Digging a deeper money hole.

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Glencore Gets Clobbered. Who’s Next?

A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” Some portfolios he manages invest in currencies and commodities.
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As commodity prices continue to fall, bankruptcies among producers and industry consolidation will no doubt accelerate.  Suppliers of farm, mining and construction equipment are already troubled. With this onslaught, it's no surprise that Glencore, the huge Swiss company that dominates global commodities markets, lost a third of its value in a single day last week.   

Glencore was founded in 1974 by Marc Rich, the commodity trader and U.S. tax fugitive who died in 2013. Initially the firm, called Marc Rich & Co., didn’t own mining assets because Rich believed they were too volatile. He focused instead on commodity trading and eventually turned the company into the world’s largest trading house. Rich tried and failed to corner the zinc market in 1993-94 and was forced to sell 51 percent of the company in a management buyout to a team that included Glencore's current chief executive officer, Ivan Glasenberg.  

The new company became directly involved in mining operations, yet continued to stress the stability of its trading profits. Glencore's 2011 initial public offering prospectus stated that its trading business is “less correlated to commodity prices than its industrial operations, making Glencore’s earnings generally less volatile than those of pure producers of metals, mining and energy products.” 

It hasn't turned out that way. The nosedive in commodity prices and $30 billion in debt have put Glencore on the ropes, at least in the eyes of investors and possibly credit-rating companies. Despite measures announced in early September to reduce debt by $10 billion through stock sales, dividend cuts, asset sales and cost reductions, the yield on its U.S. dollar-denominated bond maturing in 2022 leaped from 4.6 percent at the end of July to 11 percent recently. Glencore's stock plummeted 29 percent on Sept. 28 and is down 90 percent since its 2011 public offering, done at the peak in commodity prices. 

If Glencore’s huge trading operation can’t protect its mining business, what’s in store for giant, concentrated mining companies like BHP Billiton, Vale, Rio Tinto and Anglo American? Or mining-equipment companies like Caterpillar? And how about smaller, less financially secure firms? Alcoa just threw in the towel on basic aluminum production and split those operations from its downstream, higher-value-added aluminum businesses. 

Investors who are much less knowledgeable about commodities than Glencore will probably continue to be forced into agonizing reappraisals. This includes pension funds that got swept up in the commodity craze a decade ago and hoped further rapid price rises would help them achieve their investment goals in an era of low interest rates. Many elevated commodities into an investment class alongside stocks and bonds. 

I’ve always insisted, however, that commodities aren’t an investment class, but a speculation. Sure, I use such commodities as crude oil, copper and sugar in the aggressive portfolios I manage, but on the short side. Since the mid-1800s, commodity prices, adjusted for inflation, have been in a steady downward trend. The price spikes due to demand surges in the Civil War and both world wars were soon retraced, as were the effects of the oil-supply curtailments in the 1970s. 

Sure, there’s only so much oil in the ground. Devotees of the Hubbert peak theory -- geophysicist M. King Hubbert's idea that world oil production had peaked in the 1970s -- thought that crude oil supplies would have been fully exploited by now, with surging prices as the result. Then came fracking technology and huge new supplies of relatively cheap shale oil. 

I can recall when serious economists predicted that the telecommunications expansion would come to a grinding halt because there wasn’t enough copper in the earth’s crust to make the needed wires. Fiber optics obviously eliminated that problem. 

Human ingenuity and free-market prices have always eliminated commodity shortages, and probably always will. Commodity investments may continue to be rewarding -- as long as they’re based on further price declines.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
A Gary Shilling at insight@agaryshilling.com

To contact the editor responsible for this story:
Paula Dwyer at pdwyer11@bloomberg.net