Nagging doubt behind the excitement of Glencore IPO
If some of the smartest guys in the market are selling, investors should ask themselves whether this is really the best time to buy.
After 36 years as a private company, commodity trading giant Glencore is going public with listings in London and Hong Kong. In what is set to become the biggest initial public offering of the year, the company is expected to raise as much as US$11 billion in a deal that will net its senior executives billions of US dollars each.
With trading operations in commodities as diverse as aluminium and barley, and mining interests from the Congo to Kazakhstan, Glencore shares have been touted as the ideal way for investors to play the structural bull market in commodities driven by surging demand from developing Asia and China in particular.
Yet beneath the excitement there lurks a nagging doubt. Some investors are wondering why, if commodities are such a compelling story, Glencore's current owners are so keen to cut their exposure to the business by going public.
Perhaps, reason the more sceptical, Glencore's bosses know something we don't. Perhaps they don't share the widely held belief in the sustainability of the commodity bull market and are selling while they still can.
If so, this would not be the first time that the flotation of a successful privately-held company has signalled a market top in its sector.
In June 2007, for example, US private equity behemoth Blackstone went public in a US$4 billion flotation complete with a hefty investment from Beijing's brand new sovereign wealth fund, the China Investment Corporation.
As this column explained at the time: 'The explosion of private equity business has pushed asset prices up to the point where the attractiveness of targets is diminishing ... Deals are becoming more risky and the chance of sustaining losses is rising. China has arrived at the party just as the booze is about to run out.'
Sure enough, within a couple of months of Blackstone's IPO, the private equity bubble burst. Today, Blackstone's shares languish at just US$18, down 40 per cent from their US$30 issue price.
Now some investors fear that the Glencore IPO may herald a similar setback for commodity markets.
That doesn't mean they think the structural bull market in the sector is at an end. Most still believe that rising demand from Asia will continue to support prices in the long term.
But they do worry that a flood of investment money into commodity markets over the last year or so has pushed prices way out of line with their underlying fundamentals.
Now they fear the markets may be primed for a nasty cyclical correction, and that knowing this, Glencore's bosses may be cashing out before their window of opportunity slams shut. There are some signs theses fears may be justified. Although the common perception is that commodity prices are booming across the board, in reality the rise in commodity indices this year has been propelled almost entirely by oil, which is carrying a handsome risk premium thanks to the political turbulence in the Middle East, and precious metals, which have seen a powerful momentum-driven rally.
In the last week, however, these markets have stumbled as investors have pared back their appetite for risk. Both oil and gold have fallen from their recent highs, while silver has nosedived by 23 per cent as speculators have fled the market following a margin increase (see chart below).
Meanwhile, away from energy and precious metals, other commodity prices have struggled to make headway. The US dollar prices of industrial metals including copper, zinc and lead are all down over the year to date, despite the US dollar's own weakness. At the same time, soft commodities including sugar, wheat and cotton have slumped by between 20 and 30 per cent from their highs of a couple of months ago (see charts below).
And there may be more falls to come. With central banks in Asia behind the curve on tackling inflation pressures, many economists believe the region is heading towards a severe round of monetary tightening which will inevitably slow economic activity and reduce demand for many commodities. For example, mainland construction activity has slowed markedly over recent months, eroding end-user demand for metals like copper.
On top of that, there is a growing sense in the markets that with the US policy of quantitative easing coming to a close, liquidity is only going to get scarcer, potentially squeezing speculative investors in commodity markets. What's more, any tightening of liquidity conditions will tend to support the US dollar, weighing on the US dollar prices of key commodities.
As a result, the short- to medium-term risks for commodities have swung to the downside just as Glencore is coming to the market. That doesn't mean the company is a bad long-term investment. But it does mean that potential investors may be able to do better by hanging back from the IPO and picking up the stock more cheaply in the secondary market in a few months time.