Predicting the downfall of Glencore

As the year draws to a close, we like to use this natural timeframe as an opportunity to reflect on the winners and losers over the past 12 months. And, after another awful year, mining is easily the worst-performing sector in 2015 as excess supply continues to push down commodity prices.

Despite cutting production, selling assets and axing dividends, heavyweight miners continue to struggle, none more so than Glencore. The miner and commodities trader is having some success tackling its gigantic debt pile, but the share price is still down 70% this year, from 300p to just 92p currently.

That's devastating, but shareholders who got in when Glencore floated at 530p in May 2011 have lost even more.

While sorting out the paperwork at Interactive Investor HQ, I came across this incredibly prescient piece on Glencore by former ii writer and equity analyst of 18 years, Peter Temple.

His piece on Glencore, written just hours after the company began trading on the London Stock Exchange, is so good, it's worth republishing here:

Why all the fuss about Glencore?

By Peter Temple | Fri, 20th May 2011 - 16:03

As Glencore begins trading on the FTSE 100, Peter Temple questions whether all the fuss surrounding the commodity trading giant is worth it.

Am I alone in viewing the recent flotation of Glencore with some trepidation? Not, I should of course add, because of any particular doubts about the quality of its management, or the indicated offer price of the shares.

My concern is more over what it betrays about the appetite of the market for shares linked directly to the seemingly booming market for commodities, and what happens when the boom turns to bust, as it inevitably will.

Glencore's announcement took place against the background of some extreme volatility in the price of silver. It seems to underscore, if any were needed, that there is a lot of speculative money involved in commodity markets at present. There is a hint of this in the Glencore prospectus, with the presence of a couple of hedge funds in the list of so-called "cornerstone" investors. In fairness to Glencore, sovereign wealth investors and big fund groups like BlackRock and Fidelity are also present. And "cornerstone" investors are locked in for at least six months.

There is also a certain circularity in the fact that several of the banks advising Glencore are among the largest traders of commodities in the financial sector, which proves if nothing else that they should have a good insight into its business. It also perhaps suggests a certain element of self-reinforcing "groupthink", that the commodity supercycle upswing is here to stay.

What I guess no-one really wants to talk about is what happens when the commodity supercycle turns down. The boom in commodities prices has lasted 12 years already, if you quietly forget about the sharp setback seen in 2008. When Jim Rogers floated the concept back in 1999, the theory was the boom would last around 17 years. If you believe this suspiciously precise number, that means the bandwagon has another five years left to roll. Rogers is still bullish on hard assets.

But the nature of commodities is that higher prices encourage higher supply, after a lengthy time-lag. Usually too much supply is the result, after which prices collapse. That's why to describe something as a commodity business at one time used to be almost a term of abuse.

The next problem I have with all this is the degree to which the Glencore IPO will skew the FTSE 100 to an even great extent towards the mining and oil sectors. On its indicated IPO valuation, Glencore will rank around thirteenth in the FTSE 100 by capitalisation. This will force tracker funds to buy the shares.

Finally, Glencore is an unusual beast to value, with commodity trading and logistics, mining operations and minority stakes in a number of sizeable mining businesses, notably mining finance house Xstrata, all under the same roof. One could perhaps be forgiven for thinking that all this complexity, and the colossal leverage the group employs in its commodity trading business, might eventually give some investors pause for thought.

Finally and most importantly perhaps, it is worth remembering that the last significant time businesses were floated and instantly entered the FTSE 100, and that a single sector came to dominate the movement of the index, was in the late stages of the internet boom.

Marconi, ARM Holdings, Kingston Communications, Cable & Wireless, Freeserve, Thus, Baltimore Technologies and Psion all entered the FTSE 100 between November 1999 and March 2000.

And we all know what happened after that...

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.