Shares in Glencore, the troubled mining company, are recovering today (up 10% to £0.88 at the time of writing). But even that recovery begs the question: Why is a mining giant that has $US221 billion (£146 billion) in annual revenues, which was once big enough to attempt a takeover of Rio Tinto, trading like a penny stock?
One answer is that the current chatter about Glencore revolves around how much it might be like Lehman Brothers or even Long Term Capital Management. For the older generation — people over 30 — those are scary names. Both triggered wholescale financial collapses when their leveraged bets went wrong.
So, could Glencore really be on the verge of creating another systemic worldwide threat?
Now, before we get into this, let’s just make it clear that the evidence for this theory is thin at best. We are not saying this is going to happen.
Glencore does not, right now, look like it is going to implode and take a huge chunk of the global economy with it. Rather, this is what people have been saying about Glencore over the last couple of days. There is a difference between what people say and the actual facts. Unfortunately for Glencore, what people say sometimes moves markets.
In its defence, the company — which has declined to talk on the record to Business Insider — points to its balance sheet, which has $US10.5 billion (£6.91 billion) in available liquidity:
But that liquidity will not be much comfort to the citizens of Zambia, where Glencore just suspended its Mopani copper mines.
Glencore is the largest private employer in the country, and as GLEN.LN stock has tanked, it has dragged down the Zambia’s currency, the kwacha, with it. The kwacha has declined 48% against the dollar this year, Bloomberg reports:
That’s powerful stuff: When Glencore sneezes, entire third world countries catch colds.
Now look at what happened to Glencore’s credit default swaps (CDS) in the last couple of days. Glencore has a lot of debt, in the form of bonds, and those bonds come with CDS, which function as a type of insurance. Basically, Glencore pays a fee to insure its bonds against the prospect that it can’t pay the bonds back.
The price of Glencore CDS went through the roof in the last couple of days, as this chart from Bloomberg on Monday shows:
Two weeks ago, Glencore CDS were trading at 286 basis points, the FT said. That implies that it would cost $US286,000 (£188,293) to insure $US10 million (£6.6 million) of Glencore’s debt. Then they went up, as counter-parties decided that Glencore CDS were becoming more risky and therefore the insurance ought to become correspondingly more expensive:
Martin Enlund at Nordea Bank notes:
Here’s a blast from the past, an “old” rule of thumb from 2008. Whenever a CDS spread hits 400bp, someone is in big trouble… a 400bp spread is consistent with a one-in-four chance of a default within 5 years
So 550bps is bad news.
Indeed, now the price of insuring a $US10 million (£6.6 million) bond would be an implied $US550,000 (£362,065) — twice what it was hours before. But the “bad news” didn’t stop there, as Bloomberg noted later:
Five-year credit default swap spreads on the commodities giant’s debt jumped from 550 basis points on Friday to 757 bps today, indicating investors are willing to pay more for protection against default.
And then it got worse still, as Reuters reported yesterday:
Glencore’s euro curve is now inverted and its CDS is also under sustained stress, peaking at 964bp on Tuesday morning in five-year terms.
Finally, back to Bloomberg: “The jump in Glencore’s CDS spreads means investors would now have to stump up 1.4 million euros in advance to insure 10 million euros worth of Glencore’s debt for five years, plus pay 500,000 euros annually.”
As we explained previously, Glencore is heavily indebted but only marginally profitable. So the cost of insuring its debt is more sensitive for Glencore than other companies. And that has people worrying about the extent of Glencore’s “leverage,” meaning the amount of money the company has borrowed in order to make bets within its commodities trading arm.
A few days ago, Private Eye’s City Slicker column (not online) made a long-winded, slightly sketchy argument that Glencore’s trading desks were so leveraged that they resembled Long Term Capital Management (LTCM).
LTCM is the hedge fund that made a series of disastrous bets on interest rate swaps in the late 1990s that went belly up, triggering a systemic banking crisis that was only averted when 16 other banks bailed it out.
That sounds histrionic, but the fact that Glencore can apparently tank an entire country’s currency (albeit a small one) all on its own doesn’t help the optics.
And then there is the Lehman issue. Here’s Frank Holmes on CNBC:
“Glencore is like Lehman Brothers, they have the most sophisticated trading desk when it comes to metals, coal, copper, iron ore. They’re not just a company processing ore from the ground. If it was to unravel, that could have a global impact,” Frank Holmes, CEO and chief investment officer at U.S. Global Investors, told CNBC on Tuesday.
Those debt fears weighed on Asia-Pacific commodity stocks on Tuesday, with Sydney-listed Rio Tinto and BHP Billiton tumbling 5 and 6 per cent respectively within the first two hours of trade, while Singapore-listed Noble Group tanked 12 per cent.
Glencore could be the name that drags the entire market down because it has an elevated leverage ratio in order to secure high returns, Holmes explained, adding that the firm also has many counterparty transactions, so there are concerns about a domino effect and the leverage of other parties.
Glencore flatly denied that comparison when contacted by CNBC.
But the “Lehman” word keeps cropping up. Legal & General Group CEO Nigel Wilson also made the comparison on Bloomberg TV, saying Glencore faced “a quasi-Lehman moment.” Wilson is a shareholder in Glencore, too. That was the kind of chatter that prompted Glencore to put out an unusual statement this morning saying it was doing just fine:
Our business remains operationally and financially robust – we have positive cash flow, good liquidity and absolutely no solvency issues.
We are getting on and delivering a suite of measures to reduce our debt levels by up to US$10.2 billion.
Glencore has no debt covenants and continues to retain strong lines of credit and secure access to funding thanks to long term relationships we have with the banks.
Of course, these CDS numbers are just prices. They are not actual deals getting done. And as Glencore’s stock recovers as investors decide that it’s not going to implode, the price of its CDS is likely to go down again. Even better, as GLEN.LN goes up, the comparison between its debt and equity gets better, and Glencore can expect to benefit from that too. There will be something of a self-fulfilling, virtuous cycle aspect to that.
And hopefully those Lehman comparisons will go away.
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