When Investec analysts published a report on Monday questioning whether commodities trading giant Glencore could service its huge debt load if commodity prices stay low, investors immediately chopped 30% off its share price.
Glencore has had its share of troubles. The company’s stock has been on a steady downward trajectory for quite a while. In May, the stock was being traded around £3.10 — before Monday’s selloff it was around £0.97. Before the oil rout, general commodities turmoil and Chinese economic slowdown began, Glencore’s stock had hit its highest point in more than a year, valued at nearly £3.78 in July 2014.
The company has tried to respond to the confluence of events weighing it down. In the last year, Glencore has raised $2.5bn of capital, shed assets and suspended dividends in an effort to reduce its net debt by $10bn by the end of 2016.
But after Investec’s report on Monday, Glencore’s shares closed at $68.62. The company’s five year CDS spreads jumped from 542bp last Friday to 876bp on Monday, according to Markit. 10 days before that, the figure was 345bp.
Investec unearthed no scandal. There was no drastic mark-to-market revaluations of the kind that brought low Lehman Brothers during the crisis. Glencore had no major disasters at any of the mines or commodity infrastructure the firm owns.
What the report said was only that Glencore would struggle to service its debts if commodity prices don’t recover — Investec analysts see commodity prices “gently recovering” and forecast “shareholder value in all [the major diversified natural resource companies] appreciating steadily from 2017 onwards.”
It also said that "Glencore offers the potential to deliver meaningful equity appreciation from anticipated [fiscal year 2015 estimate] lows."
So anyone who read the report and sold it off should really be hitting themselves, for two reasons.
One: Investec expected Glencore's share price on the Monday open to be around the low for the year. That sounds like a recommendation to 'hold' (which it indeed was), if not an outright 'buy'.
Two: Investec's prediction that Monday morning's prices were the year's lows turned out to be immediately inaccurate upon, and due to, the publication of its recommendation.
And yet you, Glencore investor, were willing to sell the stock based on what you mistakenly thought was the recommendation of that same analyst?
Hunter Hillcoat, one of the Investec analysts who authored the note, was taken aback by Monday’s market reaction to his work. He told GlobalCapital the next day: “There’s nothing in the note that suggests it should have fallen to those levels.” He added, somewhat bemused: “It was just a scenario.”
So, if there wasn't any actual event that drove the selloff, then what just happened?
To begin with, it seems there is a widespread misunderstanding within the investment community of the difference between statements of fact and conditional hypotheses.
Let's take the following two sentences:
1) Andy has fallen asleep at the wheel, and his car is going right off that cliff up ahead.
2) If Andy were to fall asleep at the wheel, his car would go right off that cliff up ahead. It's a good thing Andy just got a call from his asset manager, so he's way too pissed off to fall asleep.
Spot the difference? Glencore investors didn't.
Perhaps it also has something to do with the fact that many investors don't actually know anything about what commodities mining and trading companies do.
Glencore, with a market cap of $10.25bn, is one of the most traded companies on the London Stock Exchange and the FTSE 100. As a commodities trading firm, it is also probably one of the most complex and difficult to value. Commodities firms, after all, operate in multiple unstable jurisdictions, both own and trade commodity assets, and place leveraged directional bets on highly unstable price moves.
It’s one thing to look at an annual report or a business presentation and come to the conclusion that a company may be worth investing in, despite the risks. It’s another to analyse the future supply and demand dynamics of something like oil, whose value depends on things as difficult to predict as international relations.
Glencore recovered some value back before the close on Monday, and on Tuesday continued to climb.
Citi analysts have been credited with aiding the modest bounce-back by recommending a “buy” at prices it saw as oversold and suggesting the company go private. Again, no news.
Cynics have noted Citi's global coordinator role on Glencore's IPO (at a price of £5.30 per share) and its role underwriting Glencore's $2.5bn capital raising at £1.25 earlier this month.
But something beyond the global economic recovery is broken when a company as large as Glencore can lose more than a quarter of its market cap on a hypothetical premise that doesn’t even represent the theorist’s baseline scenario.
Of course, this isn’t Investec’s fault. Analysts are paid to, and should, think through the consequences of various scenarios.
This one is on the investors, who a) should have finished reading the report, and b) should think about doing some of their own analysis on their investments.
If you think, today, that Glencore is worth 17% less than on Monday morning, then you probably haven’t been thinking about it much at all.