Is This The Cheapest (And Most Levered) Way To Play The Chinese Credit-Commodity Crunch?

Tyler Durden's picture

"The best way to define the mood in the market right now is panic," warns one commodity broker, adding that "everyone understands why we are going down, but nobody can tell where the bottom is." As the WSJ notes, the economic slowdown in China is hammering prices of some raw materials, driving down industrial commodities from copper to iron ore and coal - exacerbated by the vicious cycle of credit-collateral-contraction. So what is the cheapest way to play continued stress (with potentially limited downside)? The diversified natural resources company Glencore has a huge $55 billion of debt, is drastically sensitive to copper (and other commodity) prices, and its CDS remains just off record tights...

Is Glencore the most exposed to a decline in commodities prices? – A trading giant rated BBB with over $55bn of debt and heavy exposure to commodities. 

A downgrade to below investment grade would be catastrophic to Glencore’s trading business. 

Company’s 12/31/2013 presentation says a 10% decline in Copper Prices would reduce EBIT By $1.2bn...


As of 12/31/13, Glencore had $55.185 billion in Gross Debt

By 3/12/2014, Copper has declined to a 44 month low, 12% decline in YTD 2014

Glencore reports Net Debt of $35.882bn, which is $55.2bn of gross debt minus $2bn of cash minus $16.4bn of "Readily Marketable Inventories." Nowhere do they define what’s included in the Readily Marketable Inventories and whether or not the RMIs are hedged.  The firm is still highly levered for investment grade even if RMIs can be converted into cash at stated value.

As if that was not enough, the CFTC and DOJ are currently investigating commodities price manipulation and Glencore has been named in several aluminum antitrust suits; leaving the question of liability hanging over their head.

Via WSJ,

“The economic slowdown in China is hammering prices of some raw materials, driving down industrial commodities from copper to iron ore and coal

 

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copper prices skidded to their lowest level since June 2010, bringing the metal's year-to-date losses to 12%. Iron-ore prices are down 8.1% this week, after falling to their lowest level since October 2012 on Monday. Aluminum, lead and zinc prices also have declined in recent days

 

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"The best way to define the mood in the market right now is panic,"

 

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Now that growth in the world's second-largest economy is downshifting from double digits to an estimated 7.5% this year, many investors and analysts predict global demand growth for industrial commodities will slacken...Iron ore is the main component of steel. China's steel consumption has surged in the past decade as the property and manufacturing sectors boomed. Now that China's leadership has pledged for a more consumer-focused economy, the demand trajectory for steel is in doubt, analysts said…Coking coal, used to fuel the blast furnaces that forge steel, has also been under pressure, with prices down 7.1% this year…

 

Last week's first-ever corporate-bond default on the mainland showed that the Chinese government isn't guaranteeing this corner of the country's credit market, as was widely believed. The yuan's weakening has made it more expensive for companies to import dollar-denominated commodities to be used as collateral for loans created outside formal channels for bank lending

 

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"If there's a string of defaults in China, there's no question that demand for copper and iron ore and other commodities where China's been a major driver would be threatened in a material way,"

 

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And some analysts and investors say the magnitude of the recent price declines in copper and iron ore aren't justified because Chinese authorities are unlikely to allow the country's credit markets to completely unravel…"You've got the credit issue in China...and you've got also reasonably high iron-ore [stockpiles]," said Jimmy Wilson, for iron ore at BHP Billiton, on the sidelines of a conference in Perth, Australia. "Traders have a view that the price is going to go down so they do everything they can to hold back" on buying.”

At 170bps and with 155bps as a floor for the last 6 months, it seems like a cheap protection play on further Chinese/Commodity contraction

 

h/t Manal