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Glencore May Be Worse Off

|Includes: Glencore Plc ADR (GLNCY)

When I warned readers on 2 October 2015 the potential threat that commodities giant Glencore plc (GLEN.L) could be wiped out, my inbox was flooded with replies from concerned readers. One particular respondent felt the article was ignorant.

But since then there's been widespread market consensus. Bank of America (BAC) published a report on the true size of the potential fallout.

In the interim something outrageous happened. Against all expectations, the stock has gone up.

But for all the wrong reasons. A new research report uncovers the real reasons behind the Glencore stocks surge. According to the report, research has showed that the recent surge in the company's stock price was largely a matter of short covering, not investors suddenly believing that all is well in the Glencore dynasty. On the contrary, it is clearly not the case.

It's a sure indicator of what's wrong with these markets. Individual investors will get caught in the crossfire and wiped out on a stock like this and others around it. For this reason, the research report call out the misapprehensions and fallacies that are causing this recovery - and show what to expect next.

Let's not have any illusions, the situation at Glencore may even be much worse than we realise.

Doing Everything Possible to Calm Markets

Since hitting a low of 68.62 pence per share on September 28, Glencore stock has doubled to 129 pence per share. Even its credit default swap spreads have recovered to 650 basis points from a panic peak of 900 basis points.

The company is doing everything possible to calm markets.

Glencore is also going to great lengths retain its credit rating, from selling assets to ditching the dividend, but the company can't control commodity prices.

Maintaining its credit ratings, the second-lowest investment grade at S&P and Moody's, is mission critical to Glencore's business model because it borrows heavily to sustain trading operations that account for a third of company earnings. Markets are pricing the company like a weak single B credit instead of a CCC credit. So while the major credit rating agencies still consider Glencore an investment-grade company, the markets have a much dimmer view of its prospects.

On Tuesday, 6 October Glencore published an unprecedented six-page "funding factsheet" to allay market concerns about its liquidity and solvency. The factsheet, however, shed very little light on what is really going on at the company, however. It glossed over Glencore's derivatives contracts, stating only that these derivatives contracts were in accordance with "industry standard frameworks." But the company's statement was vain assurance for anyone since "industry standard frameworks" usually require companies to post additional cash collateral upon downgrading of an investment-grade rating.

Second, Glencore bosses are pointing fingers at short sellers and rivals for its problems. Non-executive director John Mack, who led Morgan Stanley to the brink of insolvency during the financial crisis in 2009, told Bloomberg that speculators in Glencore's credit default swaps were to blame for creating a false impression that the company is in trouble. This blame-shifting demonstrates why Morgan Stanley nearly collapsed under Mack's watch in 2009. There are more legitimate lenders looking to protect themselves against losses on their Glencore exposures than speculators wanting to make a fast buck on the company's collapse.

Last, CEO Ivan Glasenberg, cried wolf by blaming mining rivals for oversupplying commodity markets. What hypocrisy. It's like the Devil preaching repentance. Glencore bosses would do better to pause, look within and man up for building a company whose fate now rests with rating agencies, capital markets and banks.

They have been borrowing too much money, ignoring all indications that the global economy was swaying on an unsustainable debt bubble that had inflated the prices of all commodities to hyper levels that were inevitably going to burst.

Shadow Debt

But the bigger elephant in the room that is being completely disregarded and which company bosses have kept under wraps as well is Glencore's shadow debt: the enormous amount of undrawn bank lines and letters of credit that banks have made available to the company over the last few years. Over and above the company's $30 billion of net debt and $19 trillion of derivatives, Bank of America estimated that the exposure could run Glencore's total indebtedness to the global financial system to $100 billion. Most of this debt is unsecured.

The so-called recovery in Glencore's stock is not nearly enough to change anybody's view that the company is still probably a house of cards. When credit rating agencies eventually catch up to the markets, all hell could break lose.

So, what's in still store and where to from here? The new research report discusses the situation and most likely scenario for Glencore.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.