— Today we’re getting some respite from the heavy selling seen over the past few days. Commodities rallied in the US overnight and that helped drag the S&P500 up by 0.3 per cent. And just as well. The market was down earlier in the session after the drop in durable goods orders in April were a much larger than expected 3.6 per cent.
— But can commodities continue to rally when record amounts of excess liquidity are slowly draining out of global markets? Probably not.
— Is this why Glencore International, the commodities trading firm and mining company, chose to sell a chunk of itself to the investing public recently? Maybe. The motivations for listing are many and varied. For example, the private equity owners of Myer saw an opportunity to dump their stock on a gullible public in late 2009. They took the money and ran.
— In the case of Glencore, it might be a way to cash in (or cash out, if you’re an owner) on the boom, as well as lowering the cost of equity for the company to go on an acquisition spree.
— The beauty of the stock market is that it allows businesses to gain access to capital at a far lower cost than if it were just an ordinary, unlisted operation. Well, it’s beautiful for the business but often not so for the unsuspecting shareholder.
— When a business is not listed on the stock exchange, a potential investor doesn’t have an ever-present share price to tell them what the ‘value’ of the company is. So if they get an opportunity to buy into the enterprise, they only have the accounts to go on.
— Chances are the potential investor, not distracted by the noise and emotion of the stock market, will come up with a far more rational price for the business, after taking into account all the risks that running a company entail.
— But who wants to raise capital that way? You’re far better off timing your entry into a hot sector or a buoyant market in general and demanding a high ‘multiple’ for your business.
— The higher the multiple (of earnings) the lower the cost of capital. And this is what Glencore’s listing is all about. It probably hopes to use its share price as cheap currency to acquire more assets.
— It’s also why Nine Entertainment, currently owned by private equity group CVC, has decided to put off plans for a float this year. Because media companies are on the nose at the moment, CVC realises it has no chance of getting investors to pay a stupid (or even mildly stupid) price for its assets.
— In an unlisted business, generating a strong return on invested capital creates value. It’s the same in the stock market. But the owner has the added benefit (or sometimes detriment) of having the emotion of the market add to his or her paper wealth.
— Regardless of the underlying value of the business, the market places a price on it via a multiple on earnings. So when investors are not too excited and not too depressed, you might see a company trade at 12 times earnings. But if a central bank lowers interest rates and you get asset inflation, the multiple might grow to 16 times earnings. Even though there has been no change in the underlying business value, the market value has increased by 33 per cent. (16/12)
— This is why vendors love the stock market, either to sell out at a price they could not hope to get in a private transaction, or to lower their cost of capital for further acquisitions.
— It’s all in the name of creating wealth, but paper wealth is fleeting. The just-released BRW Rich 200 list shows four of the top five spots filled by those in the resources sector.
— And Ivan Glasenberg, head honcho of Glencore, is at number two with an estimated paper wealth of $8.8bn. This is his first time on the list. Did his wealth grow so profoundly in just the last year?
— Of course not. It’s just that the stock market listing of Glencore has helped quantify his wealth. According to the share price investors are willing to pay for his company’s stock (over the past few days, anyway) Glasenberg is a multi-billionaire.
— Good luck to him. But is the fact that the wealthiest in Australia are resource beneficiaries another sign that the boom is topping out? We could be wrong, but wasn’t James Packer numero uno at the height of the credit boom when just about every pie he had a finger in was inflated in price?
— What goes around comes around, as they say. And completely off topic, but the NSW Blues look like coming around again after a gallant defeat last night against the awesome Queenslanders. If the Maroons were a stock price, they might look to be topping out. And after a deep bear market, NSW look like very good value. Go the Blues.
— Where were we?
— Yes, commodities. The signs point to an interim peak. The global economy is slowing. Nothing too dramatic at the moment, but it is slowing. This raises the question of whether we’ll see QEIII soon.
— Dan argued yesterday that the Fed needs to see a sharp fall in ‘risk’ markets to justify revving up the printing presses again. That makes sense. But do you think it would occur to them that rounds one and two have done very little to improve the underlying economy, except to push stock and commodity prices higher? Would they be wary of doing it again, causing more hardship for the average household through higher prices?
— We doubt it. They’re more likely to argue that past efforts were clearly not enough. That they were not wrong, but merely didn’t go hard enough.
— When we get to that point, you’ll want to own gold.
Daily Reckoning Australia