Morning Mumble: Prozac Anyone? Maybe a Coffee? Dr Copper & all taking a spanking - whilst likening Glencore's webcast to Star Trek's Captain Kirk & Engineer Scotty...plus the need to actually do a full days work whilst on Holiday. RIO finally surpasses the 2200 target price.

Good Afternoon, 

Back up, albeit briefly... 

It's been a while! Although far from inactive - it has been fun to relax and enjoy the holidays.

The views and positions here have pleasingly been validated by the market. A pleasant bet being honoured on RIO hitting (and surpassing) my target price of 2200 pence today! Now, with a tangent look at Glencore, with some analogies to Star Trek.

We'll ignore what the critics stated about the target prices here and on FTML, with some pleasing emails of acknowledgement. Stopped clock or not (as some called it here) there was no deviation. Not because of stubbornness, but the indicators have only become a) apparent and b) a lot worse than even those reading here thought. So why would one change their view over the longer-term? Perhaps revisit the analysis but certainly not change this view, at the moment.

Initial analysis started to appear more positive after Glencore’s webcast on the 2015 half-year report. If you have a position in any stock, in any country, it's sensible to consider the webcast and in particular the defensive body language displayed and the wide range of earnings guidance. Also, as a validation, a quick visit to Fortescue Metals Group (FMG) annual results that aided the selloff in Australia last night.

In the webcast (45 mins onwards (Q&A) section), it was noted that some analysts were rightfully enquiring about the leveraged nature of the balance sheet, specifically what flexibility there is in the working capital. 

The market is now waking up to the acknowledgement of Glencore’s wider guidance of $2.7-$3.7bn (Page 9 in Presentation). Being near 2 months into H2, one surely should have been able to be more specific or is there lot of hope being priced in? It does suggest there's a lack of confidence in their operating divisions including Russian Wheat export taxes, Canada grain harvests and the copper / oil woes and finally, China.  Is this representative of the current wider global theme?

Least we not forget Glencore's thermal coal adjustments. Despite assertions of profitability and low costs, why did Glencore have “no other option but to scale back 18MT’s of thermal coal per annum.” Is it implying that Glencore are not understanding the full extent of the market deterioration in commodities, or perhaps across the board? Not a good thing if you operate in such fields.

There are a number of issues Glencore's copper division appear to have missed. One being that the "sudden" appearance of significant physical, that is suggesting a destocking of inventories. We are even starting to think that it suggests the Asian market had stored significantly more than what the market had allowed for in warehouses and of those cashing out (by pulling levers).

Having had a target price for Glencore of 165 since from Xstrata (XTA) merger completion on the 2 May 2013. The risks are still there in China, Russia, Canada, in fact every area that Glencore has an operating divisions, but more importantly net debt and its ratings, inventory valuations (and consequences of hedging), whilst being in a global deflationary environment.

Glencore are in a position of being forced to sell off assets, allegedly non-prime/central to Glencore's needs. We note Glencore announced the sale of Tampakan, Falcondo and Sipilou on the 14th August. The buyer, a subsidiary of the Alcantara Group (via their subsidiary Indophil Resources NL) appear to have benefited from Glencore's woes. Not forgetting that the sale also proves the case that yet more volume is hitting the market. Or are Glencore and the market believing that Indophil purchased these assets to do absolutely nothing with them? “Give o’er…” as Polonius said in Hamlet!

There's going to be a temptation by funds to start averaging down given the current price compared to the IPO. We'll ignore the warped belief of the investment case for Glencore, but some 'averaging' down will give risk to shorts in the interim. Without further woes in the price of oil, copper and agri-commodities it's “about the price” (for now), with more volume likely around the 150 pence.

Simply, Glencore is no-longer a conviction short, until further testing and understanding. Namely, “how bad is it really in China?” China’s next about turn in policies, devaluation and protectionism is likely to answer that. To the detriment, of course, of their trading partners – both Asian and global.

It’s ironic that Glencore go as far as to blame 'aggressive' short-selling on copper woes. Hang on a minute, don't Glencore have a copper trading desk? It would be a fair statement if they were but a "mere" producer blaming the woes of the market, rather than a fully integrated Goliath.

It’s rather taking the biscuit to point the finger when you have a capital intensive trading / marketing division? Were GLEN the counter-parties of such positions? What is the impact of the Russian export taxation on profits, with most trading houses with active positions from June taking a large hit?

If we liken Ivan Glasenberg to Captain Kirk and Steven Kalmin to Scotty the "engineer" from Star Trek, it is bemusing to review the discussions in the webcast regarding debt, working capital and trading/financing deals (Circa 50 mins onwards). 

When pushed on the debt position, debt rating and the hypothetical situation of $2/lb copper, Capt. Kirk/Ivan explained the benefits of being a trading house etc...Where there is flexibility in business model. Steve aka Scotty was able to step up the power or reduce it accordingly by these magic levers to reduce working capital, change the interest rate on internal lending to trading / marketing or look to derisk financing positions with third parties. Warp speed anyone? Perhaps Scotty in reality is “giving all he can Captain?!”

Admittedly there's evidence in the webcast of both Capt. Kirk and Scotty not understanding the business. Glencore need to reduce their debt by about $8B and essentially by as much as the carrying value of the inventories. Why was there no comment on the reduction in volumes across their divisions? After all it’s essential to trading to have volume.

Glencore’s biggest concern is its inability to call the market. One would have thought the overall theme of a market would have enabled better guidance rather than statements about “China being weaker than anyone envisaged.”

Likewise, Scotty suggested, that one can simply reduce inventories and/or working capital in addition to intra-company loan rates. This may actually be harder than what Glencore have previously done in the past. Especially in light of volumes of commodities available in the short-term. Their selling, could actually warp (speed) the market further (at least in the very short-term).

Glencore have failed to consider the currency benefits of a strong dollar on the marginal producers, that are given (yet more) lifelines. Especially as America “hops along” to an interest rate increase (but no doubt delayed by 9 months+).

The currency beneficiation has not only helped the likes of Kaz Minerals and FQM stay in business, but most other leveraged players. The ability of producers to ramp up to reduce the costs further, whilst  putting a glut on the market, is under-appreciated (at present).

Admittedly there's some hope, Glencore think the worst is over in agriculture - with the new wheat export tax now having visibility. Glencore appear to think there's near balance of supply and demand in copper and the market price is false. Ironically those statements were made just before the PMI data for China (1). The market is waking up to just how leveraged and unstable/weak China was, but one suspects not how weak it is. Could Glencore have been overly optimistic, so far it would appear they are, and perhaps will still be. 

An example being copper piping, where over the weekend Li informs us there's a couple of cargoes going for a proverbial song. Has someone perhaps been caught on the hop contractually? More on this later, if we manage to find out a price.

Yet in contrast to these cargoes (as a snap shot), analysts are banking on China spending on the electricity supply grid and infrastructure. This may actually be a pointless exercise as energy use has reduced near 3%, one cannot see China being able to afford the previous levels of wastage to support the economy.

Whilst avoiding being gleeful of near 4 years work in commodities, one suspects the market is now at risk of capitulating to a bear market, with the wider ramifications needing further analysis.

For copper, there are contradictory indicators coming out of the sector. We have Platt's* on the one hand forecasting growth in 2015 of near 5% whereas ICSG (International Copper Study Group) at negative 3%* (Source: ICSG PDF File). That's some range considering what the implications are at an economic level, although more recently there have been a few production issues in the market that may provide support (based on a reducing supply). 

Like in China, are we now going to see the forced selling of stock pledged/secured against loans or mortgages globally? What of the collateralised loans? Or perhaps with a hope of security “in cash” now being forced to sell. An example being the sale by Martin Rowley of First Quantum Minerals. Whatever the reason behind Martin’s sale, one suspects there’s going to be more globally, whether current or former management of most companies. It’s certainly the case in China, Asian and Pacific economies.

Freeport-McMoRan (FCX) are a prime example of expanding into the rout of commodities. They are yet to press the button for equity (perhaps due to lack of interest). Are they waiting for glimmers of hope in the commodity prices? One suspects they cannot wait much longer without a restructuring/raising.

China have significant problems that without a multi-pronged approach to their economy, without some form of foundation building rather than bubble focus, their economy will continue to raise concerns. The next trend (reiteration) is likely to be PFI (Private finance initiatives) or PPP's (Public Private Partnerships).

The Chinese have very cunningly been creating their own supply chains, whether Aluminium, Steel, Copper, Nickel, Coal to petroleum. This is evidenced in Taiwan, where they have felt the might of China in the semiconductor market.

Taiwan’s semiconductor exports were significantly larger than China, their market was near 3 times the size of Chinese in 2009 but is now is en par with the Chinese market. Like solar panels in Germany, this expansion into a commercial space and supply has hurt them. Many Emerging Markets will have to consider the implications of the determination of a weakness in their currency, with a reducing demand and reducing level of investment in their countries. Examples being Taiwan, Thailand, Korea and Japan.

If one considers read across of the semiconductor market in Taiwan to the copper draw/demand on copper in China. Then China’s demand/needs may not change that much, but what may is the demand from predominantly emerging Asian markets that have relied upon China. These markets have only just woken up to the fact their industries have been replaced/replicated.  

One cannot ignore the compliment from a devout critic of the views here, where "the macro environment commentary on China/Asia and India is very accurate and almost psychic here", (to quote one reader. Maybe it's only one reader!

May be a little biased of course, but one would be hard to disagree in light of the carnage on the markets and ensuing ‘recorrection’, reading back and comparing here with the realities of the PMI data and those of the bulls of the commodities. 

Why did this blog post became so popular over the weekend, EMC: Fanya Metal Exchange. What of others? Perhaps it was after this article about angry investors capturing the head of Fanya metals exchange (FT). Quite how much commodity do physical ETFS have, what are the implications for the Jo'burg PGM ETF's etc..With humour, should one be factoring in security costs for under-performing companies?  

Atb Fraser

*Platt's from memory does not distinguish between refined and unrefined copper whereas ICSG is focussed on refined copper. 

1) Add Diary of Release Dates for PMI information to your diary.