The global commodity price slump and how Glencore is coping with the pressure
Commodity prices have plunged in recent months on the back of weak demand from China, excess supply, a strong US dollar and increasing global economic uncertainty. In the face of this strong downward pressure, and the interconnectedness of global markets, how should traders respond?
Effective solutions to the commodity price slump
Markets have been saturated with high inventory levels of multiple commodities for quite some time, notably crude oil which is being stored in oil tankers offshore waiting to be unloaded on the market. Much the same is true across the board since producers are reluctant to sacrifice market share for the sake of raising prices. But the tide is turning and major multinational mining conglomerates like Glencore are focused on resolving the commodity price conundrum by proposing radical measures.
Recently the CEO of Glencore, Ivan Glasenberg, suggested a series of steps that would go a long way towards decreasing the global supply of commodities like copper and iron ore by shuttering poorly-producing mines to bring about a tightening in the markets. Glasenberg proposed these measures at the FT Africa Summit in London on Monday 5 October.
By cutting production at two of its copper mines in Africa, Glencore is hoping to decrease the supply of copper which will in turn raise prices and increase profits. Copper mines with high cost requirements place undue pressure on the operations of Glencore plc’s bottom line. By temporarily shuttering these operations the company is effectively divesting from loss-making mines.
As one of the world’s premier mining companies, Glencore is front-and-centre in the stock market. The closure of two copper mines in Africa, in Zambia and the Democratic Republic of Congo, will remove 400,000 tonnes of copper from the market. This will have the effect of raising the price and returning profitability to the copper market. Of course Glencore will be required to implement a series of cost-cutting measures aimed at tightening the purse strings to keep shareholders happy and put the company in the black, given the tumult that Glencore shares have endured of late.
Factors precipitating the commodity prices rout
The interconnectedness of global markets is both a boon and a bane to market participants. No longer can we expect immunity or containment of economic crises if they occur in Asia or the Americas. The synergy of the global market is the reason why a Fed rate hike, a strong US dollar, weakness in China or a commodity price rout are of concern to everyone.
What happens in China is of the utmost concern to mines in Africa, and the companies operating those mines from Switzerland or the UK. Glencore is a prime example. The most vulnerable economies are the emerging market countries. These include, but are not limited to, BRICS countries (Brazil, Russia, India, China and South Africa). These countries are heavily reliant on mining and agriculture and the commodity rout has severely impacted their production capabilities.
We have seen how hard global markets have been hit by China’s equity market collapse. Structural weakness in the world’s second-largest economy has led to a massive loss of confidence which is manifested in the share prices of companies like Glencore. EM countries are vulnerable and capital investments to the chief supply zones of these mega-mining companies are drying up. Shareholders are getting antsy and the slightest anxiety oftentimes becomes a speculative tsunami of put options.
Everything must be viewed in perspective however: the possibility of a Fed hike before the end of 2015 is real. The US economy is robust and Yellen has intimated that the Fed will likely hike rates in October or December this year. That does not bode well for EM currencies or commodities at all.
Closing the gap between currencies
It should be remembered that commodities are priced in US dollars. When the greenback strengthens, by dint of higher interest rates, the dollar becomes more attractive to investors. EM currencies are sold and dollars are purchased. This leads to an inexorable weakening of emerging market economies and ultimately weakens these countries.
Higher-priced commodities are only possible if global demand increases and global supply decreases. This requires a turnaround in China. If the Bank of England, the European Central Bank and the Fed decide to hike rates, the chasm between EM currencies and developed economy currencies will only widen. Volatility is being fed by anxiety about impending rate hikes.
Glencore adopts a strategic vision for operations
Glencore shares have been swinging wildly, first rebounding by 17% after taking a beating on Monday 28 September, then plunging in early trading today (Tuesday 6 October) before a swift recovery. It may take a while for a settled picture to emerge.
That the company has a favourable rating by over 300 banks and financial institutions extending lines of credit to it is important. Glencore plc is fully prepared to be privatized in the event that the price of metals (copper, gold, silver, iron ore etc) continues to slide. Glencore’s CEO has put the blame squarely on China for the slide, citing hedge funds for going short on commodities and causing market turmoil.
The ‘destocking’ of commodities like copper has been notable in 2015, but traders can rest assured that ultimately the fundamentals of the metals market will prevail. Inventory levels of copper are at multi-year lows and just three weeks of copper remain in Glencore warehouses. This means that prices will start rising as demand catches up with supply. Glencore mined 730,900 tonnes of copper during Q1 and Q2 of 2015. Should the company suffer a 10% loss of production, it would cost the company $1 billion in adjusted earnings, but the converse also holds true.
Glencore plc’s stock price has struggled since posting a $676 million loss for the first half of 2015. But what concerns investors more is the unusually high debt at the company. To this end, Glencore has announced several debt-reduction measures to help alleviate the pressures on the company and assuage investors too.
Glasenberg is firmly of the opinion that speculators are driving down Glencore’s share price and that the company’s fundamentals are sound. The share price dropped 29% at the end of September, then recovered losses. Copper prices may have hit six-year lows recently, but demand is increasing in China and supplies are being reduced. Still, many traders remain bullish about Glencore, especially after its Hong Kong share price spiked by 71.6% after talks about a takeover circulated. On the LSE, Glencore is currently trading around 110p per share, as against 300p in May 2015.
How should traders react to Glencore’s volatility?
Glencore is first and foremost a massive multinational conglomerate with substantial holdings. It is also viewed favourably by the vast majority of its creditors. The fact that the company is a major market player means that it can manipulate production levels to bring about a reduction in global copper which will ultimately raise prices and profits.
Glencore also has substantial asset holdings that can be sold to inject liquidity into the company. And there is tremendous interest among trading companies and pension funds to purchase minority stakes in the company too. Glencore is not resting on its laurels: it has announced a $2.5 billion debt-reduction plan too. However, the balance sheet is $10 billion in the red, and many analysts are deeply concerned that this is the real elephant in the room. For the year to date, Glencore plc is down 68%, making it the FTSE 100’s worst-performing component.
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