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07 October 2015

LME Dinner Week 2015 - Shadows Loom




October 2015; another LME Dinner Week looms. It’s difficult to imagine that it will be an event bringing unfettered joy and celebration to the denizens of the non-ferrous metal trade - or to the investment community hangers-on. In fact, it’s not a particularly pretty picture; the years of plenty ushered in by the ‘super cycle’ seem no more than a dream, rather than the current nightmare that has metal prices and mining equities both having taken something of a battering; and there are some grim headlines in the news.

Glencore...

The big story of the moment is the fall from grace of Glencore. I have to admit to being one of those who - at the time of the flotation - firmly believed that the share price would by now have been substantially above its opening level. Instead, illustrating that Glasenberg and his cohorts were in fact perhaps good judges of the top of a market, there’s been an accelerating drop in the value of the company, only halted this week by a recovery at least partly predicated on ‘takeover prospects’. Surely it can’t just be me who has difficulty in seeing Glencore as the target rather than the aggressor in such a discussion; but that’s how it is in today’s world. The other mining majors have all seen substantial falls as well. 

Meantime, Mick Davis sits in his SW1 eerie with a pocket full of cash, ‘waiting for the right opportunity’. Does Glencore - or at least a slug of the assets - represent that opportunity? You could argue that the timing is perfect, with Glencore bombed out. But, and it’s an important but, the way the market is now, surely the covetable assets are those at the bottom of the cost curve, and that doesn’t altogether apply to much of Glencore’s portfolio. So although that story looks attractive on the surface (and, to be frank, one would guess that some of the Davis investors may have reached the stage where they would really quite like to see some action with their investment), it may well be that the balance of probability weighs against it, however appealing the symmetry of such a deal would appear.

China

China’s slowdown is probably at the heart of the problems now stacked in front of the resource industry. The strength of the power of suggestion rules here, because China is actually still growing; just at a slower rate than had been predicted by the army of analysts. Who, incidentally, have been making the same error of over-optimism for years. So when growth turns out to be lower than predicted, that has significant effects on the supply/demand balance. At the same time, monetary policy in various countries has conspired to help find a home for excess production of metal which in a more rational world would have been cut after demand began to fall some few years ago. Less demand than anticipated in a market that is over-supplied - that’s why the prices are softening. And softening commodity prices are the pressure behind falling equity prices.

VW

Platinum group metals are not traditionally part of the LME, but it’s very difficult to ignore the Volkswagen story. That deals a heavy blow to platinum (while potentially encouraging greater palladium use), and that in turn is another weight on the mining industry. 

And Less Obvious...

Those are the surface issues, the ones that are very obvious and visible. There’s something else, perhaps less obvious, going on as well though. Banks lend money to commodity companies to enable the trades to be made. That can be in the form of plain loans, L/Cs, structured derivative transactions or other exotica. In good times, those loans tend - to a large percentage - to be syndicated out to other banks, which has the beneficial effect of spreading and diffusing the risk. I understand that that business, right now, is far more sticky, as a result of ratings, interest rate levels and counterparty risk concerns. Those trying to sell on the percentage of loans they don’t want to keep are finding buyers thinner on the ground than they would like and they are therefore being obliged to hold more of this paper than they may ideally wish. That means - I would suggest - that there may be an unhealthy concentration of risk building within those banks who have traditionally large commodity businesses. The ‘too big to fail’ mantra is probably not appropriate for commodity companies - after all, if they are miners, the underlying product doesn’t disappear, and if they are traders, well, they tend not to be of that kind of size - but these are worrying signs in a market that still doesn’t seem to have reached the bottom. 

We all know it’s a cyclical business, and it will turn up at some point; nevertheless, although the attendance may be good, these looming shadows may exercise a lot of minds this LME week.










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