From John Ficenec at telegraph.co.uk:
The collapse in commodity prices has sparked a second credit crisis as investors dump high-yield bonds, shattering the fragile confidence necessary to support global markets. Those calling it a Lehman moment forget their history. Current events have chilling similarities to the Bear Stearns collapse and mark the start of a new crisis, not the end.
Canary in the mine
The world of commodity trading has been thrown into chaos as the cost of borrowing to fund operations soars. Glencore has become the poster child for the sector’s woes as its shares have more than halved in value during the past six months. More worrying has been the impact on the group’s credit profile.
Glencore’s US bonds due for repayment in 2022 have collapsed to around 82 cents in the dollar. Only four months earlier, they had been stable at around 100 cents, implying that those who lent money would get it back plus interest. Now for every dollar lent to Glencore, banks face losses, and as the price of bonds falls the yield has risen to 7.4pc.
Without the oxygen of cheap debt, commodity trading houses are finished. Each trade in oil or iron ore might generate only 1pc to 2pc in margin – but this greatly increases when magnified by debt. The only limit on profits is then how much you can borrow. Greed drives returns.
Glencore is a profitable business when it can borrow at around 4pc, but if it has to refinance at 7pc to 10pc those slim profit margins evaporate.
The fear of those holding Glencore debt can be seen in the soaring price for the insurance against a default, or credit default swaps (CDS). Glencore five-year CDS has soared to 625, from about 280 just a month ago.
A rule of thumb is that a CDS above 400 means a serious risk of a default, or about a 25pc chance in the next five years.
To continue reading: Commodity contagion sparks second credit crisis
