There was a really interesting column penned by Matthew Lynn on Tuesday.
In a nutshell it argued that investors should be mindful of investing in a company known for its shrewdness when it comes to market-timing.
As he noted:
The main concern about Glencore isn’t the state of the commodities business. It is about timing. The record shows that when trading businesses come to the market, investors usually get outfoxed. Take Goldman Sachs, for example. No one disputes that it is a great bank. But if you bought shares in its IPO in May 1999 and sold in November 2008 you would have lost money, though there would have been better selling opportunities along the way.
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“Is it the top of the cycle?” Chief Executive Officer Ivan Glasenberg said in an interview with Bloomberg reporter Jesse Riseborough last week. “Who knows, who cares? We are only potentially selling out in five years’ time, so let’s worry about the market in five years’ time.”
It doesn’t make any difference. They will still choose a point that looks like a peak in the market to sell. They can’t help themselves: cashing in at the top is in their blood.
But here’s the thing. Are Glencore traders really all that good at calling time on commodity bull markets?
We’re not so sure.
As sources privy to Glencore’s flotation documentation confirm, so-called ‘flat price’ movements in commodities are largely irrelevant to Glencore’s trading model.
Glencore makes money from well-established and tested market inefficiencies — otherwise presented as geographic, quality or timing-based arbitrage opportunities — not outright long commodity positions. This is the company’s added value. They are the house that consequently always wins.
Take contango/backwardation in markets as an example.
While the ordinary futures investor only outperforms the market when the market is in backwardation, Glencore wins no matter what the structure of the curve.
In contango markets, it has access to low financing costs and cheaper than average storage facilities, something which allows it to profit from an inefficient forward curve by buying now, selling forward and holding till delivery. (And other strategies, thereof.)
During backwardation the company prices sales contracts as early as possible while deferring the quotation periods of supply contracts, so as to purchase at as low a price as possible versus its eventual sale price.
Flat-price irrelevant
The market-price neutrality of the model further means Glencore’s risk exposures are relatively contained.
The same sources confirm the company has limited exposure to directional price movements because price exposures to physical inventory held in transit for processing or for time arbitrage trades are usually substantially hedged, or pre-sold to end customers.
Thus, its marketing margins have a very low correlation with commodity prices overall. In oil, for example, Glencore’s oil derived marketing margin per unit sold is only 14.4 per cent correlated to the underlying price, while BHP Billiton’s is 93.1 per cent.
In aluminum, that correlation is an even smaller 7.4 per cent, compared to 52.2 per cent for BHP Billiton. And 29.2 per cent for nickel, compared to 55 per cent for the equivalent metal at the same rival.
Now, if and when Glencore does take a directional position — and it will do now and then — the company benefits from what have been described as “unrivaled informational advantages” for identifying pricing opportunities.
Though, the company says, these account for just a small proportion of the group’s annualised marketing profits and are only taken when the group has a genuinely strong market view based on what are described as unique “trading insights”. Make of that advantage what you will.
All of which means things like financing costs are actually a much bigger issue for the company — largely because when prices are high the company needs access to ever cheaper funding just to maintain its positions, hedges and arbitrages.
As is guaranteed accessibility to key markets and/or exclusive procurement or sales agreements with long-standing counterparties. Let’s not forget, Glencore are dealmakers just as much as they are traders.
Funding
Which brings us neatly to how the company finances its marketing operations in the first place.
According to our source, the firm typically has access to roughly year-long debt facilities backed by its own trade receivables and or inventory, annually rolled over. (Commodity collateral-backed financing, if you will.)
As of Dec 2010 it is understood these arrangements saw Glencore’s marketing activities average a variable funding rate of about 2.86 per cent, with net cash availability of some $1.5bn.
It’s a cheap rate, but it could arguably be cheaper. At least from an industry perspective.
Which, by the way, potentially explains Glencore’s previous keenness to collaborate on things like physically-backed commodity ETFs — an arguably superior form of inventory financing.
It also adds the notion that access to cheap funding (potentially by adding to its inventories) is as real a motivation for the IPO as is market-timing and/or cashing out. Especially since its ETF plans seem to have been put on ice — (for now at least).
But don’t take it from us, here’s the funding hint from the horse’s mouth itself:
The Company intends to apply the proceeds of the Global Offer towards increasing its ownership in JSC Kazzinc (“Kazzinc”); funding its capital expenditure for the next three years, including expansion projects; and reducing drawings and/or repaying various debt obligations of the Glencore group.
Related links:
Glencore’s trading strategies disclosed! – FT Alphaville
Glencore trading empire unveiled - FT
Only toughest thrive in Glencore’s trading culture – Reuters