Commodities approach ‘peak pessimism’

Is pessimism in the commodities sector reaching a peak?

Take commodities trader Glencore, for example. Its shares are down over 20% at the open today. It’s never traded this low since it first floated on the stockmarket in 2011. And it could trade lower still. Check out the chart.

Glencore share price chart

It’s a life or death moment for the company. It may not survive lower commodity prices, according to a report by Goldman Sachs.

The Goldman report cited lower coal (thermal and metallurgical) and copper prices. It cited the restructured $10bn in debt that has led to a lowering of its credit rating to BBB.

But corporate-speak aside, the fear is simple: the equity in the company is being wiped out by debt and lower commodity prices. The assets Glencore bought with its debt are failing to generate enough income to service that debt. Without a rally in commodity prices, it could be curtains.

This is a cautionary tale. And as usual, I blame low interest rates. Glencore was a perfectly respectable and profitable private commodities trader before 2011. Then the owners decided to sell shares to the public.

That’s always a revealing moment. Why?

If they couldn’t raise capital in the debt markets (clearly not the case) then selling equity to the public would have been the logical way to get more money. Instead, you often see insiders selling when they see that there’s more profit to be made selling shares than whatever the core business of the company is.

I say ‘more’ profit but what I mean is ‘marginal’ profit. Either way, the decision to sell a stake of a valuable business has to be examined closely. Is it driven by short-term thinking, where you’re maximising the value you can extract from your position? Or is it done in the long-term best interests of the firm and its shareholders?

Low interest rates corrupt your decision-making by encouraging short-term thinking. You can’t plan for the long term if you’re managing earnings expectations on a quarter-to-quarter basis. Glencore went public when the commodities boom peaked. The question now is if it’s going bust at the nadir of pessimism about commodities.

What’s bad for VW is good for platinum group metals

The VW scandal could be good for palladium, according to a research note from Australian-based Macquarie Group. It’s an interesting claim, that sales of cars with petrol engines (which use palladium in their catalytic converters) will increase as the diesel makers face the firing squad.

Diesel cars account for 45% of all new car sales in Europe. Diesel engines use platinum for their catalysts. In fact, 40% of global platinum demand comes from the car market.

It’s a weird little pairs trade then: short platinum and long palladium. You can see below that palladium prices are coming off a five-year low. The chart made that distinctive ‘V’ formation you get at key bottoms. Can it keep it up?

Palladium price chart

For stockmarket investors, it’s hard to find a platinum group metals (PGM) producer that doesn’t produce both platinum and palladium. It’s a mixed bag. You get exposure to rising palladium prices and falling platinum prices. It’s a push.

The real winner? Russia. Russia, along with South Africa, is one of the world’s largest PGM producers. It has stockpiles of both platinum and palladium, although no one knows exactly how much, because the Russians don’t say.

China factory orders report due

China’s factory sector will shrink for the second month in a row, according to a survey of economists by Reuters. Take it for what it’s worth. The official Purchasing Manager’s Index (PMI) numbers will come out this week. The August numbers showed the biggest contraction in three years.

Markets are desperate for any good macro data from anywhere. With central bank stimulus on hold in Europe and the US – where rates may go higher this year – it’s nothing but bearish news everywhere. Or so it would seem.

Indeed, it does seem that way to me. All the signals point to it. But that’s where you have to use your brain, too, and force yourself to be a contrarian. What goes up when everything else goes down? More on that tomorrow.

Category: Commodities

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