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Sunday, 22 October 2017

The commodity collapse and the banking industry

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  • Peters 475px June 2014

Are banks really prepared for further price drops?

That commodities are not the flavour of the month or even flavour of the year can surely only come as news to those recently returned from a trip to Mars. But there are days when the subject breaks surface again like a breaching whale. Yesterday, Tuesday, was one of those days. This time the big headline maker was Anglo American which announced the suspension of its dividend for this year and for next year and, just to underline how little its management expect any immediate return to happy times, it also announced 85,000 job cuts.

We’re not talking of a bit of marginal trimming but of a root and branch restructuring of the business which takes Anglo American into snooze-mode pending better times. The company has had some of its coal assets in Australia on the market for a while and so they remain. If, however, they have not been sold yet, what chance of this happening in the near future at anything other than a clearance price? I can’t see shareholders, already long of a stock which has declined 74% year-to-date – and 12% intra-day in yesterday’s session alone (and more this morning) – being enthusiastic about locking in another bunch of hits on rock-bottom asset disposals but they might find themselves forced to follow CEO Mark Cutifani’s radical plans.

I noted in yesterday’s piece that the implosion in prices (Brent crashed through US$40 per barrel but has bounced back in overnight trading) probably tells us more about the lack of discipline on the supply side than a collapse of demand and I tend to believe that the same applies to metals and minerals.

Excessive growth expectations attached to China led to hubris and hence to over-investment and there now seems to be a race amongst the miners to be the first to complete the “right-sizing” process.

In Economics 101 we learn about the legendary pig cycle and what goes for pigs obviously also goes for iron ore, copper and coal – except that it happens in a notoriously capital intensive, long-cycle business where the penalties for getting it wrong can quickly swamp the benefits of having previously got it right.

Much of this was brought sharply into contrast by the publication of Citigroup’s rather weighty Global Asset Allocation preview for 2016. I know most of us think of Citi as another huge and boring money-centre bank but under the austere surface still beats the heart of Salomon Brothers, one of the greatest and most innovative firms ever to grace Wall Street.

Its forward-looking overview begins: “Subdued global growth with downside risks from EM, low-flation and policy divergence are the key themes for 2016. We are thus inclined to be more cautious and continue to de-risk our recommendations as well as run a DM equity/bond & cash barbell approach. Now is the time to be selective about portfolio risk, not bullish across the board” followed by “we downgrade equities overall and the US specifically (especially as the outlook for margins doesn’t inspire). But QE and likely FX weakness keep us overweight EA and JP equities. We stay underweight EM equities and downgrade EM credit. We upgrade US credit after seeing it underperform, but still expect European equities to outperform their credit counterparts. UST’s still look attractive to us so remain max overweight.”

Spot the last sentence! The erstwhile most powerful bond house the world has ever seen says “load the boat!” and that a week ahead of the putative first step in the US tightening cycle. The call is for a slow, very slow, lift-off and one which will neither drive inflation higher nor bail out the emerging markets which have all but pissed away the proceeds of the hot half decade on German cars and Korean TVs. Not to make too fine a point of this but aren’t next year’s Rio Olympics the vanity trade to beat all vanity trades?

Things don’t look pretty. The banking sector cannot do and has not done what Anglo American has announced and so the time has come to look at some of the stress testing.

Does it really cover an oil price of less than US$40? We’ve watched some of the shale gas guys get into trouble – talk is of the best part of US$700bn of lending at risk – but minerals and mining are teetering along with a string of sovereign credits which depend on them.

The ridiculous Angola 10-year bond which came to market four weeks ago with much pomp at 9.5% is already trading at 10.20% on the bid or a four-and-a-bit point discount to its 100 offering price.

Heavy mark-to-market write-downs, not necessarily defaults, on loan books – forget NPLs for a moment – will rapidly chew up even the enhanced capital and reserves and with the seriously reduced market liquidity, banks will find their hands tied. This need to preserve capital could well push them to pull the plug much earlier than in the past on SME borrowers who look stressed.

If I were asked which sectors to skirt around, going forward, I would go against what I think is general consensus and banks and finance would be close to the top of my list.

Being as fed up as I am of reporting on undershot targets, there is one number which comfortably beats forecasts: Germany yesterday booked its 1,000,000th registered refugee for 2015, a 25% overshoot on the 800,000 which had been predicted by Berlin.

Mutti Merkel looks to have sown a bit of a whirlwind. In the aftermath of the Front National’s barnstorming performance in the first round of the French regional elections, that number looks scary. My peregrinations of last week took me through the north of France where Marine Le Pen found sterling support. The one comment by a local which will stick with me for a very long time was, “They all talk of majority black rule in Africa. Now is the time for majority white rule in Europe”.

I don’t think the Frenchman in question has got it right but if that is how the people on the street in Nord/Pas de Calais think, it is something the mainstream parties need to tackle. Perception, we keep on being told, is reality.

Oh, and as far as that idiot and bigot Donald Trump is concerned, free speech or not free speech, I’d be happy to join any movement which might pursue a ban of his entering this United Kingdom. I often rail against the so called “liberals” who are supposed to defend the rights of the individual and the freedom of expression – remember the quote often but incorrectly ascribed to Voltaire “I disapprove of what you say, but I will defend to the death your right to say it” – but who have taken to vilifying and hounding those who hold any view which does not suit them or their opinion on what opinion others might have the right to hold. My thoughts on Trump are, “Think and say whatever you like, mate, but please not in my country”.

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