Commodities: can’t live with them; can’t live without them…

While money may make the world go round, and our lives seem to be becoming increasingly de-materialized in a number of ways, there is no escaping the fact that we are all still dependent upon the availability of many commodities.

As we mentioned in a previous post, the price of many commodities has declined significantly over the past few years, with that trend accelerating over the past year, causing increasing pain across, inter alios, the global mining industry, in the same way as that suffered by the O&G industry; because costs (having risen significantly) are not as flexible as prices, and hedging is a very difficult art that many have avoided or deliberately eschewed. Knock-on effects then extend into support and service industries, as well as shipping.

When companies of the size of Glencore have to scramble to reassure shareholders and debt investors that they are not facing insolvency, with extreme volatility in its equity and bond prices, one knows that something has changed in terms of risk perceptions.

Even though it is a truism that commodity-based businesses are inherently cyclical, nevertheless a view had developed that demand would continue to rise, primarily because of Asian (read, Chinese) demand continuing for any foreseeable future (7% forever…); and, in a number of sectors, even in the face of declining demand and prices, the development of new capacity continued (vide iron ore.) Major mining houses believed that they could bring on-stream massive low-cost operations and force out higher cost capacity. This approach has been mirrored in the O&G business, with an existential battle now under way between the “traditional” swing producers such as Saudi Arabia and the “upstart” ones of the US shale-based fields.

In one sense, those who consume commodities, or are large net importers, clearly benefit from lower prices; but there is, of course, a destabilizing “mirror” effect for those who produce, or who depend upon commodity exports for revenues and foreign exchange.

All of these factors lead to heightened uncertainty; lower levels of international trade; and an increase in geo-political risks as commodity-dependent sovereigns react to yawning current account deficits; reduced levels of import cover; and restive populations that have come to expect a certain level of income and job security.

And, as always, debt, deflation, leverage, liquidity and the availability of cash assume increased importance- just ask Glencore’s management! However, as long-term observers and analysts of risk “in the real world”, Awbury remains comfortable that managing the contingent risks related to commodities is a solid business opportunity, in spite of the volatility and “fear and loathing” being exhibited in the markets. Commodity-based businesses are not going to disappear; nor will the need for them and their banks and finance houses to manage and hedge risk.

We are never complacent; we are simply pragmatists, who focus on the real, not the (mis-)perceived.

So, give us a call.

The Awbury Team


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