Oct 10, 2015

How The Commodity Crash can Lead to Another Financial Crisis


The 3Q of 2015 has been one of the brutal quarter the world has ever seen since 2011. Global equity markets were down by more than 10% and the Singapore stock is down by 16% for 2015. Two major events occurred during the month of September that made an already depressed financial market even worse. The first event was the highly anticipated US Federal Reserve meeting in which the central banks opted to not to raise the interest rates out of concern of the slowing Chinese economy. The US stock market tumbled on the interpretation that the US Feds were fearful that the US economy is also slowing down.

The second major event is a rumoured potential collapse of one of the biggest commodity trading firm in the world: Glencore. The saga started when news of Glencore’s revenue has fallen so low that it can no longer able to service the interest payment of their $30 billion dollars. The share price of Glencore fell 80% within days and its bond was trading at a mere fraction of its face value. The fear of a commodity debt contagion sent the share price of major commodity companies around the world plummeting. 

How did Glencore accumulate so much debt? In 2007, Glencore bought a nickel mine in Australia for a whopping $2.4 billion, with most of it financed by debt and sold it during 2015 for only $19 million. Glencore has pledged to sell off its assets at a distress price, in an attempt to plug the huge financial hole which it has created buying over inflated commodity assets. Should the price of commodity maintain at the current level, Glencore's strategy of selling its assets to raise sufficient capital to prevent its collapse will fail and its collapse will lead to a reverberation on all commodity related countries and companies around the globe. 

The problem is that the price of commodity is tied to the health of the China economy and should there be slow or no recovery on the Chinese front, the problem will get worse.

Our Portfolio Strategy

The portfolio survived the September Glencore crash with only minor losses. The cash portfolio is down 0.95% while the CPF portfolio is down by 1.15%. The increased losses is due to the increase in equity allocation from 20% to 50% at the beginning of September. The portfolio lost 0.16% for the entire 3rd quarter of the year as compared to a 10% fall in global equities and 17% fall in the Singapore Stock Index. I am expecting that the intense sell-off in the last 3 months will abate in days to come and there will be a short window of opportunity to ride on the wave up for a year end rally before trouble starts knocking on the door again.

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