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Who would bet against commodities now that the rebound in raw material prices has restored the industry to rude health and profitability? Well, the answer is some Mayfair hedge fund managers who trade corporate credit for a living. They advocate a particular form of negative bet, selling short the debt of commodity trading companies, such as Glencore or Trafigura.
The reason isn't a view about prices for copper, oil, and coal, or insight into the direction of the Chinese economy, at least in the short term. Instead the trade is more like a form of insurance, designed to pay out if there is a repeat of last year's market turmoil, which temporarily closed access to the debt markets for many companies. The payoff would come from faltering confidence among banks and investors in the ability of these commodity trading companies to refinance their debts.
Trading businesses, they operate much like the banks, financing the activity of mines but without the cost and capital ratios of regulated lenders. In the market turmoil of a year ago, many bonds traded well below $0.80 on the dollar. For Glencore, which has around $9 billion worth of debt coming due in the next three years, some investors debate the worth of inventories on the asset side of the balance sheet. Were they to be liquidated in a hurry, what price would they get for them? Private Trafigura, meanwhile, well, it has no public shareholders to turn to for support if it needs it.
But both companies can argue credit market fears have been put to rest, with prices for the bonds having rebounded to trade above par values. Well, for the shorters, the rebound, that limits losses from here and also makes the cost of the trade cheap, around 3 and 1/2% for Trafigura debt maturing in 2020 and below 3% for Glencore, plus around another 1% to finance the position. After all, they might conclude, the time to buy flood insurance is when the mud is cracked, the skies are clear, and the river is reduced to a trickle.
