The Participant 10/8/15: Glencrash

by Jason Kelly

Thursday, October 8, 2015




Glencore (GLNCY $3.84) is the world’s largest listed commodity supplier. It operates in three segments: Agriculture, Energy, and Metals and Minerals. It employs more than 180,000 people worldwide. From its headquarters in Baar, Switzerland, it controls most of the world’s zinc market, half of the copper market, and sizable portions of the grain and oil markets. It’s the world’s biggest exporter of thermal coal. It’s number ten on the Fortune Global 500 list, with revenue of more than $220B.

It’s also imploding.

The commodity crash sent raw material prices to the floor, which in turn compressed commodity companies’ earnings to 13-year lows. At the same time, dollar-bond borrowing costs are at their highest in five years. This unfortunate confluence of events resulted in Glencore’s rating falling to BBB at Standard & Poor’s, just one up from the bottom rung of the investment grade portion of the market. Two downticks away lurks the junk pile.

To deal with this, Glencore cut its 2015 spending plan by $800M and sold $300M worth of mines. In May, it raised a one-year $8.5B revolving credit facility from a banking consortium that it can extend for another year. It might need to do so, considering it has $6.3B worth of bonds maturing by the end of 2016. It could take additional steps such as lowering its dividend, slashing other costs, increasing output, or selling more of its assets, and may be forced into taking some or all of these steps.

A year ago, the American proxy for Glencore’s stock traded at $10.50. It closed yesterday at $3.84 which, at a 12-month loss of 63% probably looks pretty bad, but it fell to $2.03 last month. Most recent coverage has applauded the 80% bounce from $2.03 rather than the 60% drop from a year ago, but this kind of gyration in a stock representing one of the world’s largest companies is reason for concern. Among those most concerned, the phrase “next Lehman Brothers” is a popular way to fit the risk in a nutshell. Duly noting that Lehman’s assets were nearly $700B while Glencore’s are closer to $150B, and Lehman was 97% debt while Glencore is 50% debt, the comparison is nonetheless unnerving people.

The reason for the ignominious “Lehman” label was confirmed in a research note issued by Bank of America Merrill Lynch yesterday, in which the team of analysts estimated “the financial system’s exposure to Glencore at over US$100B, and believe a significant majority is unsecured.” They break it down as $35B in bonds, $9B in bank borrowings, $8B in available drawings, and $1B in secured borrowing. That gets us to $53B. On top of that, BofA estimates “that the group has US$50B in committed lines against which it can draw letters of credit with which to finance its trading inventories.” Adding together the gross lines available and the letters of credit with no credit for inventories held gets the bank to the $100B ballpark.

What happens if banks backing this creative borrowing operation decide they’re too exposed to it going wrong? Considering that Glencore isn’t the only commodity operator cracking its knuckles these days, this looks possible, if not likely. BofA emphasized the point in another note: “With [Glencore’s] bonds at around $36B, this would still leave $64B to the banks’ account (assuming they don’t own bonds). For the banks, of course, Glencore may not be their only exposure in the commodity trading space. We consider that other vehicles such as Trafigura, Vitol and Gunvor may feature on bank balance sheets as well ($100B x 4?)”

One could imagine a coterie of commodity-backing bankers looking over these figures and deciding they loved the business model back in the days of high commodity prices, but aren’t so fond of it now amid low ones. A couple of keyboard pecks later, up goes the cost of commodity credit, down goes its availability for trading, and out the window goes the commodity business model. This would be the dreaded liquidity squeeze, and that phrase is what gets knees knocking when remembering back to the dark days of 2008.

Can’t quite recall? Here’s an excerpt from “A Liquidity Squeeze Reveals Vulnerability Of a Wall Street Firm,” which ran in the WSJ on March 15, 2008: “With Bear Stearns Cos. cratered by a cash crunch, investors turned a nervous eye on the other big Wall Street companies, worried that they, too, could become vulnerable if markets turned against them. … In a statement Friday, a Lehman spokeswoman said: ‘Our liquidity position has been and continues to be very strong. We consider the liquidity framework under which we have operated for almost a decade to be a competitive advantage.'” On September 15, 2008, Lehman went bankrupt.



From Note 36 sent to subscribers last Sunday morning, with data as of Friday, October 2:

I’m pleased to see the signal working. Its pacing is a big part of its success. It gives the market time to move, which is important because our fast-firing emotional minds think a lot of time has gone by and the world has changed when often not much has happened and nothing is any different from usual. It might be the hyperbole of the media or the shrill rhetoric of politics, but the notion that “this changes everything” is drummed into people’s minds, then exacerbated by news presentations. Look how much attention was paid to insignificant Greece. It literally doesn’t matter to the global economy whether Greece exists or not, but it was obsessed over to the point that some people thought it a harbinger of Armageddon on the way.

Worse, the events that really do matter to the market are usually not covered in advance. They come out of nowhere, which is part of why they exert so much impact. In most time periods, nothing important happens and the market meanders along its long-term path higher. This is why bears are fighting a losing game. The majority of what they worry about never means anything, so the money they “protect” by tucking it away in safe corners fails to keep pace with the general upward trend.

Now we know the signal did the right thing back in July. Notice that analysts saying the Fed would not raise rates and would remain stimulative were correct in that, but wrong in the associated advice to either stay fully committed to stocks or add to one’s commitment. The Fed has remained stimulative, but stock prices fell.

Analysts got this wrong; the signal got it right. When the market dipped a little, it bought only a little. This was good, because the market was preparing to dip a lot more in the quarter to follow, and now the signal is saying to buy a lot more for a recovery.

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The following excerpt is from an interview with Jeff Gundlach last Friday, as reported by Reuters.

“The reason the markets aren’t going lower is people are holding and hoping. The market bottoms out when people are selling and sold out — not when they are holding and hoping. I don’t think you’ve seen real selling in risk assets broadly. Markets need buying to go up and they need volume to go up. They can fall just on gravity.”

DoubleLine Capital co-founder Jeffrey Gundlach warned after the weak jobs number on Friday that the US equity market as well as other risk markets including high-yield “junk” bonds face another round of selling pressure.

“People are acting like everything is great. Junk bonds are at a four-year low. Emerging markets are at a six-year low and commodities are at a multi-year low — same level as in 1995 … GDP is not growing at a nominal basis. … Clearly what’s happening is people are waking up to the idea that global growth is not what they thought it was.”

Even International Monetary Fund Managing Director Christine Lagarde affirmed this, Gundlach said: “You talk about an important moment when somebody who is traditionally a cheerleader for a bright future says, ‘I have to downgrade my global growth forecast,’ as Lagarde did.”

To see this call in The Z-val Zone, please visit:

Recently Judged Forecasts:

3/2/15 Hiltzik: Be Afraid of Nasdaq 5,000 | Medium-Term Bearish | RIGHT

3/3/15 Lim: Nasdaq 5,000 Not Different This Time | Medium-Term Bearish | RIGHT

3/31/15 Jakobsen: Sell Stocks, Take Six Months Off | Medium-Term Bearish | RIGHT

So far, eleven forecasts have been judged. Four were right, seven were wrong. The aggregate accuracy rate is 36%. Although the sample size in this young study is still too small to be considered significant, we know from other more comprehensive studies that the accuracy of forecasting is about 50%.

* * * * *

Background: The term “z-val” is a shorthand introduced in the book, The 3% Signal, for “zero-validity forecasters” and “zero-validity environment.” The latter phrase was coined by Nobel Prize winner Daniel Kahneman in his book, “Thinking, Fast and Slow,” where he wrote that “stock pickers and political scientists who make long-term forecasts operate in a zero-validity environment. Their failures reflect the basic unpredictability of the events that they try to forecast.” This is why stock market forecasters are proven to sport an accuracy rate of about 50%, same as a coin toss, yet they continue forecasting.

You can peruse the growing collection of tracked forecasts in The Z-val Zone at:

Seen a forecast I should track? Send me the link in a reply to this note.



Well, what have we here? Fresh input on the dietary front!

In the closing thoughts of Note 33 sent to subscribers on September 13, I mentioned reading a book called The Big Fat Surprise: Why Butter, Meat and Cheese Belong in a Healthy Diet by Nina Teicholz. I wrote that “It’s well-researched and well-written, with a tour of the sloppy science and forceful personalities that pushed the low-fat diet as a way to combat chronic disease and obesity. However, isn’t the nutritional case for animal products obvious with a simple look at human history?” It always has been to me.

Some readers protested, telling me I had no right to comment on dietary research given my lack of expertise in the area. One thought I might have cut some readers’ lives short. Another said one single book flying in the face of decades of research was not enough evidence to warrant rethinking what’s healthy and what’s not. Several suggested I stop believing everything I read, then told me to spend time on, presumably to believe what I read there.

I told protesters that I’d merely shared my own experience with diet, which has been corroborated by not just the one book I mentioned but several others, including Wheat Belly: Lose the Wheat, Lose the Weight, and Find Your Path Back to Health by William Davis, Why We Get Fat: And What to Do About It by Gary Taubes, and Grain Brain: The Surprising Truth about Wheat, Carbs, and Sugar — Your Brain’s Silent Killers by David Perlmutter.

Now, this just in.

On Tuesday, Peter Whoriskey wrote in the The Washington Post’s Wonkblog that a growing group of scientists are questioning the US government’s longstanding advice to avoid whole milk in favor of fat-free or low-fat choices. “In fact,” he wrote, “research published in recent years indicates that the opposite might be true: millions might have been better off had they stuck with whole milk. Scientists who tallied diet and health records for several thousand patients over ten years found, for example, that contrary to the government advice, people who consumed more milk fat had lower incidence of heart disease.”

He quoted an assistant professor of epidemiology at the University of Texas saying that by warning people against full-fat dairy foods, the United States is “losing a huge opportunity for the prevention of disease. What we have learned over the last decade is that certain foods that are high in fat seem to be beneficial.”

After a discussion of the history of dietary research, including contrary opinions, Whoriskey concluded: “The advocates of whole milk allow that it has more calories than its low fat cousins, and for some, that might be reason to avoid it. But the traditional case against whole milk — based on the risk of heart disease — has frayed enough now that many argue the Dietary Guidelines should yield to the new findings.”

Yours very truly,

Jason Kelly

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