Glencore International, world’s largest commodity trader, considering $7B IPO

IPOs like this occur frequently, but not always, near the top of an industry’s underlying price ranges. From CNBC:

Glencore International, the world’s largest commodities trader, is signaling to bankers that it expects to issue at least $7 billion in stock as part of an initial public offering to launch as early as April, says someone familiar with the matter.

The Swiss trading firm, which is also heavily engaged in the physical production and marketing of oil, gas, wheat, corn, aluminum, nickel, and other raw materials, met with bank analysts in London as part of a two-day presentation earlier this week, according to several people who were briefed on the meetings.

[…]

The company carries a heavy net debt load of $14.8 billion, up from $10.2 billion last year.

Indebtedness and the strong need for cash in its capital-intensive trading business may be spurring Glencore’s desire for an IPO, say bankers and traders knowledgeable about the company. Glencore debt trades at junk levels, and its bonds were battered during the financial crisis, amid doubts about the company’s future creditworthiness.

Commodity bubble reaches July, 2008 levels

These were the vital signs at the top of the commodity bubble on July 4, 2008 when crude oil traded at $145/bbl:

• Reuters/Jeffries CRB Index = 472.36
• average Bullish Consensus = 68.9% (18 commodities)
• soybeans = 89%
• crude oil = 80%
• heating oil = 84%
• natural gas = 85%
• cocoa = 86%

Today:

• Reuters/Jeffries CRB Index = 341.27
• average Bullish Consensus = 70.0%
• corn = 82%
• coffee = 94%
• cotton = 96%
• copper = 80%
• silver = 84%

The 2008 bubble was fueled by the energy complex (crude -39%, heating oil -34%, nat gas -71% since).  It’s 2011 cousin is inspired by the endless-demand-from-China fantasy with the wildest speculation in soft commodities like cotton, coffee and sugar, and industrial metals like copper, palladium and platinum.

The difference between gold and commodities

We are having a hard time understanding the recent hand-wringing over gold. Since July 11 its price is down just 14.8% in dollar terms (currently $818.60/oz. on the Dec. futures contract), this after a 3.7-fold rise over a 7 ½ year bull market. During the past 2 months gold has also lost 9.3% of its purchasing power vs. the S&P 500 and 4.6% against the euro. However, gold now buys 3.8% more copper, 9.0% more corn, 32.3% more crude oil, 44.0% more silver, and 58.6% more platinum.

We were actually expecting a correction in gold and were underweight 2 months ago. Since that time the case for gold has clearly improved with the lower price and better fundamentals (i.e., massive bailouts moving us closer to the day of running the printing presses flat out). We now have our gold/gold stock weighting back up to about 19%, and expect to take this higher.

Commodities are a different animal, its inflation-hedge credentials questionable heading into a global recession/depression. That said, we actually did some nibbling in the food/fuel area yesterday on the weak open (in part because there has been a bit of capitulation by some commodity bulls like Ken Heebner). Over the long haul, we’d prefer to own the businesses instead of the actual commodities. Michael Aronstein stated the rationale against owning physical commodities very well a few weeks ago:

“The whole cycle that began around the turn of this century ended. Human ingenuity creates productivity, and the real price of almost everything that’s extracted or manufactured goes down over time. That’s the nature of human progress.”

This is not to say commodity-related businesses can not do well in a declining price environment; witness Dell Computer in the 1990s. They just don’t prosper in a weak economy. As for industrial commodities, we’ll relegate these to the penalty box at least until the global malaise is constant front page news.

Ken Heebner starting a hedge fund: Sign the commodity bust still early?

According to an article on Bloomberg today, Ken Heebner hopes to launch his first hedge fund raising $5 billion. This got our contrary juices flowing with several bells ringing:

• Hot portfolio manager becomes hot commodity among the mainstream financial media. (not the least bit influenced by all the money his firm spends on fencing ads!)
• Assets in his flagship CGM Focus Fund more than triple from $2.9 billion to $10.4 billion from June 30, 2007 to June 30, 2008, coinciding with a boom in commodity-related stocks. (Heebner runs a concentrated portfolio with 93.5% in such stocks as of March 31.)
• After nearly 4 decades in the business, he decides to raise $5 billion in a hedge fund…
• …despite the fact that his fund is down 29% in the first 10 weeks of Q3.
• The Bloomberg reporter is very blasé about this recent implosion.
• And investors are unfazed, apparently buying the dip, to the tune of $700 million in inflows during Q3. (CGM Focus Fund should be down to $7.4 billion with the 29% loss, yet is reported at $8.1 billion in assets.)

My comment: You just can’t script this much better. After a 7 year run, the commodity bear is slightly more than two months old… and by all appearances has much further to run. There is just far too much complacency.

Bloomberg reports commodity downturn nearly over

Yesterday, Bloomberg published an article calling a bottom in the commodities correction which repeated the endless demand from China/India rationale:

Supply constraints come at a time of sustained demand in China and India, home to a third of the world’s population.

China may spend as much as 400 billion yuan ($58 billion) to stimulate the economy and ease monetary policy, said Frank Gong, head of China research at JPMorgan Chase & Co.

The nation’s factory and property spending accelerated through July, fueled by rebuilding after the Sichuan earthquake, the statistics bureau said Aug. 15. Exports surged and retail- sales growth was the most since 1999. Chinese demand may also increase as factories shuttered for the Olympics reopen. The economy expanded 10.1 percent in the three months through June.

India, which could emulate China in demand for raw materials, will grow 7.7 percent in the year to March, a government panel said Aug. 13.

In addition, the article served up plenty of market opinions…

Bulls:

Alan Heap, global commodity analyst at Citigroup Inc. in Sydney:

Supply constraints are “coming more and more to the fore” and that “will separate the performance of individual commodities. We’re still looking for higher prices next year and in some cases the year after.”

Jim Rogers, 65, chairman of Rogers Holdings:

“Over the course of time, it’s a bull market.” While oil could fall to $75 or rise to $175, prices will appreciate during the next 10 years.

Malcolm Southwood, a Melbourne-based commodities analyst with Goldman Sachs JBWere Pty:

“I don’t think the commodity boom has ended at all. We’ve got a little bit of a cyclical downturn in a longer-term bull market, and the structural fundamentals are very much intact.”

Clark McKinley, a spokesman for the California Public Employees’ Retirement System (Calpers), the largest U.S. pension fund, which oversees $239 billion:

“We’re in for the long term. Short-term market moves are not of great importance to us.”

Bears:

Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc. in New York, who returned 15 percent a year in the 1990s managing commodity investments:

“The whole cycle that began around the turn of this century ended. Human ingenuity creates productivity, and the real price of almost everything that’s extracted or manufactured goes down over time. That’s the nature of human progress.”

Nicholas Sargen, chief investment officer of Fort Washington Investment Advisors Inc. in Cincinnati:

“We’ve seen the end to the upward trend” for commodities. “The global economy is weakening, not just the U.S. economy. All the evidence coming out of Europe is that the economy now is stagnating. Japan and parts of Asia are weakening as well. That’s just too powerful to be overcome.”

My comments:

1. Such optimism indicates the bear market in commodities is likely still in the early innings.
2. We find the arguments of the minority skeptics much more convincing, particularly a) real commodity prices decline over time due to human ingenuity and b) a global recession will sap demand already weakened by high prices.
3. This is reminiscent of an article on Bloomberg almost exactly a year ago that claimed stocks were at their lowest valuations in 12 years. (We posted on this here.) We don’t expect the consensus to fare much better this time.
4. Note to self: short Goldman Sachs.

Commodity boom meets demand destruction

Apparently, even the 7-year commodity boom is not immune to the laws of supply and demand…

Gold
According to the World Gold Council, total demand for gold dropped 19% in the second quarter from a year ago to 735.6 tonnes. Jewelry demand was particularly sensitive to higher gold prices, with the greatest declines coming from India (down 47% to 118 tonnes) and the U.S. (down 30% to 33 tonnes).

Crude Oil
According to the Department of Transportation, Americans drove 12.2 billion fewer miles in June 2008 than in June 2007, a decline of 4.7%. “Since last November, Americans have driven 53.2 billion miles less than they did over the same period a year earlier – topping the 1970s’ total decline of 49.3 billion miles.”

Recession
Finally, in a bearish article on gold, silver and commodities on LewRockwell.com, Gary North states the obvious: commodity demand does not fare well in consumer-led recessions.

If we are talking economic fundamentals, gold and silver have had their big run. From now on and for months ahead, the pressure will be downward. Why is this the case? Because the recession is real. If the rest of the world moves into recession, as I think is likely, the demand for commodities will fall. The value of commodities has nothing to do with value in themselves. They are valuable only because the consumer goods that commodities are used to produce are expected to rise in price.

Strategy
The Bearing Fund has traditionally held a significant long position in gold and gold mining equities, as well as a small long position in commodities. As of July 31, the fund held its smallest position ever in gold (6.15%) and gold stocks (11.35%), and its largest short position ever in commodities (15.31%) which is comprised of crude oil, grains, and copper. We have, however, been slowly adding to our holdings in physical gold and gold shares on recent weakness.

"America’s hottest investor" turns ice cold

Fund manager Ken Heebner, who Fortune deified one month ago (we blogged about it here), appears to have succumbed to the magazine cover curse. His CGM Focus Fund – packed with commodity, cyclical (steel), and emerging markets stocks – is down 11.55% for the first five trading days in July. The S&P 500 is -0.49% over the same period.

"America’s hottest investor" rings the commodity bell

Ken Heebner graces the cover of the latest Fortune with the title, “America’s Hottest Investor.” While we won’t begrudge Heebner the honor (his CGM Focus Fund returned 24% per annum over the past 10 years vs. 4% for the S&P 500), we’ll simply point out that such fanfaronade often tempts the investment gods.

Predictably, Heebner is making a concentrated bet on – drumroll, please – commodities. In fact, as of March 31, 71.8% of Focus’s assets were invested in commodity-related stocks:

• Aluminum – 5.9%
• Copper – 9.9%
• Fertilizer – 9.7%
• Food – 4.7%
• Oil drilling & oilfield services – 7.5%
• Oil producers – 10.8%
• Steel – 23.3%

If that weren’t enough, another 21.7% is invested in emerging markets:

• Brazilian banks – 12.4%
• Foreign telecoms – 9.3%

Ken Heebner is known for rapid trading (387% annual turnover) and pulling the plug quickly if he senses the investment winds changing. In any event, a 93.5% of portfolio bet that gains the adoration of a popular financial publication strikes us as some sort of bell-ringing event.

Addendum: The banner at the top of the November 28, 2006 issue of Fortune read “The greatest money manager of our time.” That distinction went to none other than Bill Miller, whose Legg Mason Value Trust underperformed the S&P 500 by 7.60% in 2006, 12.21% in 2007, and 12.81% so far in 2008.

Oil supply and demand: The tide has turned

Two weeks ago, Investor’s Business Daily ran on op-ed titled “The Ship Turns” which made the case that dramatically higher crude oil prices are changing the supply/demand equation.

Supply:

According to data from a variety of sources, world oil output has jumped by 11%, or 8.5 million barrels a day, since 2002, to 83 million barrels a day.

Contrary to the predictions of petro-paranoids, private oil companies are producing flat out — even though government entities such as the Organization of Petroleum Exporting Countries and the U.S. Congress work to keep prices high.

Fueled by the high prices, new sources of oil are being discovered. They include the 33-billion-barrel bonanza recently found off Brazil’s coast and other huge finds in the Caribbean and Asia. The U.S. itself has 656 trillion cubic feet of natural gas and 112 billion barrels of oil on federal lands alone — there for the taking if only Congress would allow it.

But even without it, we’re going gangbusters. As the American Petroleum Institute recently noted, “an estimated 4,577 (U.S.) oil wells were completed in the first quarter of 2008, up 12%” from last year and the highest rate since 1986. U.S. oil companies are going back to tapped-out wells and pumping oil that wasn’t economically recoverable at $25 a barrel but is at $100.

Demand:

U.S. fuel demand in the first three months of 2008 was down 1.4% from a year earlier — the third straight quarterly year-over-year decline in a row.

Gasoline consumption has risen about 1.5% a year since 2000. But Energy Department data showed demand in the first quarter edging down for the first time in more than two decades.

In short, the tide has turned.

The New York Times notes that U.S. car buyers have suddenly gone ga-ga over small cars. One in five purchases is now a compact or subcompact, while SUV sales are off 28%. “It’s easily the most dramatic segment shift I have witnessed in the market in my 31 years here,” said George Pipas, Ford Motor’s chief sales analyst.

Meanwhile, Market Vane‘s Bullish Consensus is 86% on crude, showing extreme optimism. T. Boone Pickens was interviewed on CNBC this morning and expects $150/bbl oil. And now crude oil for 2016 delivery is higher than spot prices, a rare event and sure sign of speculation. This contango situation in the futures markets is all the more notable considering the onset of peak driving season is days away. The spot contract is saying there is plenty of oil available at these prices, perhaps a sign that demand destruction has, in fact, occurred.

Commodity bubble? Follow the hot money

The Investor’s Business Daily 100 Index has been a pretty good proxy for the momentum crowd and outstanding contrary indicator when it gets top-heavy. For example, last October, 14 component companies were based in China (not a bad time to be shorting the FXI, -27.0% since). Last December, tech momentum darlings were well represented: Priceline #5, Apple #7, Research in Motion #9, Synchronoss Technologies #15, VMWare #17, Google #32, Garmin #44. The seven are down on average 21.6% since vs. -8.6% for the S&P 500 and -11.5% for the Nasdaq 100.

Today the IBD 100 is chock full of commodities companies, especially those in agriculture and oil & gas:

Agriculture: 11 (up from 6 last Dec)
Energy: 32 (up from 10)
Total commodities: 52 (up from 28)
Brazil/Chile: 10 (up from 5)
Industrials + Commodities + Emerging Markets + Shipping: 72 (up from 61)

Companies from Texas, Louisiana and Oklahoma are well represented: 28, up from 11 in Dec. 16 are based in Houston.

Also, Intrepid Potash (IPI) went public today and popped 50%. Cramer (our favorite contrary indicator) has jumped on the commodity bandwagon. And Market Vane’s Bullish Consensus has corn at 81% and crude oil at 90%.

Our strategy: Avoid commodity-related stocks, short grains and crude oil.