down in the copper price" to $5,800 per tonne ($2.63 per pound) by the end of the third quarter, while the iron ore price is forecast to end the year at $90 per tonne.

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RIO DE JANEIRO — Vale’s status as the most generous payer of dividends among major miners will be put to the test if iron-ore prices do not stabilise after falling to two-year lows.

Higher cost of freight means Rio de Janeiro-based Vale earns $10 to $15 less per metric tonne than BHP Billiton and Rio Tinto, according to Citigroup, making it more vulnerable than its Australian rivals as expanding production and slowing Chinese demand growth push prices below $100 a tonne.

At the same time, Rio Tinto is lifting output faster than Vale, allowing the London-based firm to displace more higher-cost competitors and gain market share.

While asset sales and cost cutting mean the world’s largest iron-ore producer’s ability to pay dividends this year and next is assured, next year’s payments are at risk if iron-ore prices continue dropping, according to Citigroup and UBS.

"There is a view amongst some investors in Brazil that Vale’s dividend is intangible," Citigroup equity analyst Alex Hacking said in New York. "Vale can only pay what the iron-ore price affords them to pay. There are iron-ore price scenarios that would require a cut in dividends."

Vale declined to comment on its dividend strategy in an e-mailed response to questions.

"We will deliver free-cash flows to appropriately reduce our debt levels and distribute increasing dividends to our shareholders," CEO Murilo Ferreira said during a May 13 conference in Miami, according to a presentation on the company’s website.

While future payouts will depend ultimately on iron-ore prices, in the most likely scenario Mr Hacking still expects Vale to generate earnings before interest, taxes, depreciation and amortisation (ebitda) of at least $16bn a year, enough for the company to sustain its dividend levels. The analyst has a "buy" recommendation on the stock.

Vale’s estimated dividend yield of 6.7% is the highest among the 10 most valuable mining firms, according to Bloomberg data. BHP and Rio Tinto are forecast to pay about 4% over the next 12 months, the data show.

Vale last month paid $2.1bn to shareholders in this year’s dividends, the first installment of at least $4.2bn it agreed to disburse this year. As metals prices declined, the company has been trimming dividends since 2011 when it returned a record $12bn including a $3bn share buyback. It distributed $4.5bn last year.

A period of iron-ore prices substantially below $100 would reduce Vale’s available cash for shareholder retribution, UBS equity analyst Andreas Bokkenheuser said. "Vale’s after-tax ebitda could fall close to or even below management’s near-term capex (capital expenditure) guidance, leaving little cash leftover for dividends. In this case, dividends would likely decline, unless financed by a ramp-up in debt and or asset sales".

Iron ore extended declines and dropped to the lowest in 20 months on Wednesday on concerns that global supply is gaining faster than demand in China, the biggest consumer of the steelmaking ingredient. Ore with 62% content delivered to the Chinese port of Tianjin fell 1.3% to $96.80 a dry tonne on Wednesday, the lowest since September 2012, according to the Steel Index. The commodity has traded below $110 a tonne since April 28, retreating 28% this year.

Vale expects prices for iron-ore to average $110 over the next two years, Mr Ferreira said on April 3. "The iron-ore price falling to the lowest in 20 months confirms a more negative scenario for Vale," Faros Investimentos economist Fernando Senna said in Rio de Janeiro.

"At $100 per tonne, the dividends are compromised."

Benchmark iron ore will average $120 this year and $115 next year, sliding to $105 in 2016 and $98 in 2017, according to forecasts compiled by Bloomberg.

Vale shares have lost 5.2% in dollar terms in the past year while Rio Tinto and BHP Billiton1 have rallied 16% and 13% respectively.

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