Oct 19th, 2015
… (A) $30 billion, all-stock deal – coupled with subsequent mining purchases – transformed Glencore into a global mining powerhouse… a strategy designed to augment the firm’s hyper-lucrative trading operations.
Today, Glencore controls about 50% of the world’s copper production, 60% of zinc production and 45% of lead production. Besides huge nickel, coal and oil-and-gas operations across the globe, Glencore has massive agricultural holdings and a monster ag-trading operation.
The company’s problems began when its huge hard-asset commodities positions started taking hits last year as prices plummeted in the wake of slowing growth in China. …
(The subsequent) free fall in commodity prices is a huge problem itself. But that’s exacerbating an even bigger problem facing Glencore.
I’m talking about the company’s massive debt load.
Glencore… net debt load is nearly $30 billion. … But the immediate concern isn’t the company’s total debt load, which management has promised to slash by a third through as much as $10 billion in asset sales. It’s Glencore’s short-term debt that’s become the company’s financial Achilles’ heel.
Thanks to its $18 billion “trading book,” Glencore’s trading operations typically account for about 75% of the company’s total earnings. But the short-term debt that finances that huge trading book has to get “rolled over” (refinanced) every 30 to 45 days.
And that’s the slice of Glencore’s finances that’s really pushing the firm toward the brink.
Because of the market’s fear over Glencore’s potential insolvency, continually rolling over that hefty amount of short-term debt is becoming a problem.
If Glencore’s trading desk – the “engine” of its profits – sputters or stalls because the company can’t serially refinance those short-term loans, the firm’s revenue guidance will keep getting cut.
Thanks to the bear market in commodities, that’s already been happening. … On top of all that, the company’s equity cushion got hammered as its stock price fell as much as 85%. …
Unfortunately, the trouble is far from over for Glencore. … There are big concerns about the firm’s credit rating. … If the ratings agencies – Standard & Poor’s, Moody’s and Fitch, for instance – slash Glencore’s credit rating to “junk” status, all sorts of debt covenants get triggered and the company has to post more margin on its $19 billion in derivatives liabilities. …
And any cascade of unexpected, negative events could bring the company to its knees.
One such event would be the unwinding of the Chinese copper “carry trade.” For years, Chinese speculators, and others, have been buying copper, warehousing it and borrowing in dollars (because U.S. interest rates are so low) against their copper collateral. Then they’ve been speculating in higher-yielding Chinese fixed-income securities, Chinese real estate and Chinese stocks. That’s called a “carry trade.” Cheap financing is used to carry higher-yielding positions.
To bolster a slowing economy, Beijing has been lowering interest rates, which narrows the spread between U.S. interest rates and those in China. That dampens the carry trade and puts pressure on the Chinese yuan (which makes paying back dollar-denominated loans more expensive) – even as the U.S. Federal Reserve is talking about raising U.S. rates. More importantly, it’s also happening as the price of copper – the collateral backing Chinese carry-trade loans – keeps falling.
In other words, if a massive carry-trade unwinding takes place because the value of copper collateral collapses, Glencore, with all its copper holdings and derivatives bets, including its own carry trades, is toast.
Global panic over falling commodities prices, especially copper, will immediately impact emerging markets – because so many of them depend on commodity exports. That will ignite a situation known as “capital flight” – causing the dollar to strengthen as investors pile into the greenback in a flight-to-quality move.
A strengthening dollar will trigger even lower commodity prices, because most commodities are priced in dollars, a situation known in finance as a “negative-feedback loop.” (And it also puts more pressure on to unwind the Chinese copper carry trade – for more negative feedback. And the bursting Chinese securities and real estate bubbles are putting yet more pressure on the carry trade. … Glencore is toast. Plan for it.)
The price of copper is also a key to the intriguing trades I’m going to outline for you – in my (Shah Gilani) next report.
See you then…
- Wall Street Insights & Indictments: Glencore’s Murky Past and Uncertain Future.