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Why Glencore’s problems matter, and why today’s rebound doesn’t

Trucks and heavy earth moving equipment operate inside XstraTrucks and heavy earth moving equipment operate inside Xstra
How will the holes in Glencore's balance sheet be plugged if prices continue to fall?Photograph by Jack Atley – Getty Images

Shares in Glencore Plc (GLNCY) the world’s biggest miner and commodities trader, are rebounding Tuesday after the company rebutted suggestions it might go bust.

Analysts at investment bank Investco had warned on Monday that if commodity prices stay where they are for any real length of time, then all of the cash flow at the company that was ranked no. 10 in this year’s Fortune’s Global 500 list would be needed to service its $30 billion pile of net debt, “leaving nothing for shareholders.”

When the managers sell, is it a good time to buy? Glencore's shares are down over 85% since their IPO.
When the managers sell, is it a good time to buy? Glencore’s shares are down over 85% since their IPO.
Source: Investing.com

 

Investco’s warning had sent the shares down 29%, not least because it went against the wisdom of much of the rest of the analyst community. Only two out of 23 analysts polled by Reuters currently have a “underperform” or “sell” recommendation on the stock.

Glencore said in a statement Tuesday that it’s “operationally and financially robust – we have positive cash flow, good liquidity and absolutely no solvency issues,” pointing to its recent “proactive steps to…withstand current commodity market conditions.”

Glencore’s supporters in the analyst community have also come to its defense, suggesting that the company’s managers (five of whom were made billionaires when it listed) could take the company private again if the market sharply undervalues it. They also noted that Glencore could sell more of its agricultural commodities business than the minority stake it has so far put on the block.

But it’s a bold person who would just dismiss the events of the last 24 hours out of hand. The stock is still down nearly 18% from where it ended last week, and it’s still down over 85% from when it listed in 2011.

The bond market is even less convinced, and what the bond market thinks matters at least as much as the stock market when you have as much debt as Glencore. The yields on its bonds have soared to over 15%, pricing in a high expectation that its debt will be downgraded to junk status. The cost of insuring Glencore’s debt against default through credit default swaps is also soaring.

A downgrade to junk would make it much more expensive for Glencore to run its massive trading business, or to fund investment in its diverse mining operations scattered around the world (it aims to slash capital expenditure from $6 billion this year to $5 billion in 2016).

Why does Glencore matter? A number of reasons: firstly, and most visibly, it’s a living, breathing example of how the slowdown in China is sending shockwaves through the world economy, and of how wrong the outside world has been about China.

Screen Shot 2015-09-29 at 15.55.48

Source: RBS Credit Strategy

As the chart above from RBS shows, China accounts for around half of total global consumption of many of the things Glencore sells. The mining sector has badly overestimated China’s requirements, and now jobs are being lost in thousands from Zambia to Peru and Australia as companies shelve more marginal projects (Anglo American Plc alone outlined plans earlier this year to cut 53,000 jobs over the next few years).

The currencies of commodity exporters have been pummeled as a result, something that will–as sure as night follows day–crimp global demand for everything from Procter & Gamble’s tampons to Apple’s iPhones. It’s not just emerging countries with relatively poor governance such as South Africa that are suffering: the Australian and Canadian dollars are down by 25% and 19% since August 2014.

But Glencore’s problems are about more than just China. They’re about the global corporate credit market, which has gotten used to a world without defaults in the age of never-ending zero-cost central bank money. Defaults on even speculative grade debt have been well below their long-term averages for most of the last five years, according to Standard & Poor’s.

There have been plenty of warning signs this year that the huge misallocations of capital of recent years would start to be punished: overextended shale oil producers have fallen, and China’s stock market bubble has burst spectacularly, but nothing has really shaken the markets’ complacency the way a Glencore bankruptcy would. Capital misallocation of capital may have been worst among the resources sector, but plenty of other companies have credit ratings that are predicated on old assumptions about emerging market growth that are starting to look outdated.

It may all yet prove to be nothing more than a scare, but the sense of déjà vu is disconcerting. Yesterday felt a lot like the day Meredith Whitney called out Citigroup Inc. (C) for its life-threatening subprime lending. Today feels like the relief rallies that followed Bear Stearns’ promises that they were just fine. History may not repeat itself, but it does tend to rhyme.